Minsky Moments

Minsky Moments

A Minsky moment happens when a long period of stability encourages a diminished expectation of market risk. That, in turn, encourages excessive risk taking using borrowed money. Eventually, crisis occurs, which is the Minsky moment, when losses are realized and forces deleveraging. As an example, the 2008 crisis is often considered a Minsky moment, generally centered on housing.

Last year, we had a period where a large number of people tried to hedge away risk. As we’ve talked about before, when a large enough proportion of people try to hedge away a risk, that insurance reflexively helps prevent a real crisis from happening. Instead, we largely got a restrained and contained move down.

This year, people have eschewed protection. Instead, they seem to have decided that they’ll largely only buy very short-term protection, particularly for one-day events like CPI and significant economic reports. Thus, we’ve seen a rise in 0DTE options.

The thing is, the risk hasn’t gone away, it’s only been transferred. Or, in this case, hasn’t been transferred. What if we get a sustained period of problems? I’m not even positive we’d need all that big of a shift. I don’t think the world has changed, and an unhedged market is traditionally one that’s at risk.

Looking forward, just in the next two weeks we’re going to see Powell Congressional testimony, JOLTS, jobs, CPI, PPI, retail sales, and OpEx. Can we do as we have done lately and keep ignoring the data that happens on any given day? Maybe, but I think that’s easier when volatility is somewhat elevated, rather than near YTD lows.

What we’ve seen instead is this rolling volatility, where volatility edges up to highs, sending the market down. Then, volatility gets pushed down a bit and the market recovers. Rinse and repeat. Even if we just keep following that pattern, we should at least expect stocks to trend down in the weeks ahead.

Could we break out of that pattern? It seems likely we will, eventually, but I freely admit that it’s a little hard to know just when. In my mind, the odds of an eventual recession are extremely high, but it seems likely that event is months away. Can we just keep drifting sideways until then?

I tend to doubt that. While we got quite a boost from the Treasury in terms of a heavy January T-bill issuance, that ship has sailed. Now, the market is once again acting starved of T-bills, which is sending money back to the RRP facility. That party seems over. In fact, once we deal with the debt ceiling debacle, the Treasury will refund itself, which will actively take liquidity out of the market. That’s likely to hurt.

In general, we still have the pain from QT and higher rates. That involves long and variable lags, so we haven’t seen the full effect of past cuts, and we’re still hiking rates. Considering the historic, worldwide round of rate hikes we started last year, would it be so crazy to consider the slowdown’s ferocity may end up surprising many?

My broad point is that the best point to hedge is right before others start hedging, and the best time to worry is before others start to worry. Does complacency seem appropriate right now?