All posts by NY Times Bestselling author Lawrence McDonald

Larry McDonald; founder of THE BEAR TRAPS REPORT investment letter, is a political policy risk consultant to hedge funds, family offices, asset managers and high net worth investors. As former Managing Director, Head US Macro Strategy at Societe Generale, he's a frequent guest contributor on Bloomberg TV, CNBC, Fox Business, and the BBC. Larry is a NY Times bestselling author, his book "Colossal Failure of Common Sense" is now translated into 12 languages. He ran a $500 million proprietary trading book at Lehman Brothers, made over $75 million betting against the subprime mortgage crisis and was consistently one of the most profitable traders in the firm. His "Bear Traps" letter is one of the most highly regarded on Wall St. He's participated in 3 major financial crisis documentaries: Sony Pictures, Academy Award winning documentary the "Inside Job," BBC‘s "The Love of Money" and CBC‘s "House of Cards." He's delivered over 72 keynote speeches in 17 different countries, at Banks, Investment Firms, Conferences, Law Firms, Insurance Companies and Universities.

RIP Covid-19 Portfolio

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The global reflation rotation, what´s the problem? Millions of investors have a portfolio constructed for 2010-20 (big tech and bonds), not 2020-30 (commodities, value, and global equities). Trillions are on one side of the seesaw and billions are on the other. A colossal rebalancing process is born.

The 30 year treasury index is solidly oversold for the first time since 2018. The prior time before that was 2016. The sell-off has taken it close to its 20 quarter moving average, in other words, to where it should have been in the first place. It is not unusual to be at roughly the same level you have been at for five years. What is unusual, perhaps, is for Treasuries to finally be at normal levels in the time of Covid. But this means one very big fat fact: the Covid trade is over. Mean reversion to normality = mean reversion away from the abnormality. The Covid trade is dead. And the treasury market buried it yesterday. We have thus officially entered the Covid-Is-Dead trade.

Bonds are NOT there to Protect Stocks

Risk-parity asset managers delivered their worst day in nearly 5 months this week, the $1.2 billion RPAR Risk Parity ETF plunged the most since the depths of the Covid rout in March.

Positive Correlation – Stocks and Bonds
It was the worst single day for 5s (five-year Treasuries) since 2002… What lending instruments are tied to US 5 year bond yields? FCIs are key, financial conditions will determine when the Fed comes in with YCC, yield curve control. Most investors don´t realize that for much of the 80s and 90s, stocks and bonds were positively correlated, moved together (see above in red). As we move back toward that regime, investors must be positioned accordingly. Email to get our latest Bear Traps Report.

The Year 2021 – So far we have Two 6 standard deviation moves so far.

– hedge fund deleveraging in the GameStop drama, de-grossing…

– relative value rates, sell-off in 5s vs rest of the curve, US treasuries.

*in both cases too much capital was hiding out in crowded venues. Death of the Covid trade.

Credit Leads Equities
When central banks do NOT allow the business cycle to function over longer and longer periods of time – the good news is wealth creation becomes colossal. The bad news is Capital moves into crowded venues, poised for disruption. In rates, as the bond market sold off. Originally, the long end 30s was deemed at risk. Next, capital moved into 10s, 7s (10 and seven-year U.S. Treasuries), a “safe” place. As selling pressure moved into the middle part of the curve, trillions moved into the front-end looking for duration risk shelter. In recent weeks, 5s (5 year U.S. Treasuries) became the colossal hangout, a perceived “safe” place. Then the US treasury brought another* $100B for sale (5-7 year paper) this week. Anemic demand triggered the now historic, 6sd (standard deviation ) blow-up in 5s.

*total $1.8T U.S. Treasuries for sale in 2021, ABOVE Fed asset purchases.

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Commodities and Bond Yields, tied at the hip – 10 Things you Need to Know

See our Reports Here

Must-Read List

1. Lessons from Omaha

2. Convexity Climax

3. Juggernaut

4. Energy Bull Case

“Commodities are starting to revive after a 10-year bear market. Natural resources like energy, metals, and agriculture look set for an extended run, and investors should get on board.

