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*I've been following with keen interest the recent events and wanted to provide some commentary on the liquidity cliff, safe haven dumps, and pending tightrope course the global economics need to navigate in order to execute a smooth transition without a mass financial disaster unfolding.*
*Needless to say, it's been fascinating, and this has left me putting my driveway that needs a clean, and organising a structural engineer for my house on the "next week" backburner.*
So what's new?
**Key points:**
\- Fed Chairman Warsh appointment: President Trump nominated Kevin Warsh on Friday. He is a known hawk; his appointment signals a loss of the Fed as a buyer of last resort, tending toward short-term interest rate drops while maintaining long-term raised rates and strong Dollar rhetoric.
\- Treasury Secretary Bessent provided verbiage on Wednesday, January 28, stating the U.S. is not planning to intervene, indicating a significantly reduced likelihood of U.S. support in the USDYEN crisis.
\- The Yen reached a critical low point this week, testing the 158-159 range (closing Friday at 154.73). Any further drops become an un-ignorable domestic cost of living issue, and intervention becomes practically mandatory past 160.
\- Tokyo inflation CPI released on Friday proved cooler than usual at 1.5% (down from 2.0%), virtually ruling out interest rate hikes and Yen strengthening via Bank of Japan (BoJ) rate intervention, as rates remain pinned at 0.75%.
\- US Bond yields are skirting the dangerous 5.0% line (the 30-year ended Friday at 4.87%), a threshold past which mortgages and the market suffer immense stress and collapse.
\- Quarterly Bond issuance is imminent; the U.S. Treasury will release its financing requirements on Monday, February 2, with auctions to follow.
**The crossroads?**
The carry trade needs to unwind, as the path of least resistance for the Yen is upward, whilst the path of least resistance for the USD is downward. However this needs to occur in an orderly fashion to prevent financial system collapse.
**Avenues?**
A. The Fed could print USD to buy Yen, however Warsh as an appointee reduces this likelihood, with White House rhetoric indicating nil intervention and placing the burden back on the Japanese.
B. The Japanese could raise rates to strengthen the Yen, however recent economic figures (1.5% CPI) rule this out as a short-term possibility, and raising rates would trigger a more violent unwind.
C. The Japanese can directly intervene in the currency, via deploying USD cash reserves of \~$160.4 Billion (held as deposits at the Fed), or selling T-bills/notes/bonds from their $1.003 Trillion stockpile to buy back Yen.
As far as we can see options A and B appear largely off the table for now, leaving the most viable being option C.
However the three various methods there have their advantages and disadvantages.
A T-bill (short-term), T-note and bond (long term) sell off by the Ministry of Finance would cause diplomatic rows, and send US Bond yields soaring, sparking a severe risk of US economic collapse, particular in longer term treasuries. Whilst this provides Japan with a surefire way out of the Yen concerns it would ultimately result in ruin of the US markets, spark a deep recession and sever economic and diplomatic ties and create a rift in the G7 alliance.
This is the current risk being priced into the markets as hedge funds, banks and other financial institutions derisk their holdings, crypto typically first, high risk stocks, and then precious metals (as seen in Friday's sharp gold sell-off).
As I may have previously commented hedging into a parabolic, even for gold and silver, is seldom a good bet. Institutions bought early and have dumped it onto retail, as cash (USD/EUR/YEN) currently rules king as the default margin loan repayment vehicle. I suspect metals will find a floor, however commodities are not my turf so I'll let others do the deeper commentary there.
**The remaining option?**
There is a tightrope to be walked where everyone walks out unscathed and the market recover.
The sell off of USD cash reserves by the Japanese MoF, strengthening the Yen, triggering a short squeeze and liquidation cascade of short sellers, and returning the Yen to a place of value where domestic interests are aligned, whilst also not crushing the carry trade.
Here the US yields remain minimally perturbed, the carry trade is not crushed and can slowly unwind, and global stock markets grind on higher.
However what happens next remains to be seen, and the massive risk of anything other than this balanced tightrope is currently being priced in as institutions move to cash to mitigate margin calls.