Kevin Warsh forces bond yields higher to cool US economy

Markets (7)

• Jared Dillian's Awesome Portfolio allocates equal 20% weights to stocks, bonds, gold, cash, and real estate. This linear asset mix historically yields the highest Sharpe ratio of any combination Dillian tested.
• Since 1971, the Awesome Portfolio returned approximately 9% annually with half the volatility of an 80/20 portfolio. Its worst historical drawdown was 12% in 2022, compared to the S&P 500's 57% collapse during the financial crisis.
• Dillian argues that holding 20% cash provides crucial option value for future asset purchases while dampening overall portfolio volatility. He notes that conventional advisors fear gold, whereas he finds holding 60% to 80% equities far more concerning.
• Dillian compares the recent liquidation of the $45 billion, highly leveraged Leopold fund to the subprime index gap on February 27, 2007. He views this systemic purge of the crowded memory trade as the starting gun for a bear market.
• Retail investors remain indefatigable, holding onto the belief that equities only go up despite severe drawdowns in technology and memory stocks. Dillian observes that true market capitulation has not yet occurred.
• Dillian is technically bearish on financials, identifying topping patterns in the sector. Instead, he favors defensive sectors like healthcare and consumer staples, which historically outperform when the broader market weakens.
• Precious metals are carving out a long-term bottom. Dillian targets a brief final test below $4,000 for gold, followed by a breakout above $4,250 that will open the way to new highs.

Media (1)

• Financial books are getting shorter to accommodate shrinking reader attention spans. Dillian notes his upcoming book is 50,000 words, compared to his 135,000-word debut in 2011, reflecting an industry-wide drop in average book length.

Fed (2)

• Dillian asserts Fed Chair Kevin Warsh intentionally held rates steady to steepen the yield curve and tighten monetary policy via the long end. This strategy shifts the liquidity burden to commercial banks and reduces the central bank's active economic role.
• Dillian projects that the Fed will not hike rates further, despite market pricing of 1.7 hikes through June of next year. To trade this view, Dillian is positioned long in two-year SOFR futures.

Banking (1)

• Financial sector strength, evidenced by JPMorgan and the XLF trading at highs, typically cushions the broader market. Dillian notes that significant equity market corrections rarely occur when major bank stocks are performing at multi-year highs.

Macro (1)

• The US Treasury's recent coordinated yen intervention with the Bank of Japan marks its first explicit currency action in 30 years. Dillian warns against shorting the cheap yen, citing Treasury Secretary Scott Bessent's successful track record with FX interventions.

Markets (5)

• The AI trade unwind saw Leopold Ashbrer's fund, which grew from an initial $225 million to billions, forced to liquidate its public and some private market positions, with Ken Griffin's Citadel reportedly buying the assets.
• The Host notes that the AI trade's prior growth was heavily driven by leverage, including 3x retail ETFs and Korean margin calls, suggesting that a return to peak levels would be difficult without similar leverage.
• Quinn points out that the first meaningful earnings miss from SK Hynix coincided with maximum leverage in the system and increased short-selling activity by firms targeting large, vulnerable players.
• The Host emphasizes that market price often drives narrative, rather than the reverse, evidenced by varied explanations for the AI trade's decline until leverage liquidations became the clear cause.
• Quinn highlights that while nominal yields across the curve didn't show the full picture, the 30-year duration saw higher real yields, aligning with the argument that the long end has been suppressed by Fed intervention.

Fed (6)

• The Fed, led by Kevin Worsh, paused interest rate hikes with three dissents, despite market odds suggesting a 60% chance of a pause and 40% for a hike, unsettling bond investors with perceived communication issues.
• Nick Timiraos, citing Marabana from Bank of America, characterized the Fed's communication as a 'classic central bank credibility shock,' causing the long end of the curve and stocks to turn as investors doubted the chairman's willingness to deliver further hikes.
• Kevin Worsh's press conference unsettled investors due to uncertainty regarding the Fed's inflation gauge, with Worsh stating his own 'lens is broader' than the official PCE and suggesting the central bank's strategy statement could change.
• The Host argues that Worsh clearly signaled a desire to remove balance sheet accommodation from the long end of the Treasury market to allow free market pricing, which would restrict financing conditions and widen credit spreads.
• The Host asserts that Worsh's strategy implies that allowing the long end to reprice higher by 50-100 basis points, without direct rate hikes, would sufficiently slow the economy and inflation, making aggressive front-end hikes unnecessary.
• Quinn speculates that by avoiding a hike today, the Fed is making a bet that tightening financial conditions through long-end focus, combined with external factors like the Iran war, will stabilize the economy by the September meeting, allowing them to avoid a pre-midterm hike.