The recovery in commodity prices, Goldman Sachs analysts say, “will actually be the beginning of a much longer structural bull market” that could rival that of the 1970s, when gold rose 25-fold, and the mid to late 2000s, when oil peaked at over $140 a barrel.

Reasons to be bullish are ample. Global economies look poised to revive in the second half of 2021 as pandemic restrictions ease. And monetary conditions have rarely been so easy. The Federal Reserve may keep short interest rates near zero through 2023, while tolerating 2%-plus inflation.

“Commodities are set up for a significant period of outperformance after such a long period of underperformance relative to other asset classes,” says Roland Morris, commodity strategist at VanEck Global. “There is a lot of fiscal and monetary stimulus being applied globally, and the dollar may fall as global growth rebounds. There are supply constraints and new demand drivers for industrial metals from the electrification of the world.”

The Goldman Sachs commodity analysts are bullish in part because of what they see as “structural underinvestment” in commodities, particularly in energy, following a decade of poor returns. While the energy-heavy S&P GSCI commodity index has rallied 66% from its April 2020 low, its total return has been negative 60% over the past 10 years against a 263% total return for the S&P 500 index.”




A Colossal Failure of Common Sense 2.0, Act or Crash FOMC

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In our global NY Times bestseller*, “A Colossal Failure of Common Sense” – there are two key points the book focuses on – risk recognition failures by the Federal Reserve and the importance of short-sellers in the marketplace.

*now published in 12 languages, over 600,000 sold.

Today, at precisely the same moment – we are once again witnessing key stress points in the financial system which can unravel very quickly. Our 21 Lehman Systemic Indicators are screaming higher. The inmates are running the asylum and the probability of the Federal Reserve breaking out their creative “macro-prudential” toolbox is the highest in years.

What is going on? For example, when five to 15 hedge funds are in trouble, all down 10-40% each in less than 30 days and they command $100B or so of AUM (assets under management) – that´s NOT the problem. The problem is – they are levered about 10-1. So these fellows actually control $1T of assets. And when the margin clerk comes walking by your desk it’s a VERY unpleasant experience on a trading floor. It´s NOT a friendly visit, especially when the risk management team has his back, NOT yours.  You don´t just sell your losers, you MUST sell your winners, nearly “everything must go” to raise precious cash.

Here lies the problem with central bankers. Academics are often clueless about systemic risk, even when it´s right under their noses. The history books are filled with these lessons. Very quickly the Fed will scream ¨there is NO problem, all is well, stay in your seats, ladies, and gentlemen.” After a rude awakening, they realize, “oh, we do have a problem.”

This is when happens when you bail out the bad actors in March, just ten months later the leverage comes back VERY quickly.

Looking forward, U.S. central bankers are no longer Trump constrained, the banking system is strong but the equity market has far more in common with Steve Wynn (Vegas) than Warren Buffett (Omaha). We think the Fed (and SEC) sends a shot over the bow very soon. Our social justice, inequality embarrassed Fed is not happy. They will not taper but they can make serious threats to risk-takers. All the signals are there; we have an explosion of SPAC / IPO issuance, $850B of margin debt or 75% above 2015 levels, the most shorted equities up 75% vs. 16% for the S&P 500 since October (bulls running over bears), record-high call vs. put volume with the little guy leading the charge, SELL Mortimer Sell. The risk-reward is atrocious from a long perspective in U.S. equities. Unless the Federal Reserve acts quickly and decisively, we will crash, the destruction will be of epic proportions. Central bankers have a chance to arrest out-of-control animal spirits, they MUST act now.

Companies Outed by Short Sellers

Sunbeam ‬
Worldcom ‬

*In a world of state-controlled central bank liquidity, message boards, and leverage; who are we actually protecting?‬ How many Bernie Madoffs, how many Bernie Ebbers will be running around the Hamptons this Summer?

