Taper Off

"The mother of all evils is speculation--leveraged debt."
--Gordon Gekko (Wall Street: Money Never Sleeps)

A year after announcing QEternity, the FOMC told markets that they are not about to cut back (a.k.a. 'tapering') their rate of bond purchases. The Fed's balance sheet is headed toward $4 trillion in assets. These assets are being purchased with money created out of thin air.

Markets around the world embraced risk in jubilation, with the S&P 500 (SPX) closing at an all time high. Gold shot up nearly $60 on the news.

This is what unbridled speculation and moral hazard look like. As long as the Fed pumps easy credit into the system, then speculators have fuel for buying risky assets on margin (a.k.a. the carry trade). As long as these speculators believe that the Fed has their back, then they are emboldened to make their carry trades ever larger.

This works until either the cost of carry increases or the value of the assets that they have purchased on margin decreases. When either occurs, carry traders sell their positions to close their trades before they lose their shirts. Of course, it is impossible for all of these folks to escape the carry trade unwind phase with their shirts on (see, for example, the 2008 credit collapse).

When carry traders figure this out, we get the elevator shaft once again.

position in SPX