Wall Street Knows The Crash Is Coming, But Won't Try To Stop It

Easy Money Addiction Wins Over Common Sense And Reason, Every TIme

Wall Street’s addiction to “easy” money is never as plain as when the Fed tries to make money more expensive by raising interest rates.

Despite the Fed having been crystal clear on their intentions, Wall Street still is hoping the Fed will change its collective mind and “pivot” back to easy money policies. Wall Street clings to this hope even as they see how the Fed’s interest rate hikes are going to crash the markets.

“Fed officials have been scrambling to scare investors almost every day recently in speeches declaring that they will continue to raise the federal funds rate,” the central bank’s benchmark interest rate, “until inflation breaks,” said Yardeni Research in a note Friday. The note suggests they went “trick-or-treating” before Halloween as they’ve now entered their “blackout period” ending the day after the conclusion of their November 1-2 policy meeting.

“The mounting fear is that something else will break along the way, like the entire U.S. Treasury bond market,” Yardeni said.

Follow the logic: Wall Street analysts, who see interest rates rising, and can extrapolate their impact on a variety of asset prices, come to the conclusion that the US Treasury bond market will “break” because of the rate hikes.

Why would they think that? One simple answer is because they already know the vulnerability that will precipitate that exact scenario.

UK Is The Canary In The Coal Mine

Wall Street got a glimpse of how interest rates would catalyze market chaos at the end of September, when the Bank of England abruptly reversed course and intervened in bond markets to slow the rise in yields on long-term gilts.

The Bank Of England Bails On Inflation Fight

Overnight, the BoE went from tight money policy to corral inflation to easy money to prevent a meltdown in gilt markets and the collapse of several UK pension plans as they struggled to sell assets to meet margin calls.

The rationale behind the intervention was that UK pension plans’ derivatives-based hedges reacted to rising yields on gilts, requiring the plans to sell other assets to meet margin calls.

The Breaking Begins: BoE Intervention Halts The Rise In Yields At The Expense Of Everything Else

In a mini-replay of 2007-2008, deriviatives became the risk instead of the hedge.

UK thus becomes an object lesson for the rest of the world:

UK Shows How Loose Money Policy Turns Into A Giant Interest Rate Swap

The low interest rates and “easy money” policies of the world’s central banks have once again played a key role in creating a major market instability. Because of investors’ seemingly unbreakable addiction to synthetic derivative investments, whenever interest rates rise too far, derivative positions trigger a wave of forced asset sales as margin calls go up, as a market made up of buyers suddenly becomes a market made up of sellers (both are needed to maintain market liquidity). As a direct consequence, markets are no longer able to tolerate even moderate rises in interest rates.

It Can Happen Here. Will It Happen Here?

As finance Substack writer Quoth The Raven has observed, US investment funds have a similar exposure to UK pension plans on derivatives.

U.S. Pension Funds Could Be About To Implode

This is why, in my thought experiment on proper Federal Reserve Strategy, I argue the Fed needs to be taking point in organizing the pre-emptive unwinding of derivative positions before interest rate rises trigger a margin-call meltdown.

What Should Be The Federal Reserve Strategy On Inflation?

Wall Street’s fear of US Treasury bond markets “breaking” suggests that Quoth The Raven is correct—there is an extreme vulnerability among pension and other investment funds here in the US through their derivative investments. Once again, a derivative hedge against risk has become the risk.

What happened in the UK can happen in the US. If nothing changes, what happened in the UK will happen in the US. The Fed is not going to abandon its interest rate strategy, which makes a margin-call market meltdown all but inevitable.

The light at the end of the tunnel is a SHTF train coming at high speed down the tracks.

The Light Up Ahead Is Not The End Of The Tunnel

The Yardeni Research investment note tells us that this is what is about to happen in the US Treasury market.

Wall Street Won’t Act On Its Own

The persistent insistence on Wall Street that things will break if the Fed continues to push rates up tells us one more very dangerous and very tragic thing: Wall Street won’t take the hint and act now to get ahead of the crisis.

Wall Street needs to unwind its derivative investment transactions, and it needs to do so starting yesterday. The urgency is immediate and real. Wall Street’s fear of a breakdown in US Treasury bond markets indicates they already know that this needs to be done.

Wall Street’s blaming a breakdown in US Treasury bond markets tells us that they will not take proactive steps to avoid the crisis, but will ride their derivative investments right into the inevitable crash. They won’t unwind those transactions until it is too late. The addiction to the “cheap” money of a low interest rate environment is overwhelming common sense and logic, which apparently are telling all but the most somnambulent of investors that their investment strategies are about to go south in a major way, and that it is time to switch strategies.

Wall Street knows derivative investments are about to turn highly toxic. It can read the handwriting on the wall, and it already understands that derivatives have been weighed in the balance and found wanting. Yet they refuse to change direction.

A margin-call meltdown, triggering a cascade of forced selling of US Treasuries and precipitating a liquidity crisis in the US Treasury bond market is coming. Wall Street and the whole world can see the iceberg directly ahead. Wall Street is waiting for someone else to take charge of the steering wheel and turn away from that iceberg.

Wall Street is signaling that Quoth The Raven is right about the exposure of US investment funds. Derivatives are about to remind the world why they are rightly termed “financial weapons of mass destruction” by Warren Buffet.

The Fed can pivot and revert to enabling Wall Street’s addiction. The Fed can stubbornly stick to its interest rate strategy and the Treasury bond market can crash. Or the Fed can finally take up the regulatory cudgel it should have been using all along and force the unwinding of soon-to-be-toxic investments before the crisis arrives.

The more the Fed raises rates, the closer the moment of crisis comes. Somewhere up ahead there is an interest rate level which will trigger the margin-call meltdown.

Yet that the meltdown has not yet started means there is still time for the markets to act. There is still time to turn away from the iceberg and close out unstable investment positions. There is still time for Wall Street to end its addiction to and obsession with reckless investment strategies using various synthetic derivatives.

There is still time, and Wall Street is still determined to waste that time. The Fed is still determined to ignore its opportunity to lead Wall Street in making good use of that time.

There is still time, and yet there is still a refusal to act in time.

The analysts at Yardeni Research are correct. Something else will break before inflation does—because Wall Street refuses to do a damn thing about preventing the breakage.