The Floodgates Have Opened

Fed chair Janet Yellen’s comments during an IMF conference on Wednesday contributed to a global sell-off of stocks last night.

 
 

If Fed chair Janet Yellen didn’t already have white hair, she would certainly be getting it now as much as she is worried about everything.

Yesterday, Yellen appeared as a panelist at an International Monetary Fund (IMF) conference. She wasn't on anyone's radar, but in responding to a question by IMF President Christine LaGarde, Yellen opened the floodgates.

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She worries that stocks are over-valued, but she worries that bonds are so over-valued they make stocks look good. She worries that long-term rates will jump sharply when the Fed first starts to tighten. She worries about problems in high yield bond markets, leveraged loans, and the repo market.

I’m sure I left something out, but you get the drift. She said a few things to soften the language, but the message her was clear. I wonder if maybe it was a set-up between Yellen and LaGarde so Yellen could express concerns.

I wish LaGarde had asked this follow up question, “So, Ms. Yellen, can you think of anything, anything at all, that might possibly have contributed to so many asset bubbles at the same time?”

But that didn’t happen because LaGarde is too polite to ask a question with such an obvious and damning answer.

I wouldn’t lose any sleep over Janet Yellen’s worries about bubbles — my word, not hers of course. Fed officials are horrible at recognizing bubbles — yes, I'm talking to you also Ben and Alan — but are good at creating bubbles.

Although the various markets often seem chaotic, disjointed, irrational, and confusing — did I say “often?” I meant "always" —  there is a common thread running through the markets. Just a couple of months ago the consensus was overwhelming that the dollar would continue to surge and bond yields would fall into a dark, black hole of no return. The consensus opinions for oil going even lower and stocks going higher were very strong also, though not as strong as the first two.

Huge leveraged bets all going the same direction were made in all of these markets. The common thread is that all of the “sure things” suddenly look fraught with risks for going very bad starting with the bond bet. Traders are aware of this, and we could already be seeing some liquidation in the euro/dollar bets and at least the European bond bets. Perhaps it ends here. But traders are also sensing this could be the first stage of an ugly unwind of too many one-sided markets.

Everything could easily turn back around into the favor of the consensus bets, but the cracks are showing and Yellen seems to be worried about them. She even brought up the taper tantrum of May-June 2013 when expressing concern of a big jump in longer-term rates. Two years later, are we there again? Not our taper tantrum, but perhaps a European taper tantrum.

Dwight Johnston is the chief economist of the California and Nevada Credit Union Leagues and president of Dwight Johnston Economics. He is the author of a popular commentary site and is a frequent speaker at credit union board planning sessions and industry conferences.

 
 

May 6, 2015


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