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The Fed Sends Swap-Line to Switzerland

October 17, 2022

Volatility is still the norm in financial markets as the S&P puts together one of its biggest reversal moves in history. The CPI inflation numbers came out last week (Thursday) and surprised to the upside – meaning the Fed’s interest rate increases over the last few months haven’t tamed inflation. The stock and bond markets opened much lower on this news – testing new lows for the year by many measures – but then rallied all day. Short covering in the bond market started the asset markets higher, and by the end of the day closed with stock indexes exploding higher with the short covering spilling over into the stocks.

The rally turned into the fifth largest inter-day turnaround in market history. However, the markets gave most of the gains back of Friday. One important thing to note is that much of the selling was new hedge fund short selling which should set us up for another short covering rally down the road. Veteran traders are describing the underlying conditions of the financial markets as “broken” as liquidity has dried up exacerbating the volatility. The variables influencing the market now are widespread – all the way from U.S. company earnings reports to Fed announcements/rate hikes, inflation numbers, nuclear weapons threats and supply chain disruptions…you get the idea. At this point no one knows where this is going – but more volatility is a good bet.

Weeks ago, we mentioned that it appeared the world’s central banks had actually broken something with the gilts in the UK. The Bank of England came into the sovereign bond market and backstopped the pricing of gilts in order to “avoid a Lehman moment.” Basically, they implemented a focused Quantitative Easing in the sea of quantitative tightening that is happening worldwide. That took pressure off many different asset markets worldwide, but the question remains – how does this situation not get progressively worse as central bankers continue to add to the mountain of bad debts?

The next obvious question is – when and where will the next event occur requiring the “lenders of last resort” to come piling in and save the day. Well now we have the answer to that question, and it comes from Switzerland. As it turns out, for the second time since Oct 5th, the Fed has lent money through a swap line with the Swiss Central Bank. Between the two more than $6 Billion has been lent. This is the largest swap line rescue of short-term money needs in history - and it begs the question why in one of the best economies in the world has another crack in the dam shown? Most guesses suggest that it is Credit Suisse that is having issues and with an entity of that size and complexity it is unknowable how bad things can get…

So, the world’s central banks had the accelerator to the matt for the last decade and a half pouring good money/credit after bad. Now they are stomping on the brakes and things are flying through the windshield. The strength of the U.S. dollar is the real threat to continued asset market damage worldwide. Take a look at the dollar index’s long-term chart…

The dollar is the grease of the economic wheels for the whole planet and the Fed is between a rock and a hard place trying to keep economies running and still taming inflation. Higher interest rates push the dollar higher vs currency alternatives. Logic says that interest rate increases can’t continue much longer, but with inflation numbers still high we don’t know how the Fed will respond. The only silver lining is the inflation numbers from an American perspective are nearly benign compared to most of the rest of the world.

Markets are showing some panic due to this for good reason. Short term option trading has turned into a wild casino, and no one can be confident how this will end. Bank of America, Chief Investment Strategist Michael Hartnett has a favorite saying for when critical phase shifts take place in the market, "Markets stop panicking when central banks start panicking."

Lighten up if you have too much risk, never sell your gold and stay tuned…

Regards and good investing,

Greyson Geiler