The Liz Truss moment, which saw the bond market dispatch a British prime minister in 2022, is considered a black-swan event.
Over the last month, as Donald Trump’s erratic pronouncements have roiled equity, dollar and bond markets, the world came closer to a repetition than has been recognised.
The first incident occurred in the aftermath of Liberation Day on April 2. The breadth and randomness of Trump’s tariff war, aimed at more than 90 countries, shook markets.
Attention was focused on the sharp correction in equity markets. That’s not surprising because it was an arrow aimed at our pensions and savings.
More worrying action was on the bond markets. Soaring yields for ten-year and 30-year US Treasuries and the sharp weakening of the dollar reflected deep-seated turmoil.
Bond markets are regarded as the safest place to shelter in times of trouble. No longer. They have become the playground for Wall Street’s macro hedge funds.
Erratic: The breadth and randomness of Donald Trump’s tariff war, aimed at more than 90 countries, shook markets
In the US and in Britain, hedge funds, such as Ken Griffin’s Citadel, have become dominant players.
They are the biggest bidders at auctions of US Treasuries and gilts. They have also effectively become market makers outside direct regulation of central banks.
The return on bonds can be increased by the use of complex derivative strategies such as the liability-driven investments (LDIs) used by UK pension funds.
When markets go haywire there is an enormous rush to liquidate positions and this is precisely what happened after Liberation Day.
The unwinding of positions caused the dollar to plunge and central banks were ready to activate currency swaps if matters spun out of control.
There was concern that some highly leveraged hedge funds might be caught out by the storm and be in danger of failure.
The only comfort for the authorities is that robust capital buffers, put in place after the Great Financial Crisis, mean the banks were not endangered.
At this point, Scott Bessent, the US Treasury Secretary, managed to get to the President and persuade him to call a temporary halt to his trade wars or watch financial catastrophe unfold.
Trump took the advice which had been offered several days earlier by hedge fund guru Bill Ackman, a Trump funder, who advocated a 90-day freeze on the ‘reciprocal’ tariffs.
A general 10 per cent tariff on imported goods to the US and levy of 45 per cent on motor vehicles and steel remain in place.
In the last week there was another black swan after Trump threatened to terminate Jay Powell, chairman of the Federal Reserve, having branded him a loser.
Bond markets went haywire and again complex derivatives, financed by borrowing, threatened a cascading crisis. Again it was a case of Bessent to the rescue.
The Treasury Secretary hovered outside the Oval Office until other advisers had gone and counselled the President that he had to act fast to secure Powell’s position or face market calamity, which could bring Wall Street tumbling down.
Trump obliged, saying he had no intention of firing Powell. Crisis over.
These alarming events have shone a fresh light on the oversized risks of under-regulated hedge funds in managing financial stability.
There is now rising anxiety on Wall Street as to who, other than a Trump cypher, would want the Fed job when Powell’s term expires next year.
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This article was originally published by a www.dailymail.co.uk . Read the Original article here. .