In his latest weekend notes, One River Asset Management CIO, Eric Peters, picks up where BofA's Mike Hartnett left off on Friday when he said that the "QE Monster" will only end when "the Wall Street bubble" finally shocks the Fed. Yes, but what will "end it", or better yet, what will "shock" Yellen and company out of their complacency? To this, Peters' response is that the Fed finds itself in a big "quandary" not so much due to the S&P500, and overall asset levels, which even Yellen now admits "pose risks to financial stability" as per the latest FOMC Minutes, but due to China: “The real credit excesses haven’t been created here, they’ve formed in China, which leaves the Fed in a quandary.” Much as the Fed would like to have jurisdiction over every corner of global finance, they no longer control China. He's right: with rates on various Chinese debt instruments surging in recent months, as Beijing cracks down on shadow banking, any further tightening by the Fed may or may not impact the momentum-chasers that have sent Amazon above $1,000, but it will certainly have a dramatic impact on China's cost of funding, which in turn would unleash the next deflationary shockwave around the globe, sending global rates tumbling once again as the reflationary, rate hike frenzy fizzles, and forces the Fed to promptly cut rates back to zero (if not negative). Here is Eric Peters:
“Classic late-cycle action,” said the CIO. “Vol-compression, loosening financial conditions, and a pain-trade that tilts forever higher,” he continued. “Normally the Fed ends it. Hiking aggressively, flattening the curve, widening credit spreads, and then the economy rolls.”
But this cycle is not quite like the others.
“The real credit excesses haven’t been created here, they’ve formed in China, which leaves the Fed in a quandary.”
Much as the Fed would like to have jurisdiction over every corner of global finance, they no longer control China.
“By closing the capital account, the Chinese once again have complete dominion over their domestic credit machine,” continued the same CIO. “When they were actively opening up the capital account, China relinquished control over their interest rates to the Fed.” The volatility of Jan/Feb 2016 was one of many consequences; a lesson not soon forgotten.
Now that the Chinese have retaken control, economic volatility is more likely to come from within. “The warning sign for real problems will be a material decline in house price appreciation.”
Or, as we explained in March, "Why The Fate Of The World Economy Is In The Hands Of China's Housing Bubble"...