The Devil’s Triangle
April 19, 2025 – Weekly Comment
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On Sept 1, 2000 SPX closed 1521, testing the all-time-high earlier in the year of 1527 in March. Fed Funds were 6.5%. By April 3, SPX had declined 27% to 1107. Nasdaq fared much worse: from Sept 1, 2000 to April 3, 2001, it was crushed …down 66%. Starting at the turn of the year, the Fed aggressively cut in a series of 50 bps, right in the beginning of Jan ‘01, then Jan 30 and March 19. (At the time of the first cut, Nasdaq 100 had already dropped over 50% from the March 2000 peak, but SPX was down less than 20%). Fed funds were now 5%. I was on the trading floor working for Refco, and there were no rules against trading your own account. I was long a bunch of April calls on the June’01 contract, which expired worthless on April 12. Easter was April 15. I had thought the Fed would ease again, as Nasdaq was imploding, but I got the timing wrong. The bulk of my position had expired worthless, but I had a few calls further out on the curve as well.
The next week I was on the phone with Mike Spencer, an upstairs broker in NY. He was buying clips of the September contract, a couple of hundred at a time. It was a slow morning, and he said, “Sorry to keep the line open, I’m not sure if this guy is done yet.” I said, “No problem, I’m here as long as you like. We’re not busy.” The next thing Spence said, in a completely normal but slightly surprised voice is, “The Fed just cut.” Click, line was dead. I flashed an order into the June contract to buy 20 lots. It was very quiet and Julie, one of Donny Lanphere’s clerks, just gave me a bored look and started to turn into the pit. At the top of my lungs I screamed “BUY ‘EM”. I was probably 35 to 40 feet away from the pit as the Refco booth was at the top tier; I think there were three or four levels descending to the pit level. One or two seconds elapsed from the time Spence said ‘cut’ to my yell. But in the next second the floor absolutely erupted. If you’ve ever been on a trading floor when nothing is going on, and the phone rings, it’s kind of loud. Within seconds every light on our phone pads were blinking like a Christmas tree, but the sound of the rings was overwhelmed by the roar of the pits. The floor was physically shaking. Think of the biggest play in the biggest sporting event you’ve ever attended and that’s the volume. I think the June contract was instantly up 30 or 40 bps, and even though I was on two phones and buried, I remember thinking, this is either going to be a very good day or a disaster. I had entered my order at the market. If I was filled +30, there was no recourse. I wasn’t. When the cards (fills) came back to the desk over the next hour or so, my price was exactly where we had been.
When you tell a story, have a POINT, right? In the grand scheme of things the above tale is small potatoes. I didn’t have a lot of money in my account where I could have done 100 contracts. However, it was the only time I was ever first. I didn’t know if the news I heard was true in that split second but there was no hesitation. Just reflex. The second reason I mention it is because the time of year is the same, and I believe underlying conditions are similar. Emergency ease? No. But I maintain that odds of ease in the near term are much higher than the market is pricing.
When Trump fires Powell, I am going to hit a bond bid. But I am not going to be first. And I am confident bonds will be crushed. So, this now all takes a bit of strategizing. Safe to buy bond puts before the fact? Even though vols sharply compressed this week premium is still expensive. What if it doesn’t happen? What if it does and stocks crash too, sparking a bond reversal? Probably need to scale in delta hedges. How likely is it that Powell is actually removed? The May FOMC is two and a half weeks away. If there’s no ease, Trump will be apoplectic. If there is a cut, bonds will still sell off, at least temporarily.
I’ve been expecting an ease at the May FOMC. But now that Trump has publicly ratcheted up pressure on Powell, I don’t think it will occur, even though financial conditions have tightened rapidly. Economic uncertainty is obviously increasing. The inflationary impact of tariffs is going to be meaningless if the economy tanks.
When I was in college, I took a class about Keynes’ theories from Robert Eisner, a famous economist. I don’t remember a lot from my studies, but a couple of things from that class stuck with me. Here’s what (I think) I learned: Inventories don’t necessarily equal intended inventories. That’s it. At the time, classical economists would argue that excess production/unsold inventories would lead to price cuts, employment would fall, but interest rates would fall as well, to a level that would encourage new activity. It was all a self-correcting mechanism. Keynes identified a possible problem: a liquidity trap, where lower rates wouldn’t generate new activity. Keynes realized there could be a self-perpetuating negative feedback loop. This was where a temporary increase in gov’t spending came in, to stop the doom loop. Now we hear ‘Keynes’ and the negative connotation is simply that more gov’t spending fixes everything. That wasn’t the original thought.
