The latest installment from macro man column on BBG caught my attention due to the catchy acronym, LIGHT where
L: leverage
I: illiqudity
G: greed
H: hubris
T: temerity
And as a general rule of thumb, it would seem that the current state of markets is checking all of those ‘boxes’. For better or worse, what that could mean,
A Change of Course Is Rough for Those at LIGHT Speed: Macro Man
It might not be accurate to say that the die is already cast for monetary policy over the next few months, but it’s not far from being so. We’ve now had a couple of FOMC voters (Waller and Bullard) argue for a March rate hike, and such an outcome isn’t far from being fully priced. The onus is surely now squarely upon the data to convince the committee to hold fire. And while December’s employment data once again showed disappointing payroll growth, that once again looks to be driven by a dearth of supply rather than a shortfall in demand. As such, investors need to accept the reality that tighter policy is coming; that might be a bitter pill to swallow for markets trading at what I explain below is “LIGHT” speed.
The song remains the same for the labor market: Headline payroll growth disappointed, but the unemployment rate slid below 4% and wage growth surprised to the upside. Perhaps the worst case scenario for the Fed is an acceleration in nominal wages but a drop in real incomes; that’s pretty much exactly what’s played out over the past several quarters. Recent communications suggest that the Fed is ready to start applying the monetary brakes much sooner than would have seemed possible just a few months ago.
Per recent commentaries, one of the key items for debate is whether a quicker start to tightening implies a quicker end and a lower overall magnitude to the cycle. All else being equal, you’d think that the answer is yes, but you cannot really keep everything else equal; the economy keeps moving, and with it the perception of the current level of monetary accommodation. If your starting point is a more negative real funds rate than you were originally anticipating, then it makes sense that the cycle could actually have further to go in nominal terms to get policy to the desired level.
I was chatting with a friend about the change in the monetary/interest rate backdrop and its impact upon super-speculative assets. As we listed the factors that drove the performance (and subsequent swan dive) of uber-risky investment strategies, my pal coined the acronym “LIGHT” to describe them: leverage, illiquidity, greed, hubris and temerity. These are classic symptoms of an investment bubble, and they all usually conspire to make the end a spectacular one.
Ultimately, the whole point of easy money and asset purchases is to drive interest rates lower and encourage leverage and risk-taking. Obviously, the vectors of such leverage aren’t always ideal from a macroeconomic standpoint; it’s a lot easier to borrow and deploy capital in financial markets than it is in the real economy. And borrow is exactly what investors have done; through November, FINRA margin debt was up more than 25% y/y, and is now at a record percentage of GDP.
Obviously, higher rates make it less enticing to borrow, particularly if the underlying assets become more volatile, as has been the case recently. We also shouldn’t ignore the role of illiquidity. That has been a feature, rather than a bug, for speculative playthings like meme and “innovation” stocks, crypto, and the likes of NFTs. But while it is nice when each marginal buyer for the stuff you own drives the price a lot higher, it’s not quite as pleasant when you need to hit a bid. Even the rally in the relatively staid S&P 500 late last year came in the context of poor liquidity, which again raises the question of what happens when people want to sell.
As for greed, hubris, and temerity? Well, they are obviously more difficult to quantify. One might posit, though, that a market backdrop where people brag about spending hundreds of thousands of dollars (but wait! that’s in lowly fiat money!) on cartoon apes and other such frivolities comfortably qualifies. So, too, would buying “worst of” structured notes on a family of highly volatile, illiquid ETFs after they have already gone parabolic. It’s like the peak stupidity of 2000 and 2008 wrapped up in one neat and tidy bundle!
A reader kindly reminded me that the dot-com bubble was also somewhat fueled (and arguably ended) by the balance sheet expansion of the Fed in the run-up to Y2K. That’s an often forgotten development -- that the Fed flooded the market with liquidity in the run-up to the millennium, and then withdrew it after the calendar flipped without incident. Granted, the numbers were puny compared with modern-day QE, but back then they seemed pretty big. Chalk that up as a another uncomfortable parallel for aggressive rate hikes/draining liquidity.
Next week headline CPI is expected to exceed 7% for the first time since June of 1982. Coming at a time when the unemployment rate is now below 4%, from a blank sheet of paper it’s preposterous that the Fed still has rates pegged at zero, let alone continues to buy any assets at all. Obviously, this is a function of policy inertia, but it looks like the course is set to change pretty abruptly. The force exerted by a rapid change in bearing usually results in some discomfort, even if you aren’t quite traveling at LIGHT speed.
No idea WHAT next weeks data will bring and as always, anxiously awaiting what (if any) response TO higher UST yields from those in EZ and Far East … So far there’s been very underwhelming response.