The Problem of 2021 – The Fed’s Macro Pru Risk Tools are designed for 2008, not 1999

In our live chat on Bloomberg, several Institutional Clients are talking up a Possible macro-pru Fed Adjustment, Central Bank Action. Warning, beware…


Comments from Our Live Institutional Chat on Bloomberg

The bailout of Long Term Capital Mgmt LTCM: $3.6B.
The bailout of someone short $GME: $2.75B.

*According to, that $3.6B bailout in 1998 is equivalent to $5.72B today. The bailout that saved the world was $5B now look at us.. $1 trillion “isn’t enough.”

CIO West Coast: “ I think mkt is really scary when a $13bn hf can be down 40%+ a few weeks into the year and asking for bailouts.”

CIO East Coast: “ Classic Fed, wrong macropru toolbox. What did citadel securities do in revenue? $6.7bn?  I’ll bet 60% of that drops straight to the bottom line. We have an Option vol seller (Citadel) + buy-side (point 72) deploying a Reddit fire hose, comedy”

CIO Hedge Fund NYC: “I remember 1999 well.  I think this is now at least as crazy. The GME squeeze is quite a doozy.  I think the short-selling community is pretty destroyed. “

What Triggered the Bailout? It’s similar to the SoftBank whale gamma squeeze.

A) Large herd of organized players buys large amounts of upside calls on stocks with the greatest % short interest.

B) Option traders getting lifted in SIZE, have (MUST) to buy stock to hedge all the incoming call buyers.

C) As option buyers buy the stocks GME, BB, BBBY etc, this triggers short squeeze as % of the float (actual shares outstanding) is very small, short interest is HIGH. Compared to the 1990s, the options ease of use is 10x more accessible today, cheaper commissions (they are paying, just don’t see it) today as well. Message boards (Reddit), a social element similar to the 1990s. So the options angle triggers more of a gamma squeeze with a larger, more mobilized herd. Next, Elon Musk and VCs pile on the action.

Impact: On Wednesday morning, Nasdaq witnessed two inter-day bearish reversals of 2.7% and 1.8% this week. The VIX touches 200d (27.45) first time since election day. It would later touch 37.

A Bull-Raid on Short Sellers
Think of the 1990s mob taking out famed short-seller Julien Robertson vs. the 2020 mob trying to attempt the same thing, now think Genghis Kahn vs. Atila the Hun innovation, mobilized, organized leverage.

We are Looking at more Macro-pru fix Incentive Fuel for the Fed!!!

Market extremes always force a policy response, oftentimes in Bear markets with March 2020 the shock and awe moment of all time. But what about a colossal bull market perch… covered in froth?


With Lehman Brothers in mind, macroprudential policies are financial policies aimed at ensuring the stability of the financial system as a whole to prevent substantial disruptions in credit and other vital financial services necessary for stable economic growth. The stability of the financial system is at greater risk when financial vulnerabilities are high, such as when institutions and investors have high leverage and are overly reliant on uninsured short-term funding, and interconnections are complex and opaque.

For the first time in four years, we are looking at an FOMC without Trump constraints. More importantly, they’re wearing the inequality dunce cap sitting in the corner. After a decade of fueling gross inequality, central bankers are out to prove their innocence as newfound social justice warriors.

The problem, looking over the list of the Fed’s macro-prudential tools – most are bank balance sheet related, that’s not where the problem is. Over the last hundred years, after each financial crisis, there has been a unique metamorphosis, a transformation into another serpent, a far different beast. If the Fed has learned anything, this time the focus must be on stock market leverage, margin requirements, etc. It´s far more 1999 than 2008. If Alan Greenspan could go back in time, what macropru tools should he have used in the dotcom era?

Mobs vs. Shorts
Good one from MacroCharts… In our view, mobs have been taking out shorts for decades, NOW they use tactical nuclear weapons (mob-induced option leverage), vs. more primitive methods in the 1990s.

How Times Have Changed

The bailout of Long-Term Capital Management LTCM: $3.6 billion*
The bailout of someone short $GME:  $2.75 billion

*Fourteen financial institutions recapitalized LTCM with $3.6B: Bankers Trust, Barclays, Chase Manhattan, Credit Agricole, CSFB, Deutsche, Goldman, JPM, Merrill, Morgan Stanley, Paribas, Salomon SB, SocGen, UBS.

