Comments About Last Week’s Treasury Flash Rally

Last week, the 10-year Treasury fell in yield by 9 basis points in three minutes in “frenzied trading.” Yields were hovering around 2.98% and then promptly plummeted to about 2.89% as 100,000 future contracts changed hands, buying predicated upon volatility in emerging market sovereign debt. Some are dubbing this huge advance as a “flash rally.”

Wow! In my view, this emphasizes the illiquidity and the total domination of the Treasury and bond market by technology. I rhetorically ask what happens if there is a sudden shift in inflationary expectations, expectations that are rising but not yet reflected in Treasury or fixed income prices? Many times I have commented about the regulatory forced changes in the trading mechanics of the fixed income market that is further exacerbating this lack of liquidity.

Speaking of liquidity, I believe this will be the next crisis. Will it morph into an economic crisis?

Some are writing the rotation of the FAAMG companies is accelerating. I find this statement suspect given the incredible advance these companies have made over the last 30 months, an advance that was accelerating until mid-last week.

In my view, perhaps one of the greatest risks the market is facing is sudden selling in these shares, selling that commences without any apparent reason, selling that accelerates via ETF and indexing liquidation.

As noted many times, by many measures the percentage these companies comprise of total market capitalization is unprecedented, thus suggesting that there is a lack of liquidity under the simple premise if everyone owns the shares, who is left to buy when selling commences? Additionally, because the absolute dollar price of these companies is very high, any decline (or advance) will have an outsized impact.

A potential black swan is the solvency of a money center bank that is custodian for a large number of ETFs/indexing because of massive selling that creates a liquidity crisis, a crisis partially the result of the lack of transparency in composition and structure of ETFs/indices. This liquidity crisis then morphs into an economic crisis… aka Long Term Capital Management, but on steroids.

Far-fetched? It could be s similar to 2008, but on a smaller scale given the equity markets are significantly smaller than the debt market, the result of the regulatory entities focusing upon speed and cost of execution versus capitalization and liquidity capabilities of clearing houses.

Bank of America wrote yesterday that this week is the most important week of the year. There is response to the G-7 meeting, the Korean Summit, Fed meeting and Brexit votes as well as a strong probability that the ECB will end its QE program. How will the markets interpret these events?

Last night the foreign markets were up. London was up 0.73%, Paris was up 0.19% and Frankfurt was up 0.24%. China was down 0.47%, Japan was up 0.48% and Hang Sang was up 0.34%.