Front Loaded: China, Volatility, and Debt Deflation

Below are some excerpts from our latest macro note, "Front Loaded: China, Volatility, and Debt Deflation." The full report with the charts and footnotes is on  The key question raised by the comment is this: Do Chair Yellen and the other members of the Federal Open Market Committee actually believe that there is a positive trade-off between the "benefits" of QE and zero rates and the carnage now unfolding in the global capital markets?  

The downside of the social engineering experiment by Ben Bernanke & Janet Yellen is measured in the trillions of dollars, but the benefits seem to be few.  Indeed, the only segment of global society that seems to benefit from zero rates and "large scale asset purchases," to paraphrase Chairman Bernanke, are debtors.  

So was this whole exercise with zero rates and purchases of trillions of dollars worth of Treasury and agency securities simply a delaying tactic to avoid deflation and debt liquidation?  The FOMC says that QE and ZIRP are all about restoring jobs and growth, but when you examine the situation carefully, it seems hard avoid the conclusion that the Fed's actions were really about managing a world that is drowning in a sea of uncollectible debt. 


Front Loaded: China, Volatility, and Debt Deflation

Kroll Bond Rating Agency

January 21, 2016



Kroll Bond Rating Agency (KBRA) believes that the secular shift of asset allocations away from high-yield and leveraged credit, and into more secure government and investment grade credits, will result in lower interest rates as the year progresses – even as the Federal Open Market Committee (FOMC) talks about raising interest rates in its policy guidance. 

Increased market volatility results from changes in expectations for global growth and come at the end of Fed bond market market intervention, euphmestically called “quantitative easing.” The credit bubbles in sectors like energy and commodities created during the period of FOMC market intervention must now necesssarily be unwound. 

Watching the benchmark 10-year Treasury trade through 2% yield confirms KBRA’s earlier judgement that the bias with respect to market interest rates will remain negative for some time to come – regardless of what the FOMC may say or attempt to do in terms of increasing the cost of short-term funding. Ironically, KBRA believes that short-term benchmark interest rates will remain under downward pressure even as credit spreads widen and the process of remediating distressed credits moves forward. 


When financial markets began the New Year 2016, comfortable assumptions about financial stability were dashed by strong selling pressure coming from the Chinese equity markets. This outflow by domestic Chinese investors somehow caused a cascade of selling throughout global equity markets. Many analysts have concluded that worries about forward growth prospects in China are the cause of the selling pressure, but we believe that rising debt levels and central bank manipulation of financial markets are also significant drivers of renewed market volatility. 

The Fed and other central banks have pursued a policy of purchasing hundreds of billions of dollars’ worth of debt securities, action meant to change investor preferences and, indirectly, result in higher growth and employment. KBRA believes that the end of debt purchases by the FOMC, not only selling in China’s equity markets, is now the chief source of instability in the global financial markets, especially given that most other central banks are easing policy as the Fed attempts to tighten. 

The conclusion of Fed securities purchases over a year ago essentially marked the start of a tightening process that has coincided with a sharp decline in demand for commodities and has seen an equally sharp selloff in the high yield debt sector. Former Dallas Fed President, Richard Fisher, describes how the FOMC “front loaded” a rally in financial markets starting in 2009, but now says that the global economy must go through a “digestive period” of lower growth. Fisher specifically opines that one should not blame the equity market selloff on China and that market distortions caused by the Fed are to blame for recent market volatility.

Of note, the just-released 2010 minutes of the FOMC reveal that former Chairman Ben Bernanke unsuccessfully sought to get a consensus to accurately describe QE, namely as “large scale asset purchases.”  Mass purchases of assets, it should be recalled, are fiscal activities that traditionally required Congressional authorization. For example, the government purchase of gold in the 1930s was funded by the Reconstruction Finance Corporation, an executive branch agency created by President Herbert Hoover. 

The market intervention conducted by the Bernanke and Yellen Feds exceeds the scope of past practice by western central banks, which have become de facto fiscal agencies funded not via the debt markets but by investing moribund bank reserves on deposit with the central bank. Significantly, the real economy has not responded to the Fed’s social engineering experiment. Indeed, since 2013 economic growth has gradually slowed so that as 2016 begins the world economy seems on the brink of entering a recession. Many economists, joined by the International Monetary Fund and Atlanta Fed, have lowered forward growth estimates for 2016 and beyond.

To read the rest of the KBRA research note, go to: