Hey There Income Hunter,

 

The severity of the losses caused by higher interest rates across global markets has forced bond traders at the top banks to slash their risk.

 

Some trading desks are even refusing to trade with customers if it means holding onto positions for more than a couple of days. 

 

A few of the large bank trading desks, including Goldman, Deutsche, Citi and JPMorgan, are cutting back less liquid sectors of the bond markets i.e. (corporate and munis) in the US and Europe. 

 

Any decrease in liquidity could mean different sectors of the bond markets grinding to a halt. This presents enormous risk for asset managers needing to close positions to meet redemption requests. 

 

This is a must-watch situation because a lack of liquidity is an event that could cause a major spike in volatility and ultimately be the catalyst that forces the Fed to pivot back to QE.  

 

Today, I’ll lay out where the greatest risks lie and their impact on the markets just as QT begins.

 

Illiquidity is the Biggest Concern

 

Bond market illiquidity could lead to dysfunction just as the Fed begins quantitative tightening.

 

Confirmation of this will support my view that the Fed is facing one of two disastrous choices. 

 

• Continuing to tighten to fight inflation and risk a long drawn out debt crisis similar to the Great Depression. 
• Admit they must bail on fighting inflation and revert back to QE and risk hyperinflation while avoiding a debt crisis.  

 

Either path creates greater fear of a government approaching insolvency, which ultimately causes a final capitulation of financial assets. 

 

I have been pounding the table on this Fed dilemma for months and we are approaching the end game for the Fed.  

 

European Volumes Are Plummeting 

 

Trading volumes in European high-yield bonds have been decimated since the beginning of June. The volumes in high-yield fell by half from 28 billion euros in June 2021 to 14 billion euros toward the end of last month. 

 

Trading in US junk bonds fell from $207 billion to $160 billion in the same timeframe. So, I will be keeping a close eye on US high yield volumes. 

 

“Liquidity has completely dried up, and banks are not willing to take any risk on their books,” said Jochen Felsenheimer, a managing director at XAIA Investment in Munich. “Every bank is telling their traders not to make a single mistake, and to avoid that, they’re taking zero risks.”

 

This fear has caused a trend higher in the cost money managers have to pay for insuring junk bonds against their counterparts default.

 

 

Recent Breakout in US 

 

Normally when inflation spikes, it can be fixed by the Fed just simply raising interest rates to slow demand … 

However, when the US total debt is up near $90 trillion, like it is today, and you get a spike in inflation, economic growth slows because consumer demand shrinks from rising prices. 

Now, you have a Fed that is tightening aggressively into a growth slowdown. This is rapidly reducing market liquidity and causing feras of a debt crisis.

For a deeper look into the US liquidity breakdown read Financial cracks in the system. 

 

Bring It Home

 

When the Fed finally admits its plight and pivots to QE, I believe gold, commodities and especially energy and agriculture will outperform all risk assets…

 

However, until the Fed pivots, cracks in the system will continue to build, which favors the dollar, short-term Treasury bonds and possibly gold. 

 

Also, keep an eye out next week for earnings reports, which may be a catalyst for a deeper correction and greater chance for a Fed pivot announcement into the Fed meeting on July 27.

 

In the meantime, don’t forget to check out Mark and Andrew TONIGHT with 5 Stocks NOT to Own.

 

Live and Trade With Passion My Friend,

Griff