The latest buzzword is “macroprudential” as in macroprudential regulation. It’s basically means be more conservative, or save a penny for a rainy day. The idea is to institute laws and rules in order to avoid systematic risk, the risk of the collapse of the entire financial system. Policymakers and their research analysts are warming to the view that regulating in anticipation of collapse is better than after collapse. However, no regulator has ever correctly foreseen a financial collapse, even recognized it as it began under their very noses. Like generals, they always fight the last war. At best they invent new tricks for an old game.

The macroprudential thought has actually been around quite a while, in England, where the term was first coined in the 1970s. It only became less obscure, however, after the Bank for International Settlements took up the banner in the early 2000s. It came truly into its own after the late-2000s financial crisis, or the global financial crisis, in the wake of what in retrospect has been deemed as excessive risk-taking by banks given the popping of the housing bubble in the US.

So macroprudential regulation is an effort to reduce the risks of financial instability. It is viewed as optimally complimentary to macroeconomic policy and microprudential rules for financial institutions.

The important point from this history lesson is that macroprudential policy never evolved out of the collapse of the dotcom stock market bubble. It is a bank or banks-to-markets mindset. Instinctively, it views any risk as curable by treating it as in essence bank risk. So if markets are at risk for non-bank reasons, macroprudential policy may still address it, but that would involve a new mindset developing new policies and new tools.

Now to review macroprudential policy as it currently stands. Macroprudential concern divides into three categories: the agency paradigm, the externalities paradigm, and the mood swings paradigm, with most of the focus on the last two.

In the agency paradigm, principal-agent problems (where one person can make decisions for another, but not always in the latter’s best interests) are the focus. So those who run a bank may care more about their own pay than the best interests of the bank’s shareholders or society at large. Imagine! The fear is that as lenders of last resort, the Fed thereby emboldens bank heads to take undue risks. This is a moral hazard, which in economics means the incentive to increase risk at someone else’s expense. Because of the individual actor’s nature of such risk, the macroprudential policy usually focuses on the other two paradigms.

In the externalities paradigm, the main focus is mainly on pecuniary externality which occurs when an economic actor’s decision affects the welfare of another economic actor. For instance, if a lot of suburban dwellers buy apartments in the city as second dwellings, that can drive up the prices of urban apartments, negatively impacting the ability of young urbanites to purchase apartments. The macroprudential view is that when price distortions caused by lack of perfect competition occurs, policy intervention is the cure. Which is stupid. How can an economist, or government employee, determine perfect competition? What criterion would government hacks use? What prejudices and hidden agendas would affect their determinations? A world where no one is worse off no matter what choices are made by others is a pipe dream. The view seems to be that over-borrowing, excessive risk-taking and excessive levels of short term debt deserve macroprudential regulation because market failures hurt the real economy. Meanwhile the 1987 crash and zero impact on the real economy. But now banks have 52% loans to deposits, the lowest and most conservative in half a century! A classic case of developing a cure for a disease that has gone away.

As for the mood swings paradigm, keying off Keynes’s animal spirits idea, the thought is that there are moments of excessive optimism during which money managers tend to ignore risk. This means that price signals lose value and this leads to systemic crisis. So theoretically macroprudential regulation would curb such optimism. Of course, this is exactly the opposite of the current monetary policy. Ahem.

Thus, the concern over macroprudential regulation is really a fancy way of worrying about when the Fed and other regulators change their collective mind and turn off the money spigot.

So how would a macroprudential regulator monitor systemic risk in the first place? One way is to monitor balance sheets. In the case of large banks, these are superb. In the case of small businesses and individuals, as a result of lockdowns, these are disastrous and too late to repair. Another proposed monitor is to look at interconnectedness risk. But it is safe to say that the economy and markets are highly integrated and making them less so at any point in any way for whatever reason carries with it a high degree of risk.

