Notes From Underground: What Caused the Panic In Central Bank Park?

The pivot by the FED in recent months is still causing analysts to do some serious soul-searching as to what could’ve caused such a quick reversal. Remember, in the span of about three months the Fed shifted from a hawkish tone — and a balance sheet unwind on “auto pilot” — to on hold and an end to the portfolio runoff later this year. So, it’s dramatic, to say the least.

And so investors are still wondering WHY. My KEY SUPPOSITION is that the FED became extremely concerned about the risks piling up in the global financial markets as investors opted to use a SHORT VOLATILITY strategy that APED the risk parity and other short vol efforts to enhance returns.

The rise in VOLATILITY at the end of 2018 seemed to cause concerns about below surface systemic risks. This rationale supports the answer to the question as to why Secretary Mnuchin spent the weekend of December 23 calling the big bank CEOs asking about any potential problems. Ironically, that actually SPOOKED the markets, which pushed markets to their lowest levels for the fourth quarter.

So are enormous short vol positions trapping the FED in its own policy? As more investors pile into short vol positions the FED is frozen  and its DATA DEPENDENCY is a charade. This week stories are cropping up about concerns about a DOLLAR FUNDING SHORTAGE causing a run-up in the greenback, which is in turn causing severe problems for myriad foreign banks. Rumors are rife that Chinese banks are in need of DOLLAR assets to meet financing obligations. I can’t verify the rumors but the action in the eurodollar futures is suggesting that the next move by the FED will be an EASING, maybe sooner than previously expected. The data releases this week have not be weak enough to suggest such a move yet the 2020 December eurodollar contract is 14 BASIS POINTS off the lows made on April 18.

There is definitely something percolating and if it is a dollar funding crisis it would explain the strong move in the DOLLAR this week, especially today. Stanley Druckenmiller had warned five months ago that the FED‘s double-barrel approach — QT WHILE SIMULTANEOUSLY RAISING THE FUNDS RATE — was going to cause problems for the global financial system. Add that with the gargantuan amount of short VOLATILITY positions and the financial system portends far greater RISK than current complacency holds. IN MY OPINION the current environment reminds me more of the Long Term Capital Management crisis of 1998 than any other event. If my opinion has merit, it is our job to search for the market’s greatest vulnerability.

In a conversation today with Kevin McCarthy, we reflected on the markets’ complacency regarding the news about the Iranian Revolutionary Guard threatening to shut the Straits of Hormuz. The markets yawned and remained worry-free. It’s proof of nothing to be fearful of and any hike in VOLS is just an opportunity to garner larger premiums. It is not only the VIX and equities that are short vol-oriented, but ALL ASSET CLASSES as historic LOW VOLATILITY is established in currencies, gold, bonds and various other commodities.

Again, the KEY is to discover the market’s greatest vulnerability, similar to the demise of LTCM. Kevin reminded me about a BLOOMBERG interview I did in 2007 when I warned of the coming storms: The LTCM crisis was easy to contain as Chairman Greenspan could get all the participants in one room and explain how the crisis was to be resolved. In 2007, I suggested the number of interested parties would fill the Rose Bowl.

Today the involved participants would have to be cornered in central park or the largest public gathering space in China. The numbers involved in the global risk have grown exponentially. But where is the PANIC point?

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15 Responses to “Notes From Underground: What Caused the Panic In Central Bank Park?”

  1. Nathanel Serebrenik Says:

    Are all fed bankers thinking “apres moi, le diluge”, avoiding the necesary decision to spare themselves of societies rath by their decisions?

    • yraharris Says:

      Nathanel—-a tough question and they would argue it with a counterfactual—we had to do this or this would have occurred.Jerome Powell I believe was trying to breakout from the trap but succumbed as he realized the price was too high and the other central banks were conspiring against in talking dovish to keep their currencies soft against the dollar,which raised the ire of Trump and Lighthizer.Remember that Robert Lighthizer was mentored by James Baker and understands the power of threatening to depreciate your currency in response to global headwinds

    • Chicken Says:

      I’m enjoying watching the circus.

  2. Srj Says:


    What would you do if you were in Powell’s position right now?

    • yraharris Says:

      Srj—this is a silly question but let me say that I would never have proceeded with a double barrel approach and I have stated that for three years—-First I would have raised interest rates to 2% so the real yield on overnight money would be ZERO—then I would have stopped raising rates and begun reducing the balance sheet and propbably have begun to roll back the IOER—I said this for quite a lont time in this blog so it can be verified if you archive back—the FED under Powell is not the progenitor of this current policy but inherited the situation from Bernanke/Yellen—-but this is the business we have chosen said Hyman Roth to Michael Corrleone.Powell is in an untenable situation but I would right now cut rates 50 basis points and continue the 50 billion a month shrinkage but unfortunately the use of forward guidance has trapped the FED—also he has to contend with the other central banks who are working to keep downward pressure on their currencies–haven’t even discussed the White House yet

      • Srj Says:

        Thanks, Yra. Yes, it is a silly question, but I like the way your brain works. You always seem to see things that I miss. Thanks for taking the time to answer. I do see the Fed as being in a pickle, I feel a bit like all the Central banks are perched on a hill, waiting for the avalanche to start. Just not sure how to take advantage of this yet. I keep being net long volatility and my investors the past year are not too happy about it.



      • yraharris Says:

        Srj–I admire your stance but first we are traders that protect against losses.We always remain alive in the capital sense to fight another day—-Stop trying to tell teh market what to do and take what it gives you on a daily /weekly basis—-the time will come and we adhere to Keynes’ maxim–markets can remain irrational far longer then you and I can remain solvent.In this are markets are being rational as they ride the wave of central bank extremes

  3. Chicken Says:

    Watching the wheels go round and round, shadows on the wall.

