Two weeks back, after explaining what the “hierarchy of vulnerability” for markets will likely be going forward in the event the proximate cause of market turmoil continues to be geopolitical in nature (e.g. trade war jitters), Deutsche Bank’s Aleksandar Kocic outlined how the Powell Fed is attempting to reassert policymaker control over the normalization process.
Essentially, Kocic framed things in terms of curve dynamics where the post-crisis period has been dominated by abnormal “explosive rates dynamics” or, more simply, shocks manifesting themselves at the back end. To wit:
For more than seven years after 2008, bear steepeners and bull flatteners were dominant modes of the curve — while short end hardly moved, back end articulated response to market shocks. These two modes of curve response were effectively a referendum on success of stimulus.
The explosive process does not present a problem as long as the front end is in a “sleeper” mode, but as soon as it starts moving – when rate hikes commence – the risk of the long end getting unhinged becomes a problem.
Kocic ties this to the “breather” discussion as articulated last month. To wit:
Every violent bear steepener has been encountered with an appropriate response of the short end of the curve causing a gradual flattener in such a way to shift the action closer to the front end. This is the “breather” mode of the curve. Effectively this was an attempt to recalibrate rates market and remove the risk of “exploding” back end. As a result, with time the bear steepening eruptions became less volatile and more limited arguing in favor of Fed’s success in their effort.
Now, the Fed appears to be trying to take control of their own destiny (i.e. gain some level on control over the possibility that the tail risk associated with a disorderly unwind of the bond trade is realized). “Instead of risking that markets raise rates, they are taking control of that process,” Kocic wrote, a couple of weeks back.