KSTR - Weekly Commentary: Trouble Brewing In Financial Asset Wonderland

2024-04-13 06:56:17 ET

Summary

• Bubbles can inflate for a long time, sustained by loose financial conditions and government rescues.
• Bubbles eventually burst - and they have this innate diabolical propensity to somehow catch the over-exposed masses by surprise, causing the greatest damage to the largest number of traders, individuals, institutions, businesses, and governments.
• The Fed's misguided dovish pivot unleashed precariously loose market conditions, stoking wild speculative excess while ensuring inflation became deeply embedded.

Unique "global government finance Bubble" dynamics some years back compelled an adjustment to one of my favorite maxims. Instead of doubling, Bubbles inflate to unimaginable extremes - and then quadruple.

Bubbles can inflate for a long time, sustained by loose financial conditions and government rescues. There will always be ebbs and flows. Scares and shocks occasionally evoke fears of bursting Bubbles. And the more these bouts of instability are rectified by inflationist central banking, the less concern for Bubble dynamics. That which does not destroy a Bubble only makes it stronger.

Late in the cycle, "Terminal Phase" excess takes over, with a confluence of rapid Credit expansion, intense speculation, and FOMO completely sidelining Bubble concerns. I like to underscore that the colorful historical accounts of manias don't do reality justice. It's not about crowds of raving mad speculators bidding up tulip bulb prices to the stratosphere. Late-cycle FOMO is altogether more rational. After so many years, arguing that prices don't always recover to new highs is borderline insanity. Moreover, underlying fundamentals are an elemental facet of Bubble inflation, with surging profits, cash flows and incomes validating inflating asset prices and bullish narratives more generally.

In a fatefully ironic late-cycle dynamic, fear of missing out completely usurps Bubble concerns right before the inevitable reckoning. Bubbles eventually burst - and they have this innate diabolical propensity to somehow catch the over-exposed masses by surprise, causing the greatest damage to the largest number of traders, individuals, institutions, businesses, and governments. Only days before the 1929 stock market cataclysm, eminent - and soon to be penniless - Yale economist (and speculator) Irving Fisher infamously stated, "The nation is marching along a permanently high plateau of prosperity."

The past week beckons for some Bubble theory rehash. There's a decent case to be made that the global Bubble today hangs precariously in the balance. March CPI data confirm inflation is decidedly not on a glide path to kindly return to 2% anytime soon. The Fed's misguided dovish pivot unleashed precariously loose market conditions, stoking wild speculative excess while ensuring inflation became deeply embedded. The jam-packed stock market easy "money" party now risks being crashed by "higher for longer," a confounded Federal Reserve, and heightened global instability.

We don't want to overly fixate on the Fed's quandary. Odds are down to only two-thirds probability of a rate cut by the July 31st FOMC meeting. At 4.86% (up 19bps post-CPI), the rates market ended the week pricing about two cuts (47bps) by the December 18th meeting. Markets are not expecting much activity from the Fed for a few months.

Two key central banks are under much more immediate market pressure. Our friends in Tokyo and adversaries in Beijing both face acute currency vulnerability, pressure made significantly more intense by U.S. Bubble dynamics (i.e. loose conditions, "higher for longer," and booming markets)....

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