Other measures to monitor risk include credit to GDP and monetary assets such as M1 growth, but of course, the response to lockdowns of Central Banks has been to inflate those metrics. Real asset prices as a measure of potential systemic risk is a joke given that Central Banks are deliberately inflating them, at least so it would seem if one simply observes their behavior. Stress tests of course have been used and, to be fair, for all their flaws, seem to have had some positive impact.

Assuming that policy geeks can identify risks beforehand, which is questionable (isn’t the definition of a dangerous risk one that can’t be foreseen???), what tools are available to reduce identified risks?

Correcting loan to value ratios might be one, but for the fact they are currently the most conservative in over a generation. And this was done by the banking industry voluntarily. Some CLOs have stepped in where banks have feared to tread, true, but no one views them as globally systemically important (yet).

Another macroprudential tool is controlled through debt to income measures, but by all appearances, as a result of the pandemic, these have been thrown by the wayside.

A levy on non-core assets would restrict banks’ ability to wander too far afield. The counter-argument is this reduces their diversification and thereby increases risk.

Countercyclical capital requirements would restrain desperately risky lending by soon to be troubled lending institutions. However, it is difficult to ignore the irony of governments who would never dream of imposing countercyclical measures on themselves. It was Adam Smith who noted centuries ago that emergency monies borrowed by governments temporarily were never repaid. Still too true to this very day.

Penalties for excessive short term funding, charges on maturity mismatches, penalties for insufficient liquidity ratios, and haircuts on asset-backed securities valuations are further macroprudential tools, none of which have any present relevance to currently overfunded global banks. In the US, banks have $6.6 trillion in deposits that cost 6 basis points to maintain, $115 billion in actual cash, $3.3 trillion in securities most of which government-issued, and about $3.4 trillion in loans. Hard to see the systemic risk there.

Further, more junior capital for banks is a basic macroprudential tool, and has already been implemented.

Basel III is in fact often enough macroprudential in outlook. Capital requirements, for example, have been strengthened, capital buffers are in place.

Pro-cyclical dynamic loss provisioning and time-varying minimum capital requirements are basically fancy names for saving pennies for a rainy day, only in this case the pennies are billions, and, while adjusting for time frames, basically means hoarding cash while you can get it and before you need it. While macroprudential, these measures are also anti-growth and ultimately makes the task of growing out of economic inequality impossible. Besides, after the existential crisis of the late-2000s, banks are if anything too risk adverse, and the pandemic has only confirmed them in their ways.

In essence, then, “macroprudential” just means “conservative”.

The management of systemic risk in the USA is in part institutionalized in the guise of the Financial Stability Oversight Council, created in 2010.

The non-coordination of macroprudential policy and monetary policy is detrimental to both.

While theoretically, they should complement each other, in fact, they are inherently at odds in the very times of crisis each seeks to avoid in opposite ways. Macroprudential regulation is conservative in its essence. Monetary policy in times of crisis is fundamentally a printing press. The one restricts as the other expands.

Current fiscal policy and government backing of loans are together meant to maintain personal spending and reward business risk-taking behavior. How to compliment fiscal policy and monetary policy to macroprudential regulation is more of a mystery than a revelation.

In any case, it may all be besides the point. If the main systemic risk is the current equity bubble, it is hard to see how making banks still more conservative will help.

All current macroprudential regulatory tools are geared to solve the last crisis, not the oncoming crisis. Besides, the easiest way to pop the current equity bubble is to raise initial margin from 50% to 60% and maintenance margin from 30% to 40% under regulation T. One doesn’t need the regulatory and intellectual baggage of macroprudential policy to pop a bubble. It’s not a secret.

The most likely scenario, in our view, is louder discussion of macroprudential regulation with everyone very concerned about what it all means. What it all translates into is good old fashioned jaw-boning asset prices lower, an oft practiced method, that can in fact prove effective in overstretched and overvalued markets such as ours now.

