Happy Black Monday (!)

rcwhalen's picture

Amsterdam | As the financial world happily fixates on who will be the next Fed Chairman, I am in Europe celebrating the 30th anniversary of Black Monday, October 19, 1987. Three decades ago, I was on a trading desk at Bear, Stearns & Co in London along with David, Joey, Gregory, Peter and Paul, among others. We had just finished a remarkable four year run, but the party was over.

That fateful day, our Treasury/MBS trader Matt got his eyes ripped out early in the day. His big mistake was answering the phone. Investors lifted every offer for US Treasury paper to be found. We were short a couple of bucks before 10 AM with no offers. We all stopped answering the phone way before lunch. Fortunately, we had large sell orders from several Japanese insurance companies so by the close Matt was flat and went home to have a couple of well-deserved pints.

This story is relevant today because the markets seem to have forgotten how it feels to be physically molested without the protection of Mother Fed. As I told Frank W. from Handelsblatt earlier today, the crash in 1987 was the last financial crisis where the private markets were allowed to function without government support. We had manipulated markets when I worked at the Fed of New York, but only on the margins.

Since 1987, however, the US government (i.e. the Federal Reserve) has turned market stability into an entitlement. The degree of government intervention in the markets has grown enormously since Black Friday 1987, with no authority or even acknowledgement from Congress, begging the question as to whether the United States can any longer be described as a free-market democracy.

Whether we admit it or not, the global markets are in the hands of a cadre of “experts” at the various central banks, who make decisions based upon private deliberations and questionable reasoning. The markets depend upon these experts to provide the expected stability, making the entire financial system more fragile today than ever before. Neither capital nor even market intervention by central banks is the issue here. The currency of financial stability is, more than ever before, confidence. And the people who are piloting the starship have not a clue what they are doing.

Case in point, the FRBNY is conducting “stress tests” on how the sale of mortgage backed securities will impact the markets. The tests are tiny, double digits millions of dollars. The fact that the Fed is even doing this illustrates not only the fragility of the financial markets, but the lack of understanding and familiarity that the FRBNY has with the markets it is supposed to surveil. With Treasury 2s to 10s at the narrowest spread in the past decade, one has to wonder just what the Fed is waiting for in terms of portfolio sales. See chart below c/o Ed Harrison. 2s to 10s Fact is, the Fed is in a special trap of its own design. By continuing the process of QE (that’s “quantitative easing” in FedSpeak) beyond the first round in 2010, the central bank skewed the credit markets to an enormous degree and, in the process, boosted asset prices for everything from stocks to bonds to commercial real estate. The rally in stocks is all about cheap credit.

Naturally, the Fed cannot “normalize” interest rates (and credit spreads) unless it first sells a large chuck of the $3.8 trillion in securities on its book. But Janet Yellen & Co on the FOMC, know now that they have screwed up large by continuing with QE after 2010. Naturally they are reluctant to admit this error. Like the Church of Rome, the Fed is never wrong. And Yellen is afraid to put the proverbial magic bus into reverse for fear that both stock and bonds, which are now 100% correlated, will tank simultaneously. And they are right to be concerned.

Chair Yellen is wedded to a neo-Keynesian/socialist world view. Thus the FOMC has moved benchmark rates before selling any of the mortgage paper or Treasury bonds in the System Open Market portfolio. Anybody who understands the bond markets and duration will tell you that there is more that sufficient demand to soak up $50 to $100 billion in MBS per month in current market conditions, especially when you consider that agency MBS issuance will probably be down $400-500 billion in 2017 at $1.6 trillion vs $2 trillion in issuance last year.

Yet somehow our friends at the Fed can look at narrowing bond spreads and a completely manic stock market, and do nothing. Raising benchmark rates is pretty much an exercise in futility because there is no “cascade” from Fed Funds to longer maturities, as we discussed in The Institutional Risk Analyst. Indeed, absent some pesky externalities, bond prices are likely to rise and yields will fall because of the intense demand for duration from end investors and other central banks, who continue to buy public and private debt.

Remember that with short-term "risk free" Treasury rates at current levels, the net-present value of equities is far higher than current market valuations. Yet by the time that President Donald Trump gets around to picking the next Fed Chair, the markets will be ready for a truly cathartic collapse, a “reset” if you will. The only thing that will delay the great repricing will be, naturally, a tax cut from Washington. Once that final act of idiocy has been achieved, however, there will be no more shiny objects to fascinate Wall Street.

Banks and interest rate investors will be starring at a flat yield curve – the traditional signal for an approaching recession – and there will be no real reason to keep playing at the big table. Indeed, the smarter players will be taking the money off the table before Congress actually votes on a tax cut. Fact is, most large cap stocks that are bobbing around at multi-year highs will tumble once the proverbial deed is done in Washington. Tesla anyone?