  4. Don H Says:

    All the warning signs are there but similar to the bubble and housing/credit debacle, when does the fat tail appear? There are no Black Swans; oh wait, what was that? lol
    As always, thanks for waving the flag!

  5. Ali13 Says:

    Anecdotal but been seeing a massive slowdown in some industrial raw material ordering. I would expect the ugliest manufacturing number in a very long time to pop up very soon.

    While you can’t fight the Fed, if this manufacturing softness persists through the Summer, you can almost bank on the US having entered a recession. Just look at Germany that has been on the brink for months now.

    A recession would likely play into the hands of Bernie getting a Dem nomination, leading markets to sell off due to the infamous “uncertainty” which no one seems to invoke anymore under the current administration.

  6. Trader1 Says:


    Do you still hold the opinion that the ECB will raise (by June) the Neg. Int. Rates they charge banks on reserve deposits??

    (part of the CB “panic”)

    • yraharris Says:

      Trader 1–Raise the Negative rate?Clarify for me and I will answer ,I just don’t want to confuse more

  7. Michael Temple Says:

    I think you are giving short shrift to the plumbing/funding “crisis” that is slowly enveloping markets. The “short VOL” trade will add kerosene to the eventual fire, but what is manifestly “off” right now are the extraordinary anomalies in the money markets/yield curve.

    And while the strength of the USD is emblematic of this “short” bid for precious dollars, I think the strong dollar story is a corollary, not the main event for what is coming our way.

    One of the finest non-mainstream financial analysts who is beating the drum about the BROKEN financial plumbing is Jeffrey Snider of Alhambra. I am linking several of his latest pieces, all of which draw on terrific data and which point to a severe breakdown in the “shadow” money markets which the FED is UNABLE to address.

    In short, I agree with Snider that several things are extraordinarily worrying right now.

    1. UST curve is heavily bid, completely ignoring the “animal” spirits of the stock market. Huge and yawning chasm between stocks and bonds almost always corrects in favor of the signal of the bond market. In other words, stocks are running on fumes. “Everybody” loves the FANGs and semis again while ignoring earnings “bombs” by “real world” companies such as FDX/3M/Caterpillar/INTEL

    2. Snider continues to highlight the scary scary messages emanating in the credit markets where the EFF (Effective Fed Funds) rate is now consistently higher than the IOER rate. And while the average rate is 3ish bp higher, the actual tail of the 99th percentile is as much as 20 bps higher on some days. 20 bp!!!

    Equally disturbing is the fact that swap spreads have gone negative again. This should not be, as dealers should be stepping in to arbitrage and pick up these “free/riskless” pennies.

    Snider asks and answers that the anomaly is that despite the Fed going dovish since the December wreck, they are unable to get the banks to re-engage and act as the proper conduits of credit creation/transmission.

    He strongly believes that between Dodd-Frank regulations aimed at curbing their “animal spirits” and charging large capital haircuts to risk assets, the banks are pulling in their horns dramatically, shrinking their balance sheets and in many cases, eliminating or dramatically shrinking their FICC/Fixed Income business units.

    So, it is not surprising that the Fed may have to do extra lifting to try to kickstart the transmission mechanisms by CUTTING more dramatically and SOONER than anybody can imagine.

    Adding to the sense of gloom (imo) is, I believe, is the slowdown in trade that seems to be the goal of our imbecilic/mercantilist POTUS. As US trade flows with the world slows, there are simply fewer dollars circulating throughout the system.

    Add that to the interest rate differentials in which levered money simply cannot “afford” to own negative yielding currencies such as EUR and JPY, it is no wonder that the dollar continues to have a stubborn bid, which just adds more pressure to any of the dollar shorts in international markets.

    Your dread of a 1998 LTCM replay is quite likely to occur, in my view.

    Candidates for the 2019 Black Swan include (but are not limited to)

    1. Possible DB funding crisis

    2. Italian Exit

    3. European Parliamentary Elections in late May

    4 Brexit (although that has been pushed back to Halloween–a rather apt date)

    5. Possible break of the HK dollar peg (See Kyle Bass for his latest thoughts on why this is quite possible/probable)….Such a de-pegging
    would make the CHF de-pegging of the EUR 4ish years ago look like
    a walk in the park.

    In short, here we are with stocks back to late August/early Sept 2018 highs….And, yet, UST curve is still roaring higher with the RED EDs
    pointing to 30 bp of EASING between EDM19/EDM20.

    Personally, I believe just a “minor” hiccup in stocks of 7ish% (S&P 2930 down to 2730) might be enough to trigger a rate cut.

    I think this could wind up being a very very hot summer, for all the wrong reasons.

    The strength of the UST 2 yr is undeniable, and any chartist can see that a chart of the 2-yr yield (not bond price) looks like it could cascade dramatically lower.



    • yraharris Says:

      Mike–a very important post and four out of five being Europe is something i agree with—also the Alhambra links are much appreciated for much thought goes into those pieces

  8. Michael Aaron Temple Says:

    And we hear this morning that McElligott of Nomura believes the Fed could “go large” with a 50 bp cut as soon as this week.
    Incredible if that were to take place. My bet, instead, is Powell
    will both
    1. Lower IOER by 5ish bps and
    2. End QT at the end of May instead of waiting until September.

    A Rate cut right now seems a “bridge too far”. But, I think we could
    easily see that rate cut by 4th of July.

    Am going to be in Chicago in August. Will you be there that month?



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