I am tempted to use one of the most tired clichés to describe the state of play in financial markets. In his famous book with the same title, Malcolm Gladwell describes a tipping point as “the moment of critical mass and threshold” at which point the parameters and rules of the game—in a market or environment—change radically. As I peer across markets and economies, I am starting to wonder whether we are getting close to just that. The eye of the storm is quite literally the U.S. where the layers of economic and political uncertainty are now so thick that I am not even sure where to start. The tinfoil hat scenario goes something like this. The devastation of hurricanes Harvey and Irma exceed expectations and become a stagflationary hit—negative supply shock and plunge in demand—but the call for decisive action in Washington and the Eccles building go unheeded. The debt ceiling bites right when the economy needs the flexibility the most and the Fed is caught between a rock and a hard place as inflation soars. Pyongyang uses the confusion to show that it means business by firing a missile towards Alaska.
Let’s be clear; this likely is a situation where the dollar and spoos fall in unison and where U.S. bond yields rise. In short, chaos.
The upshot is that if I can come up with this over a beer in the pub on a Friday afternoon, it doesn’t qualify as a black swan. But if we pick the different components apart it is not unreasonable to expect at least a couple of them will become reality. The political situation warns of a nasty inflection point in Washington. The agreement to extend the debt ceiling cliff by three months was hailed as a grand bargain, but it was probably the worst exercise in political can-kicking I have ever seen. If they don’t get their acts together next time, the economy and markets will suffer real damage. Meanwhile, at the Fed, the departure of the sage Stanley Fisher and the near certainty that Yellen’s stint will not be renewed have injected a large degree of uncertainty over what markets are supposed to expect from the Federales. I have to assume that our policy overlords will not drive the car over the cliff, but the risk is a bit too high for my liking.
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