The opiate of investors has been central bank liquidity. The degree of stimulus has been unprecedented. But, as BofAML notes, never was so much invested, by so many, on the view that the Fed would stay “behind the curve”. It seems – based on gold, credit, bonds, and EM – that no longer can be guaranteed (despite the ongoing anti-Taper jawboning by every Fed head and mouth-piece). It is clear that liquidity withdrawal will not be painless and will sustain higher volatility and BofAML sees two big risks this summer – a market event and/or a macro event.
We see two big summer risks to our core view:
A marked deleveraging of bond positions driven by private clients, a new “LTCM” or EM central banks (driven by a Chinese credit crunch), which would likely have negative knock-on effects to risk assets until policy makers could once again be forced to intervene (QE4 to save Treasuries?).
The best barometers of such risk are funding measures such as Libor and the BofAML MOVE Index.
Rapidly rising rates are a risk to the US housing recovery, the lynchpin of recent US macro momentum. As the chart below shows, higher mortgage rates have arrested the recent improvement in purchase mortgage applications. This bears watching in our view.
Refi activity, as would be expected, has been negatively affected, but if purchase demand falters in coming weeks, that could be a more concerning trend.