When police try to solve a crime one of the key tasks is to determine who benefits from the crime. The beneficiary of a crime is not necessarily the perpetrator, but motive goes a long way to narrow the circle of potential suspects.
Who benefitted from this sudden aggressive sell-off aside from anyone who was positioned short?
Certainly not hedge funds that capitulated long in January with their highest long exposure in 3 years literally right before the sell-off.
And certainly not retail that went full balls long on the aura of optimism:
This trend continued right into February 1 following the FOMO train. Remember Ray Dalio?
Panic selling with record outflows. In record time no less:
From greed to panic in less than 2 weeks.
People got hammered big time as price gave back months of gains in a matter of days:
That’s a lot of trapped supply and will present a challenge for future rallies.
So benefits from all this? One man. One man in particular:
THIS WEEK: The Passing of the Bubble#Yellen#Powell#FOMC pic.twitter.com/2soMuiqjXN
— Sven Henrich (@NorthmanTrader) January 29, 2018
From his vantage point the timing of all this has to be perfect. Absolutely perfect. And from Yellen’s position it’s perfect too actually. But it is Powell I want to hone in on in particular.
Suppose for a moment you have been nominated Fed chair. And suppose you have been part of a Fed that has been extremely dovish for years always eager to sooth markets whenever there was trouble around the corner. Case in point: Yellen retracted her rate hike schedule right at the point of the 2016 lows as we all remember. Financials bottomed on the same day:
After that it was “uncertainty” each time markets wobbled and despite tax cuts and supposed ‘global synchronized growth’ the Fed couldn’t bring it self to raise rates aggressively. Always cautious. Always tinkering.
Then came tax cuts and markets went wild.
Suppose you are that new incoming Fed chair and you see markets go wild on a policy that the Federal reserve sees contributing little to economic growth. Indeed you watch markets go into full parabolic bubble mode:
Please let me know when the euphoria begins 😂$DJIA pic.twitter.com/G9dm4RfadZ
— Sven Henrich (@NorthmanTrader) January 24, 2018
Do you want to be the sucker that owns this? Do you want to be the Fed chair associated with markets crashing under your watch? Let me suppose that no, you don’t.
So you have a very small window for the air to come out before you get blamed. How about precisely the day after you get started in your job?
Best timed exit ever. pic.twitter.com/eumsPOx1Xn
— Sven Henrich (@NorthmanTrader) February 8, 2018
It’s perfect timing from a narrative perspective. It didn’t happen under Yellen’s watch and it happened too soon under Powell’s watch to blame him.
I’m not saying the Fed is the perpetrator, but the timing couldn’t have been any better for Jerome Powell.
What symbolized the bubble? Record volatility compression and retail betting on ever lower volatility. So you tell me what the odds were that, after 6 years, $XIV suddenly imploded precisely right after Powell took over?
But it gets better. Uncertainty? Not a word. Halting rate hikes? Not a word. In fact, the opposite. The Fed’s messaging has suddenly changed.
Not only are Fed speakers coming out reinforcing the rate hike schedule, they are calling the correction small potatoes and they are almost literally saying the correction is great:
It’s almost as if the Fed wanted this correction 🤔
“More volatility in the markets, and maybe addressing some of the excesses and imbalances in the markets, by having a little more volatility, may be a healthy thing,” https://t.co/Ls6SeogYD0
— Sven Henrich (@NorthmanTrader) February 8, 2018
So they know there were excesses and imbalances in the markets. That’s motive folks.
Look, if you need ammunition to deal with a future recession and you are worried about a bubble blowing up (which would impact the economy negatively) you best take control of it and manage a soft landing otherwise you chase the fall-out.
I can’t suggest that the Fed engineered this crash because I have no evidence, and without evidence it would be silly to suggest so, but what I can say is that they certainly had the motive and the timing was perfect. Precisely when it needed to happen.
Now you can decide for yourself of course and perhaps it is all coincidental, but I’m putting it out there as a possibility.
But, based on their communications in the past 24 hours, the script has changed. Powell ain’t Yellen. No dovish signals on the first sign of trouble.
Now, if this theory, and that’s all it is, has any validity then this sell-off will end soon. After all the Fed doesn’t want any real damage and they don’t view the current correction as damaging to the economy. Kaplan already signaled this yesterday.
But if the goal was to let a bit of air out of the bubble without impacting the economy, then a low between today and the next few days would’ve accomplished this mission.
Of course if the Fed is just watching this and is hoping for the best then perhaps those scary $DJIA charts will come to fruition soon rather than later 🙂
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Plus enhancement of possible motive: FED need to take care about future issuance and placement of federal debt. Trump forced tax cuts, federal deficit will quickly increase and it has to be financed – and now also domestically as U.S. will concurrently wage sort of protectionist even trade war policies aimed against former huge U.S. debt buyers. And it isn’t viable to make debt attractive with rising USD value – definitely not in medium and long term as it will not support export, it will not support repatriation of foreign held cash by U.S. domiciled cos, it will not support foreign investment flowing to U.S. And money flowing out of stock market should be deployed elsewhere – why not at least partially to U.S. debt – supported with slightlyincreasing rates (in controlled manner). If not sufficient reincarnation of some sort of QE wiil start soon.
Eventually somebody’s got to pay for this mess, may not be today or tomorrow but QE forever just doesn’t work for ever with rates close to 0 already. At some point of time small spikes in interest rates could create major market tantrums like this with a regular frequency if the debt burden is not addressed.
The economy can’t handle normalized rates given ever expanding debt levels. There’s a mathematical reality that will curb future growth & trigger the next recession.
Rates will eventually go where they need to go and I don’t mean 2%. The Fed can try to delay it but they certainly can’t stop it. That’s not how it works.
If the FED will step in at this SPY/YM level, then the bubble will get worse, because everybody will see it as the Powell Put. They have to wait for a lower level. Then they can step in with QEx. That will be necessary because the US government and citizens can’t aford rate higher then 3%.
Ofcourse it won’t help in the long run. The unsustainability is clear, but if all the governments in the world are playing that game, well perhaps it will bring us many extra nice years before there are enough people that will see that the emperor indeed has no clothes.
By then the financial system will collapse and gold/silver will be important again, not cryptocurrencies. But probably before that moment, we already have had a couple of bigger wars and that also can reset a lot of unsustainable things.