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Trader: “The Whole System Is Massively-Skewed One-Way Around In Risk”

Courtesy of ZeroHedge View original post here.

Authored by Richard Breslow via Bloomberg.com,

Can markets have upsets? Of course. We periodically see them and everyone gets terribly upset. But as much as we tend to couch them in terms of news or economic factors that have been historically significant, they are the result of one major cause. Over-leverage. And while there are certain, and obvious, risks associated with having too much debt, it doesn’t only happen in easily measurable forms, that are the favored metric of academic discussion. The entire system has been encouraged and incentivized to be massively skewed one way around in risk. Which, taken as a whole, amounts to the same thing as being over-leveraged.

Reports of the problems of too large of a debt burden being recognized and, in some cases, being addressed shouldn’t provide a great deal of comfort. You don’t have to be a bank to have tremendous potential influence on market direction and the scale of risk premiums. And every time risk goes bid for any extended period of time, simple competition forces these players to layer on bigger positions to catch up or stay ahead of the pack. Once in a while, there is a need or desire to lighten up and there just isn’t any place to go. Chasing P&L works in both directions.

That’s the bad news. The good news, if you want to sleep at night, is investors know that the only people more concerned about this reality than they are, are the central bankers. What they worry about is, can they stop it if the snowball really gets rolling down the hill. And the further we go down the rabbit hole of extreme policy there is a growing realization that the best way to prevent that is by doing their best not to let it get started.

Reasons for being negative on equities, term premiums, credit or emerging markets are well documented and logical. Except the time for those trades just hasn’t yet come. When it does, it will all make perfect sense, but not when the prevailing attitude of those in charge remains, “not on my watch.”

There’s a reason, not an all-together good one, that equity indexes keep trying to take a look at all-time highs. And why the trade dispute takes on a significance that goes beyond the simple math of the growth drag. Those calculations, by the way, did not serve us well as this issue was beginning to explode. We didn’t need to be told not to worry. But that was standard operating procedure while it worked.

If one needs a reason to be concerned about existing positions, it isn’t that corporate earnings growth is suspect or negative interest rates are becoming exposed as absurd. We should all know that. It’s that the group of policy making dissenters is growing more vocal. And one day their message will resonate. They can’t be dismissed forever as merely virtuous signalers. Germany has company. And fiscal headroom.

ECB President Mario Draghi came out blazing on Monday pushing back against Governing Council members who criticized the outcome of the last meeting. He warned starkly that such public dissent could harm the euro-area economy. And he’s right. Sort of. But the risk is whether the forward guidance that accompanied it will be believable indefinitely. And if the market then decides these risk trades are becoming risky.

There is a very practical reason that the council is trying to lock incoming President Christine Lagarde into decisions she didn’t preside over. But, ironically, she has a greater ability than any of her predecessors to create a political consensus for reform. Which will ultimately be the best thing for Europe. But not necessarily for bunds or the Stoxx 600. And global markets tend to be most comfortable moving together.

We were always assured that implementing extraordinary monetary policies was the hard part and normalizing would be done on autopilot. How untrue is that going to be. One became intoxicating and the other the hangover.

 


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