Liquidity Trap

The Fed has finally painted itself into a corner. After several years of pumping up its balance sheet and instituting ultra-low interest rates, the Fed’s first and only attempt to reverse this policy was thwarted by a stock market sell-off at the end of 2018. Wonder why? The chart below shows that the globe is awash in central bank debt monetization (sort of) which has pumped up financial assets.

SNB: Swiss National Bank BOJ: Bank of Japan ECB: European Central Bank BOE: Bank of England PBOC: People’s Bank of China Fed: US Federal Reserve

All of this liquidity ends up being recycled back into risk assets like equities and junk debt. Why did the Fed blink in December? The debt markets locked-up in Q4 where there was zero credit extended to the junk debt market for 45 days (no new issuance). Any longer and there may have been widespread credit contraction which would have resulted in a recession in short order. Yep, it was that close. Thanks, Fed!

This chart shows how credit spreads spiked in Q4 of 2018.

What has changed since my last post two weeks ago? The dovish commentary from the Fed meeting on March 20th inverted the Yield Curve in an abrupt fashion. Translation: the Fed is running out of options and has painted themselves into a corner. The bond gurus are telling us the Fed has made a mistake and kept the liquidity spigot open for too many years. The inversion is a capital call by the bond market on the Fed’s policies – close out the position or it will be taken away from you. It all ends when the markets lose faith in the Fed but we are not there quite yet.

So, let’s look at the current technicals. Despite the gloom and doom perspective above, the stock market may not be done making new highs. Risk assets correlate with the Fed’s policies so we have to keep an open mind. Currently, the S&P 500 is working a corrective pattern which may result in a near term drop of 100 S&P points or more which may present an opportunity for those that are patient:

S&P 500 Index – SPX

The high yield market has also been tracking higher in tandem with stocks – believe it or not:

S&P 500 Vs High Yield Bonds

However, 30YR Treasury bond yields keep falling which indicates a “divergence” over the last month as yields should track higher when stocks rise – not happening.

S&P 500 Vs 30YR Treasury Bond Yields

The bond market is currently bifurcated. Risk free assets such as Treasuries are not buying the Fed’s message and are warning of slowing growth in the pipeline. Conversely, the high yield market will keep the game going as long as the Fed permits extra innings. Without the Fed’s reversal of policy in December, junk bond prices would be plummeting in 2019. But QE’s job is to keep asset prices higher so take what the market gives you and pay no quarter.

Chart of the Week!

Macro Snippets

  • Asia is home to more than half the world’s population and 21 of the 30 largest cities. In 2020, for the first time since the 19th century, Asian economies will be larger than the rest of the world combined. (FT)
  • The amount of government debt with negative yields has vaulted back over the $10 Trillion mark after the Federal Reserve’s unexpectedly downbeat outlook exacerbated concerns over the health of the global economy. (FT)
  • Purdue Pharma will pay $270 million to settle Oklahoma’s claims that illegal marketing of Oxycontin devastated local communities, the first accord in a wave of lawsuits faced by the drugmaker. Three dozen states and 1,600 U.S. cities and counties have similar suits pending against Purdue and two other opioid makers. (Bloomberg)
  • McDonald’s just got in the AI game. They have acquired Dynamic Yield, an artificial intelligence startup focused on personalization and decision logic technology. Now, the fast food chain’s drive-thru menus will be able to update instantly based on things like time of day or weather. (StockTwits)
  • On Monday, unicorn WeWork reported that it lost $1.9 billion on $1.8 billion revenue in 2018!!!! Hello, 1999!
  • The European Nanny State announced this week that all new cars sold in Europe from 2022 onward will have to be fitted with systems to limit their speed. So-called “intelligent speed assistance” systems will come as standard equipment which will force vehicles to travel within the appropriate speed limit. The systems don’t apply the brakes but instead limit engine power. Road-safety campaigners are hailing this as the best leap forward since the introduction of safety belts. This comes on the back of Germany considering imposing speed limits on its famously unrestricted Autobahn highways. (EWI)

That is all for now until next week’s Market Update. If someone forwarded you a copy of this report, you can sign-up directly at


Paul J. McCarthy, III

President – Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.