The Real Blow-Ups Happen Later

David Merkel shared a bit of wisdom this morning about the difference between the stuff that blows up at the beginning of a rate hike cycle and the stuff that blows up at the end.

I’ve sometimes commented that at the start of a tightening cycle that those who have been cheating blow up, like Third Avenue Focused Credit, which bought assets far less liquid than the shares of its mutual fund.  At the end of the tightening cycle, something blows up that would be a surprise now, which sometimes jolts the FOMC to stop tightening.  The question here is: what could that group of economic entities be?  China, Brazil, repo markets, agricultural loans, auto loans, or something else?  Worth thinking about — we know about energy, but what else has issued the most debt since the end of 2008?

I agree with David, it’s the really shocking blow-ups that happen later which signal to the Fed they’ve gone too far.

The 2004-2006 cycle was essentially a relentless march of 25-basis point hikes at every consecutive policy meeting – 17 of them with no break in between. This happened after an unprecedented period of ultra-low rates through the post-Dot Com bust / 9-11 era.

Greenspan jammed on the breaks for two full years without letting up to give the earlier hikes time to work their way through the system. This culminated with some of the most spectacular blow-ups in financial history.

I highly doubt that a repeat of the 2004-2006 hiking cycle is what the modern FOMC has in mind.


Seven Thoughts on the Market (Aleph Blog)

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