Doug Noland's Blog

The structure of today’s marketplace (especially with respect to the proliferation of hedging and derivative trading strategies) is conducive to short squeezes. This is compounded by the policy environment backdrop whereby market players (sophisticated and otherwise) fully recognize that policymakers are determined to backstop the markets.

Global systemic stress has been gaining critical momentum, and markets this week were heartened that global policymakers were in the process of mustering meaningful responses.

Swiss two-year yields ended the week at negative 48 bps. Two-year yields were also negative in Denmark (-21 bps) and traded slightly negative for much of Friday’s trading session in Germany. Ten-year German bund yields closed the week at a record low 1.17%.

For more than a year now, I have posited the thesis that unstable global finance is highly vulnerable to a problematic bout of de-risking and de-leveraging. The unfolding European debt crisis was viewed as the likely catalyst.

It’s a different era of course, but the scope of global policy interventions over the past two decades (and especially since 2008) makes 1920’s policy measures look rather microscopic in comparison. It has been an important aspect of my thesis that aggressive fiscal and monetary stimulus has become increasingly ineffective, destabilizing and dangerous.

JPMorgan is a leading player in Credit insurance and prime brokerage. Their “synthetic credit securities” positions are integral to their business operations with hedge funds and the “leveraged speculating community.” Furthermore, derivatives reside at the epicenter of the dysfunctional global “risk on, risk off” market dynamic. And it’s also been my premise that “risk on” has been showing heightened vulnerability.

Payroll data again disappointed, with U.S. job growth having now declined for three straight months. There will of course be various bullish and bearish spins on the data, yet it should be clear that the U.S. economy is lacking sufficient momentum to bolster global economic prospects. With downside risks abounding and economic locomotives not evolving, the global economy is now at heightened vulnerability.

Markets are broken. Accepted investment wisdom has been overturned and the basic tenets of value and diversification no longer work. The financial crisis put the market into a volatile ‘risk on, risk off’ – or Roro – mode for which there is no cure.

The respite from the European debt crisis has run its course, and with the return of market stress comes a ratcheting up of vitriol directed at the Germans. I find it all worrying. For a moment today I tried to take comfort from a UK Telegraph headline that scrolled by on the Bloomberg screen: “Worrying Is Good for You and Reflects Higher IQ.” I’m adding this to my list of notions that sound appealing and I only wish were true.

One can point to a momentous policy flaw: policymakers have believed that it's critical to underpin financial markets during periods of stress, while failing to appreciate that this policy course nurtures dependencies and susceptibilities. Over the years – and certainly going back to policy responses in 2008/09 and more recently with QE2 and LTRO – extraordinary policy measures have created acute dependency to ongoing liquidity measures. Each intervention sows the seeds for the next even grander intervention. At some point policymakers will simply not be able to deliver.