The Fed played a big game with the markets from 2009 until today.
That game was engaging in reckless policy until something “breaks.”
The problem with “breakage” in the capital markets; is that when something breaks it has a tendency to be swift. Consider Italy. It was considered one of the pillars of the EU since it adopted the Euro in 1999. Because of this, the markets were happy to allow Italy to borrow at stable rates with the yield on the ten year Italy government bond well below 5% for most of the last decade.
Then, in the span of a few weeks, everything came unhinged and the yields on Italy government bonds spiked, rising over 7%: the dreaded level at which a country is considered to be insolvent and set for default. It was only through extraordinary lending mechanisms from the European Central bank (the LTRO 1 and LTRO 2 programs to the tune of hundreds of billions of Euros… for an economy that is €2 trillion in size) that Italy was saved from potential systemic collapse.
My point with this is that when the capital markets “break” due to a loss in credibility, the shift tends to be both swift and violent. I noted before that the yield on the ten-year Treasury is the basis for the pricing of all risk in the capital markets. With this yield being manipulated by the US Federal Reserve to the tune of $45 billion per month, the entire landscape for risk has become distorted.
In this context, what happened in Italy can be extrapolated to risk assets in general: when the adjustment finally does happen (when something finally “breaks” as a result of the Fed’s interventions) it will be a very rough period for the capital markets. And with the Fed having already used the vast majority of the tools in its arsenal creating this environment, it is not clear that the Fed will be able to step in and hold things together as the ECB did for Italy.
With that in mind, we ask, IS the next Crisis at Upon us?
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