A Deflationary Wave Waiting for Banks to Pull the Plug

02/15/2018 1:45 pm EST

Focus: CURRENCIES

Nell Sloane

Principal, Capital Trading Group

Equity markets will give up some ground. Monetary policy variables are being removed. Add massive corporate and individual tax reductions and a massive debt overhang, then you begin to see how the landscape has truly changed, writes Nell Sloane of Capital Trading Group.

We are going to begin with an observation by JPM’s master quant researcher Marko Kolanovic.

Most of you should know him by now, we often quote his work, last week he said this, “Liquidity shocks may develop and argue that the collision of selling from various systematic strategies and diminished equity liquidity provided by electronic market making in times of stress will produce liquidity crises. In particular, strategies that are selling are those that use realized volatility, correlations, VIX and price momentum as signals to adjust exposure.”

We feel that MK’s response pretty well sums up the nature of what transpired on that NFP payroll Friday and early last week.

It wasn’t the payroll number that spooked the market, it was the wage inflation number hitting 3%.

In January we spoke about the massive need for end-of-month rebalancing from pension funds, which also led to some of the selling pressure in the equity complex.

Although we aren’t sold on the inflation jump, in fact, we will be surprised if it lasts past June. The Fed is widely expected to raise rates once again at the March meeting to a range of 1.50 to 1.75%.

Look, our goal here is not to present to you with a rationale for buying or selling, but present arguments and rational reasons why the market may move a given way at a given point in time. We all know how far the equity markets have come and we all know why they are where they are: central banks.

As of 2018 however, the market’s underpinnings have changed and the Fed is no longer offering continued support.

We spent a decade of TARP, QE-1-2-3, Operation Twist, etc. Now the rollovers have slowed and the balance sheet should start to lose on average $15 billion to $20 billion a month.

So, with that single fact alone we can start to assume the equity markets will give up some of their ground. Those are monetary policy variables that are being removed. Now couple these with fiscal measures such as massive corporate and individual tax reductions and a massive debt overhang, then you begin to see how the landscape has truly changed.


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Toss in the fact that the Senate passed late Friday a budget resolution, avoiding another shut down theatrical debacle. One can see how indigestion has formed with regards to swallowing all these sweeping changes. In regards to all of these fiscal measures and all the praises of budgets, the U.S. Treasury will now have to find to find buyers for even more of its debt. In fact, this year’s debt issuance is set to double last year’s amount, nearing $1 trillion (actually an 84% increase but who’s counting?).

What the hell, is there truly no end in sight? Not really, there are always unforeseen circumstances and even the world’s reserve currency will not be immune. It is at least a good thing the Senate was able to pass a budget deal avoiding another shutdown fiasco, nothing more than political theatrics. OK, we can’t only pick on our irresponsible never-ending debt-trodden government, the people have also been swiping the old credit card unabated.

When you wonder why we don’t feel inflation will pick truly pick up, and remember that what the banks giveth, they can taketh away, and then how will one fund the payments?

Can you say that is a huge deflationary wave that is just sitting out in the middle of the ocean waiting for the banks to pull the plug so it can come rushing in?

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