Macro (1)

• The Host believes many 'big boosts' to growth, such as the World Cup, 'one beautiful bill' stimulus, and stock market wealth effects, are evaporating, suggesting growth estimates will likely decline over the next two to three quarters.

Politics (1)

• The Host suggests that the current administration has a history of creating volatility events to achieve policy goals and will likely manufacture favorable outcomes, especially as midterms approach, rather than maintaining long-term hawkish resolve.

BTC Markets (3)

• Martial law in South Korea triggered a crypto flash crash, causing a 'reverse Kimchi premium' where Bitcoin traded at a $30,000 discount on Upbit.
• David Hoffman states the Korean panic selling was a desperate grab for liquidity in a closed system, not a critique of Bitcoin's value. Local market makers could not arbitrage the price gap.
• This market decoupling suggests Bitcoin is maturing into a distinct asset class, no longer merely a high-risk proxy for the Nasdaq.

Markets (3)

• Global crypto markets remained largely unaffected by the Korean flash crash, highlighting the growing disconnect between local shocks and global crypto resilience.
• The correlation between Big Tech and Bitcoin is fracturing; Nvidia and other 'Magnificent Seven' stocks show exhaustion while crypto holds its local highs.
• Ryan Sean Adams argues a structural rotation is underway as the 'AI trade' unwinds into the 'crypto trade.' Speculative capital is returning to on-chain markets.

Fed (3)

• Kevin Warsh's potential role at the Fed or Treasury is resetting market expectations for 2025, given his historically hawkish monetary policy stance.
• The market's reaction to Warsh's hawkish signals has been calm, despite high rates typically creating headwinds for risk assets.
• If the Fed maintains 'higher for longer' rates to combat inflation, Bitcoin’s role as a hard-money hedge becomes central to institutional investment theses.

Politics (1)

• David Hoffman suggests Warsh represents a 'professionalization' of Trump's economic agenda. The market prefers a predictable hawk over a chaotic dove.

Markets (5)

• Jim Bianco asserts that bond traders will stop panicking only when the Fed starts panicking; since the Fed didn't panic, the 30-year Treasury yield surged to 5.20%, a 19-year high.
• Consequently, the market pushes yields higher when the Federal Reserve's policy remains too easy, reflecting concerns about rising nominal growth.
• The S&P 500 fell decisively below its 50-day moving average as the stock market struggles to comprehend the Fed's new dynamic of independent voting and the prospect of sustained higher discount rates due to inflation.
• Eric Townsend highlights that large speculators are net short approximately 187,000 long bond contracts, near a 5-year extreme, indicating a fully expressed bearish thesis. A key reversal signal: bonds ceasing to fall on bad news.
• Patrick Szna recommends a bearish put spread on the iShares 20-year Treasury Bond ETF (TLT) to profit from higher yields or hedge existing bond exposure.

Fed (1)

• Bianco observes that the Fed, under political pressure, is allowing its voters to act independently, leading to three dissents favoring rate hikes at the recent meeting and chairman Worsh providing "non-answers" instead of forward guidance.

Inflation (2)

• Bianco argues persistent inflation, now above 3% and exceeding 2% for 64 months, coupled with a strong economy, drives nominal GDP higher. This increases the fair value of interest rates.
• Bianco highlights a "cognitive dissonance" where political polls identify cost of living as the top issue, yet many economists claim inflation is "well anchored," creating disagreement about the persistent problem of 3-4% inflation.

Energy (2)

• Citing Marco Papic, Bianco suggests oil prices are the independent variable driving Middle East conflict; Trump's hawkishness varies with oil at $70 versus $100. The risk of oil becoming a dependent variable due to low inventories is rising.
• WTI crude advanced 40% recently, yet large speculator shorts are near a 5-year extreme (228,000 contracts), and gross longs decreased from 380,000 to 300,000. This suggests oil has further upside potential as these positions adjust.

War (2)

• Modern warfare emphasizes cheap, expendable, iterative unmanned systems like drones, which can achieve stalemates, as seen in the Strait of Hormuz.
• Robert Pap suggests China should learn from these conflicts, noting that drones can inflict prohibitably high economic costs, challenging 20th-century reliance on expensive military systems.