Stocks rallied last night even though bond rates around the world took fright at the uptick in US inflation a day before the FOMC (Federal Open Market Committee) meeting.
US 10 year bonds closed at 2.65% and were up another point in Asian trade this morning while rates in Europe were all higher as well.
Had the capital losses, 0.96% for UK 10 year Gilts, 1.96% for the US 10s, more than 2% for Spanish and Italian bonds, and more than 3% for German Bunds, occurred on global stock markets traders the world over would be aghast.
Yet stock holders hardly noticed with a sea of green across most of the globes bourses.
But this bond market sell off has the potential to derail stocks in a manner that most investors don’t expect if the big downtrend in US 10 years break.
Hence the reference to the term “Minsky Moment” which was first coined by PIMCO’s Paul McCulley to describe the Asian crisis back in the late 1990s.
A Minsky Moment is a reference to one of my favourite economists of all-time Hyman Minsky’s Financial Instability Hypothesis which while a theory of debt within the economy breaks finance up into 3 economic units: Hedge, Speculative and Ponzi.
Minsky says that when speculative units (those that can meet their payment commitments on “income account” on their liabilities, even as they cannot repay the principle out of income cash flows) and Ponzi units ( those units where the cash flows from operations are not sufficient to fulfill either the repayment of principle or the interest due on outstanding debts by their cash flows from operations) dominate the the economy will be prone to excess (“a deviation amplifying system”).
But the key to the hypothesis and the point that is germane to a potential break higher in bond rates is that Minsky says:
over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.
Which is why Bank of England Governor Mark Carney’s warning last week on rates in the UK and the potential for Fed Chair Janet Yellen and her FOMC to do something similar at today’s FOMC meeting is potentially a devastating change in direction for markets.
As Citibank FX guru Steve Englander said in the above linked piece by Joe Weisthenal:
were the FOMC to really signal a fundamental shift in its thinking, the word ‘carnage’ would not be inappropriate.
Such a risk comes after a period of “prolonged prosperity” which has lulled observed and tradable stock market (not to mention FX) volatility back into multi-year lows.
This is important as well because Minsky says that periods of stability give way to periods of instability.
Which is important because of the role that the Fed and its balance sheet growth has played in the stock market rally from the GFC lows.
Clearly the stock market has not been able to sustain rallies when the Fed stops buying bonds since the Fed started buying back in 2009.
But Ray Attrill, the NAB’s co-Head of Currency Strategy told Business Insider:
The latest run up in longer term Treasury yields still leaves them comfortably within the range of the past 4-5 months (2.4-2.8% at 10 years). It’s debatable if the latest FOMC outcome will prove capable of moving us up into a significantly higher range.
But Attrill added that “ff longer trend bond yield do rise out of the Fed, this should accentuate the existing pressure on a number of markets especially the Aussie dollar.”
Bonds are at a significant point in the cycle as is the bank of England and potentially the Fed. So while an ability to “predict” the exact timing of Minsky Moment would largely render the chances redundant the preconditions of some sort of market trigger for global stock, bond, commodity and currency markets is increasing exponentially.