Weekly Commentary: Normal Deleveraging And Trade Wars

2025-04-14 06:48:32 ET

Summary

• Deleveraging gained powerful momentum early in the week, with global debt markets at the cusp of seizing up.
• August deleveraging was thwarted by Bank of Japan comments on August 6th, soon followed by a dovish pivot by Chair Powell at Jackson Hole.
• Barring global markets seizing up, deleveraging will be an ongoing challenge over the coming weeks and months.
• Ten-year Treasury yields spiked 50 bps this week, the largest weekly jump since the week of August 16, 2001.

Deleveraging gained powerful momentum early in the week, with global debt markets at the cusp of "seizing up." 90-day Tariff Pause.

April 9 - Bloomberg (Hadriana Lowenkron and Daniel Flatley): "Treasury Secretary Scott Bessent played down a selloff in US Treasuries, saying that there was nothing systemic at play, and also served warning against China not to attempt to devalue its exchange rate in retaliation for American tariff hikes. 'There's one of these deleveraging convulsions that's going on right now in the markets,' Bessent said on Fox Business, adding that he'd witnessed those very often in his decades-long hedge-fund career. 'It's in the fixed-income market. There are some very large leverage players who are experiencing losses - that are having to deleverage'… 'I believe that there is nothing systemic about this - I think that it is an uncomfortable but normal deleveraging that's going on in the bond market,' Bessent said."

"Bond Market Turbulence Lifts 30-Year Yield Most Since March 2020." "US government debt sells off as hedge funds cut down on risk." "Is China dumping U.S. Treasuries?" "Bond Analysts Debate If China Had Role in Treasuries Swings." "Bond Markets Retreat as US Treasuries Lead Yield Jump Worldwide." "No Emerging Market Is Spared From Trade War Losses on Dollar Debt." "Asian Stocks Tumble Most Since 2008 on Global Recession Worries."

There was nothing "normal" about this week's deleveraging - nothing if not systemic. At week's end, an optimist might think this was just another bout of instability soon to be forgotten. There was the October 2022 Liz Truss deleveraging fiasco. March 2023 saw the bank run eruption and mini crisis. The more germane deleveraging erupted with the unwind of yen "carry trade" leverage back on August 5th, 2024.

August deleveraging was thwarted by Bank of Japan comments on August 6th, soon followed by a dovish pivot by Chair Powell at Jackson Hole. As markets recovered, the narrative immediately shifted to, with yen "carry trade" leverage unwound with minimal impact, the coast was clear to get back to leveraging and speculating.

I was skeptical of the whole unwind narrative. There was likely a significant unwind of currency and swaps positioning. But there was no way the massive leverage in higher yielding debt instruments (funded with cheap yen borrowings) could have been unwound over a few days or even weeks. Such deleveraging would have been systemic and deeply impactful to global market liquidity. I actually believe that unwind is ongoing. It's worth noting that local currency Brazilian 10-year yields increased 350 bps between August and year-end, to 15%. Yields were up 100 bps in Mexico, 200 bps in Colombia, and 300 bps in Turkey.

A Friday WSJ (Jon Sindreu) article captured today's deleveraging fears: "The basis trade, said UBS strategist Michael Cloherty, has 'become the scary monster under the bed that gets blamed for everything.'" There are all varieties of leveraged speculation in myriad instruments across fixed income in the U.S. and globally. Leveraged speculation has proliferated for decades, and it's reasonable to think in terms of tens of Trillions of leverage globally.

There was stress almost across the board this week, including "carry trades" and "basis trades" and especially the "swaps" derivatives marketplace. Barring global markets seizing up, deleveraging will be an ongoing challenge over the coming weeks and months. This week was merely a notably rocky start to the process, and I doubt much progress has been made in unwinding the massive "basis trade" in Treasuries. There are a few dominant "basis trade" operators that won't be able to come out of their positions without Federal Reserve assistance....

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