“The Great Unwind Is Gathering Speed” – What Chris Whalen Is Worrying About For 2019

Tuesday, December 18, 2018
By Paul Martin

by Chris Whalen via TheInstitutionalRiskAnalyst.com,
ZeroHedge.com
Tue, 12/18/2018

First a safe and happy holiday to all.

In this issue of The Institutional Risk Analyst, we ponder past prognostications and future risks in 2019. And we are happy to announce the publication of The IRA Bank Book for Q4 2018. For those of you who were furiously buying copies of the Q3 edition last week, for which we are most grateful, hit the download link again to get the Q4 edition. You’ll want to read about why US bank earnings growth is now 100% correlated to interest rates.

FYI, new editions of The IRA Bank Book are published about two weeks after the FDIC and other regulators release their institution level and aggregate data (roughly day 60 after the quarter end) for US banks. The popular IRA Top Ten Banks usually appears after quarterly earnings are complete. And yes, to your questions, we only sell the most recent edition of each report.

So what is our top concerns in 2019?

First comes liquidity. For the past several weeks, US equities have fallen as the great unwind gathers speed. The same pressures that are causing the Federal Open Market Committee to consider pausing on rate hikes in 2019 are forcing stocks lower.

Never mind the parade of mindless reasons for the stock market reset – trade, China or even a weak US economy – the key factor pushing markets lower is the radical tightening of credit by the FOMC. Even without a single rate hike in 2019, the tightening caused by the runoff of the Fed’s bond portfolio will continue to suck liquidity out of the financial system. And lowering the target rate for Fed funds really won’t help if markets lock up.

Just as quantitative easing expanded the US liquidity base, quantitative tightening or “QT” represents a structural decrease in liquidity. As the Fed’s balance sheet contracts, there is a dollar-for-dollar decrease in liquidity because the Treasury is running a deficit. A bank deposit becomes a Treasury bill on the national balance sheet, illustrating why the Fed and Treasury are two faces of the same agency. But the key point is that QT is beginning to impact markets and credit spreads.

The destruction of trillions in equity market valuation is creating a level of panic in the US markets not seen since 2016, when China fears caused the capital markets to seize up. We may be replaying that scenario again. With high yield spreads headed to the danger zone of 500bp over Treasury yields, that tells you that the policy message coming from Washington is off key. But it also means that the market for subprime debt, including leveraged loans and CLOs, is grinding to a halt. That sound you hear is Wall Street choking on conduits full of loans that cannot be sold.

Feldkamp’s First Law states that when spreads widen too much, debt markets stop functioning and equity markets lose value. We talked about this in “Financial Stability: Fraud, Confidence and the Wealth of Nations.” When the mix of policy and personalities is toxic, spreads blow out, debt markets freeze and wealth as measured by the equity markets falls. Sadly there are only a handful of people on the Street who get the joke. The majority is captive of a narrative where trade tensions are responsible for market weakness.

Next on the string of worry beads is Europe. The European Central Bank just announced the end of its version of “quantitative easing” or QE, but unlike the US the ECB intends to reinvest its bond portfolio indefinitely. There will be no “quantitative tightening” in Europe by actually allowing the portfolio to run off as in the case of the US Federal Reserve. We reported this to readers after our trip to Paris last March. This past week, ECB Governor Mario Draghi confirmed our belief that EU banks cannot withstand a significant increase in rates.

The Rest…HERE

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