Weekly Commentary: Age Of Uncertainty

2025-02-01 04:00:00 ET

Summary

• Monetary disorder was certainly spurred by the Fed signaling the end of rate hikes - and then stoked to precarious excess by 100 bps of rates cuts over three months.
• Technology stocks tumbled on Monday after Chinese artificial intelligence start-up DeepSeek stunned Silicon Valley with advances apparently achieved with far less computing power than US rivals.
• Wall Street has been on tenterhooks about how Silicon Valley would respond to DeepSeek, the Chinese start-up whose low-cost artificial intelligence software threatens to undercut the pricey American approach to the technology.
• Technology bulls take comfort from fortress 'tech oligarchy' balance sheets, with more than sufficient resources available to pursue their spectacular AI investment programs.

Prioritize, or just go chronologically. The beginning, middle, or end of the week? DeepSeek, the Fed or Trump tariffs? Never a dull moment.

We live in an Age of Uncertainty - The Era of Nebulous. Was Monday's DeepSeek tech stock swoon the first crack - the beginning of the end - for the great AI mania? Or pretty much a lot about nothing - a mere bump in the road soon forgotten? Are financial conditions only "somewhat accommodative" and the system at a state of stability? Does the Fed have its eye on the ball? Do tariffs really not matter, as the stock market has signaled? Or is faith that President Trump won't do anything to upset the markets further evidence of manic speculative Bubble irrationality?

Matt Egan from CNN: "Following up on [Axios Courtenay Brown's] question from earlier about the stock market, how concerned are you, if at all, about a potential asset bubble brewing in financial markets? How do relatively high market valuations factor into considerations about potentially lowering interest rates further? Is that something that's in the back of your mind?"

Chair Powell: "So we look from a financial stability perspective at asset prices generally, along with things like leverage in the household sector, leverage in the banking system, funding risk for banks, and things like that. But it's just one of the four things, asset prices are. And yeah, I'd say they're elevated by many metrics right now. A good part of that, of course, is this thing around tech and AI, but we look at that. But we also look at how resilient the households and businesses and the financial sector are to those things. So, we look at that mainly from our financial stability perspective and we think that there's a lot of resilience out there. Banks have high capital, and households are actually overall, not all households but in the aggregate, households are in pretty good shape financially these days. So, that's how we think about that. We also, we look at overall financial conditions, and you can't just take equity prices, you've got to look at rates too, and that represents a tightening in conditions with higher rates. So, overall financial conditions are probably still somewhat accommodative, but it's a mixed bag."

"We think that there's a lot of resilience out there." I think there's a lot of latent fragility. The Fed should at least pay lip service to speculative leverage. To completely avoid the subject - as if it doesn't matter - raises a credibility issue. After all, hedge funds and derivatives leverage were instrumental in market crises in 1994, 1998, 2008 and 2020. The repo market was the epicenter of the 2008 market meltdown, while hedge fund "basis trade" deleveraging was instrumental in the eruption of pandemic crisis instability.

I have chronicled the ongoing historic inflation of "repo" and money market fund assets, while discussing the key role played by the proliferation of leveraged speculation. The Fed is seeing all the same data and more. Some new data points this week, courtesy of analysts at Barclays. Doozies.

January 29 - Bloomberg (Alexandra Harris): "Hedge funds' long Treasury positions and repo borrowing grew in 2024, exceeding the peak reached in 2019… Barclays strategist Joseph Abate wrote... As of September, hedge funds' long Treasury positions reached a record $2.1 trillion. Positions have increased 44% since 2023 and are about $800 billion larger than their 2019 peak. Similarly, repo borrowing increased by $900 billion, or 53%, since 2023. Barclays assumes most of this is against Treasury collateral, but the breakdown is unclear. About 40% of transactions were overnight. Top 10 funds with repo borrowings accounted for 62% of total repo, or about $1.55 trillion…"

Definitely worth pondering: Ten hedge funds with $1.55 TN of repo borrowings, likely most used for levered "basis trade" positions in the Treasury market. Hedge fund "repo" borrowings expanding 53% - apparently over nine months. Sounds like conditions have been much too loose, with the makings to trample "a lot of resilience."

The past year has experienced historic monetary inflation. Monetary disorder was certainly spurred by the Fed signaling the end of rate hikes - and then stoked to precarious excess by 100 bps of rates cuts over three months. While the Fed asserted "significantly restrictive," levered speculation and resulting liquidity excess ensured financial conditions went from loose to recklessly so. It was a blunder more consequential than "transitory."...

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