The next idea is, I believe, attributed to Milton Friedman: When considering an economic decline, first, the problem needs to be identified. Then, plans to address the shortfall need to be considered. Then policies are implemented. Each step necessarily entails lags. By the time action is taken, the original issue has likely run its course, and the policies now create new problems. A non-discretionary model is therefore the best solution.
Another concept that is, perhaps, most applicable to today is John Mauldin’s ‘fingers of sand’ paper. A scientist computer-simulated sand hills, randomly dropping one grain of sand at a time on different parts of the pile. He found that internal ‘fingers of instability’ would become buried in the pile, but there was no way to model which grain of sand would ultimately cause the collapse. The only clear thing was, the bigger the sandpile, the more likely one of the fingers would buckle, causing destruction. And, there are always unstable fault lines under the surface.
I had seen Charlie Rose interview Lloyd Blankfein, where the latter said Goldman’s real strength is risk management: Considering the probability of many scenarios before the fact, identifying which was most likely, and therefore being ready when one or another started to play out.
To tie this up: First, I still think we’re close to the last grains of sand which could create severe instability. It’s hard to get the timing right, as my worthless calls story at the top of the page attests, but it’s essential to game the possibilities. Second, in terms of unintended inventories, one might now say that’s impossible given instant knowledge of demand, supply chains, etc. How can physical inventories get out of hand in the aggregate? But that’s not where we are anymore. In my opinion, inventories are huge projects costing billions of dollars. Intellectual capital. The uncertainty regarding tariffs, the downward trend in global trade, the pullback (at the margin) of gov’t support…all of these things figure into the ‘inventories’ equation (for me, anyway). I THINK I know that fiscal support is eroding. I think the Fed will ease more aggressively to try to mitigate the uncertainty. But Powell now seems to be leaning more toward Friedman. ‘We’ll ease further when the model (hard date) tells us. We’re not going to be super-discretionary and take our cues from the plunging anecdotal data like the Philly Fed and confidence surveys. The two variables of unemployment and inflation haven’t come together for us yet.’ It always used to be that the Fed said we’ll adjust policy proactively, otherwise we’ll be behind the curve. That has always been the Fed’s defense AGAINST a rules-based policy. I believe Powell is leaning towards rules now as a shield against Trump’s attacks.
There’s one other famous economist (apart from Trump) that I’ll mention: Recep Tayyip Erdogan. He had thought it was a good idea to replace his central banker with his son-in-law. Or maybe that was the finance minister. Barely matters. He’s changed the central bank chief several times. From 2020: Erdogan has called for rate cuts, refuting established economic theory that high rates can rein in inflation. Last weekend he described interest and exchange rates and inflation as the “devil’s triangle”. The lira continues to spiral down the nine layers of hell.
The Devil’s Triangle. I love that. It’s a LOT better than the Mundell-Fleming Trilemma (or impossible trinity). “Look, it’s the DEVIL. We’ve got to try some new stuff.”
Beige Book Wednesday. Twos, fives and sevens auctioned starting Tuesday.
Q1 GDP advance on April 30. Payrolls May 2. FOMC May 7.
| 4/11/2025 | 4/17/2025 | chg | ||
| UST 2Y | 395.0 | 379.4 | -15.6 | wi 377.7 |
| UST 5Y | 416.0 | 393.5 | -22.5 | wi 393.8 |
| UST 10Y | 448.0 | 432.7 | -15.3 | |
| UST 30Y | 487.0 | 480.6 | -6.4 | |
| GERM 2Y | 178.9 | 168.6 | -10.3 | |
| GERM 10Y | 257.0 | 247.2 | -9.8 | |
| JPN 20Y | 232.8 | 223.6 | -9.2 | |
| CHINA 10Y | 166.4 | 165.4 | -1.0 | |
| SOFR M5/M6 | -64.5 | -90.5 | -26.0 | |
| SOFR M6/M7 | 13.5 | 10.5 | -3.0 | |
| SOFR M7/M8 | 23.5 | 25.0 | 1.5 | |
| EUR | 113.55 | 113.85 | 0.30 | |
| CRUDE (CLM5) | 60.90 | 64.01 | 3.11 | |
| SPX | 5363.36 | 5282.70 | -80.66 | -1.5% |
| VIX | 37.56 | 29.65 | -7.91 | |
| MOVE | 137.26 | 114.64 | -22.62 | |
