Volatile Markets. Will the Fed Get Whipsawed?

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Attention spans are so short. Eyes get focused on what the media deems the hot topic of the moment. The “instantaneous” demise of FTX, Sam Bankman-Fried and crypto is hot right now. Looks like coming up number two is Gisele Bündchen (ex Ms.Tom Brady) and her “dating life” (bikini photos with young guys sure to follow). The mid-term elections are so last week. Inflation? Ha! That was “fixed” last week, too. But wait. The big (HUGE) gorilla in the room is not getting the attention it should. Ready? Financial markets lack of liquidity and resulting volatility.

A “troubling” statement came out of Washington a few weeks ago. U.S. Treasury Secretary Janet Yellen said she was “worried about a loss of adequate liquidity in the market.” While the Fed has embarked on a mission to quash inflation by raising interest rates, it is also rapidly removing liquidity in financial markets across the board, and it’s a VERY big deal.

Worst case? The treasury market could seize up. The end of the Fed’s massive monthly bond purchases followed by the start of quantitative tightening has worsened the problem. As the supply of treasuries booms to fund government spending, regulations limit big financial institutions’ willingness to serve as market makers. Meaning – more volatility.

But it’s not just the treasury market. Notice the currency markets lately? Outsized moves in global currencies are causing havoc with central bankers, and the U.S. dollar is included. Oil markets? Crazy. Equities, too. Five and ten percent moves in the Dow, S&P and Nasdaq are becoming normal. Crypto? Well, we sure have seen downside volatility for sure. And, as markets get more volatile, risk increases. Reducing risk means reducing size of positions. Additionally, with fewer active market participants, there is even LESS liquidity.

So after “forever” trying to get inflation up at “any cost,” the Fed and global central banks sure did “succeed.” Inflation has exploded globally (yeah, it wasn’t transitory) and now, by golly, the Fed is determined to get it under control. Hmmmm! Will the Fed keep raising rates only to be “surprised” when inflation collapses (deflation) and then have to cut rates substantially (at some point)?

In trading parlay, the Fed gets “whipsawed.” Kind of the buy high, sell low thing they are getting good at. (lol)

With less and less liquidity across financial markets, fewer market participants making markets and huge positions to unwind it seems more attention should be directed to “what could possibly go wrong” thinking. Just ask the crypto players.

Or, divert attention to reports of where Sam Bankman-Fried might be. Or, even better, wait for the inevitable Gisele beach vacation pictures to slosh all over the media.