Macro

(New York)

As the ten-year anniversary of the last crisis has arrived this month, it is a fitting time to be thinking about what might cause the next one. In fact, many investors, professional and retail alike, are fairly obsessed with calling the next big blow up. But what might cause it? While trade war and political strife grab a lot of headlines, the real driver of the next crisis will be the Fed. The two big worries on that front are rising rates, but perhaps even more worryingly, its shrinking balance sheet. Crises have historically happened when money supply grew tighter, and that is what is occurring right now.


FINSUM: The markets have never been through the winding down of a major QE program, so it is hard to foresee how this may playout. Logic says that the next big blowout will probably be tied to the end of easing.

(Washington)

Investors may not realize it yet, but the Fed is in a quite pickle: damned if they keep hiking, damned if they don’t. In what is being dubbed a potential “Dollar doom loop”, the Fed might create a cycle of excessive Dollar strengthening if it keeps hiking. This may cause an overseas debt crisis as many foreign borrowers, especially EMs like Turkey, have issued excessive Dollar-denominated debt. This would in turn put stress on Europe. Additionally, the strong Dollar strengthening would start to hurt US corporate earnings and exports, in turn weakening the economy and possibly causing the Trump administration to move to artificially weaken the Dollar. That said, if the Fed quits hiking, it risks the economy, which is already hot, quickly overheating.


FINSUM: This situation is very real, but luckily we think there is a pretty simple solution—only proceed slowly with hikes. It should be enough to keep the economy in check (given inflation is not high), but not so much as to send the Dollar surging (imperiling foreign borrowers).

(Rome)

Investors in stocks will be familiar with the market’s habit of focusing on an issue for a week or two, getting anxious, and then moving on almost completely once things looks even half-resolved. That is exactly what happened with Italy’s debt crisis a few months ago. However, this problem looks likely to rear its ugly head again. Italy is the third largest debt market in the world, and its looks dangerously close to imploding. That may be why Trump offered Italy funding to help its situation. The big fear is a near-term budget vote where the country’s parties are considering a package that would offer a flat tax rate and universal income for the left, all while ballooning the deficit to 7% of GDP, way above the EU limit of 3%.


FINSUM: Italy is currently led by a pair of parties that hate the Euro, so it seems likely that they may tempt fate with this kind of package. However, there is a potential compromise in the works.

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