Once the stock market begins to crack, Yellen & Co will not only need to delay asset sales, but they will probably be bullied into mimicking the European Central Bank and the Bank of Japan, and start buying both bonds and stocks in the name of financial stability. For as we mentioned earlier, financial stability is now an entitlement, like defaulting on your home mortgage. So start practicing your Italian, make sure that you have plenty of ammo and food at home, and sit back to watch the spectacle unfold.

Happy Black Friday

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
aliens is here's picture

You don't own your home dudes. You just think you own it after you paying it off. Try not paying your property taxes and you'll see who owns your home.

tstpilot00101's picture

Exactly.  There is NO such thing as "home ownership" in this country.  The COUNTY owns your home... you're just renting it from them.  As long as you pay your "rent", you can keep it.

LawsofPhysics's picture

Well, that's better than paying interest to a bank that printed the fucking money FOR FREE with NO REAL WORK and NO REAL INTEREST!!!

For fuck's sake, at least my property taxes pay for local services I USE.

shovelhead's picture

Try the same not paying for your car.

Cops firemen teachers and City Hall don't work for free just like you.

Tax rates are really low in unincorporated county areas. Wells and septic and a cop or fireman and a school could be only a 1/2 hour-45 minutes away.

Not too many "I want it now" types out there though.

geno-econ's picture

Careful Whelan, you may be ostracized by the banking community, unless you are proven correct, in which case there will be no finance or Wall St.  jobs available anyway. Managing a gambling casino might be a good career alternative.

Mustafa Kemal's picture

"begging the question as to whether the United States can any longer be described as a free-market democracy."

That made me laugh

Fahq Yuhaad's picture

"Indeed, absent some pesky externalities...,"


Plus a plethora of fine predictions that may or may not materialize.

hibou-Owl's picture

I've been watching the German bunds which have broken the trendline leading up from 2005, its retested that trendline and turned down right on that line.
My gut feel is something going to blow up in europe very soon, and will lead the markets lower.

The CAC is a massive monthly triangle, which again did test the upper trendline, but my call is bonds. There are many fundmentals that could trigger.

Lets Buy The Dip's picture

black friday, lots of people saying a STOCK MARKET CRASH yes?

But how many months we been heareing that for...about 36 months, , so many peope been calling a crash. You are better to do research and find a company that is accurate. I follow the aussie guy here, ==> SENTIMENT TRADER  .... he called the the 2008 stock market crash [3 months] before it happend!! ANd right now he is saying lots of things, but nothing about a STOCK MARKET crash. SO I doubt it would happen. 

too much hype out there. Lots of people saying the market would crash this year, and look at us. :-) 

The market can remain irrational a lot longer than traders can remain solvent in terms of money. Remember that.

Dame Ednas Possum's picture

Luck is all you have... for now anyway. 


Fahq Yuhaad's picture

"Respect is all you will have in the morning"

--Teddy KGB to Mike McDermott during the final poker game in "Rounders"

Anarchyteez's picture

Awesome. Thanks Tyler, and author.

Truther's picture

"like defaulting on your home mortgage"

As if anyone is fooled to think they own anything. If you have a central bank, you're a slave.

new game's picture

central bank gods. rule number one in investing 1). thou shall not fight the fed.

the road to properity beyond any dreams is through the ivy league halls of indoctrination.

moar is moar, and moar, and moar. debt that is. with the fleece of fees, usery and handle fee.

not to mention outright print to accounts. private bank criminal complex allowed to happen by a swamp of criminals in very expensive suites.

simple shit maynard...

USisCorrupt's picture

I would say get out the popcorn and sit back and watch the SHIT show, BUT I do not touch GMO's so it's apples and oranges for me while I can still get them.

And I can't wait to see how much my Crypto Portfolio will be worth in US Dollars by Spring or Xmas of next year, yes I will be a multi-millionaire in US toilet Paper.

Long, physical Silver, Gold, Bitcoins/Cryptos, food & AMMO!

By Owning Crypto's YOU are YOUR own Central Bank!

VD's picture

firstly, a great article. and i agree with all of it. if in 2011 the central planners didn't come in to rescue their very own frankenstein "markets", then we'd of had the great reset pivot off of 2008 in that very year-- who knew they'd go totally unprecedented full-on cntrl +p insane?


secondly, you have to be both delusional and idiotic to think you're your own central bank w/ crypto. what you are in the end is a cashless crypt0-muppet that is even better tracked by gov, or why crypt0 is the Deep State's endgame to condition you to perfect slavery. dummy.

Fester's picture

Oct. 19th 1987 was a Monday.


Your confusing the shopping day "Black Friday" with the market crash.

VD's picture

ur uh u gotta b real dumb to shop on those days-- u might even get into a brawl if u need to grab that last junky teeveee and 5 zombies want it too.... i think ur confusd motoscrotum.