Solutions, Reg T

Two points about ending the bubble macroprudentially: the reason why changing regulation T would pop the bubble is because a mere pinprick pops a bubble! It is true changing reg T isn’t much of a big deal compared to options volumes. Changing reg T, compared to options flows, is a mere pinprick. But that’s all you need to pop a bubble. Secondly, it is empirically the case that heavily shorted stocks are targets in today’s world. That story moderates if margin requirements increase. Again, just a pinprick. What is so satisfying from the Fed’s point of view about tightening margin requirements is precisely the fact that isn’t a big thing. It’s just an adjustment. A second lure for the Fed is that it is easily reversed. A third lure is that if it doesn’t work, there is no immediate major harm either.




Tesla, the Harry Houdini Quarter

Production, Now You See it, Now You Don’t

The production capabilities Tesla says they now have are much MORE than actual production.

Fremont Model S / Model X 90,000 Production
Model 3 / Model Y 500,000 Production
Shanghai Model 3 250,000 Production

This is on slide 7. They claim 840,000 units of capacity…but actual production and sales are much less.

This means they are underutilizing manufacturing and they cannot say that they are supply-constrained.

One High Bar
“Tesla says its goal of delivering 500,000 cars this year “has become more difficult”: it has to deliver a record 180,000 cars this quarter.” Zerohedge

Unlike the last few quarters, they did not sell out at the end of the quarter.  Warning, inventory grows.  And, satellite images from dealer parking lots around the country confirm this.

Regulatory credits were more than guided.  With their deteriorating share in Europe – where most of these come from, this source of profits should be reduced shortly.

Accounts receivable continue to grow sequentially….which makes zero sense in a business where customers pay before taking cars off the lot.

Outside of the Earnings News

Waymo now has a commercial robotaxi service in Arizona

GM Cruise is applying to have cars without pedals and steering wheels.

It was Tesla that was supposed to have 1 Million robotaxi’s by now.

They are way behind, the current nearly $400B valuation is HIGHLY unsustainable. 



“Average” Inflation Targeting from Central Banks, Compounds Side Effects

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“Averaging” Inflation Does Not Eliminate The Flaws In The Fed’s Policy Approach; It Compounds Them

Larry McDonald with Joe Carson

Federal Reserve has spent over a year conducting a review of its monetary policy strategy, tools, and communication process. The review was an academic re-assessment of an academic experiment called inflation targeting. The new framework of inflation averaging is an extension of the inflation-targeting regime, with a longer timeline.

This decision on inflation targeting moves monetary policy closer to a rule-based framework. A rule-based framework creates the premise that there are no legitimate objectives besides the item being targeted.

Inflation targeting was never supposed to become a rule-based framework. Proponents of the practice argued it would help increase the “transparency” of conventional monetary policy and emphasize the commitment toward maintaining a low and steady inflation environment.

Inflation targeting has never delivered the macroeconomic results that were promised. That’s because it has no practical foundation, focuses on a narrow set of prices that are not entirely market-determined, and creates an uneven playing field between the economy and finance. Inflation averaging will compound the errors.

First, mandating an inflation rate of 2%has no theoretical justification.

There is no such thing as an “ideal” or steady rate of inflation. Policymakers have never offered any empirical evidence to justify a 2% inflation target because none exists.

Research and actual experiences show that an inflation rate too high or too low for an extended period can create imbalances and bad economic outcomes. But that range is very wide.

In the mid-to-late 1990s, reported core consumer price inflation averaged more than 100 basis points above the inflation rate of the last decade, and the macro performance in terms of growth, job creation, and wage gains was far superior.

Policymakers have the freedom to change their operating framework. But any framework should be grounded with solid research and not made up with “alternative” facts to support its use as a policy tool.  

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Second,inflation targetingfalsely assumes there is absolute perfection in price measurement. 

Subtle changes in the prices and quality of goods and services make price measurement at times a “best guess”. Every year government statisticians face new products, changes in old products, shifts in demand, and company pricing strategies.

One of the most complex issues in price measurement is the pervasiveness of item replacements. Item replacement refers to a process whereby government statisticians must select and price a different product because the one previously included could not be found. Previous studies have found that some items are replaced more than once a year and annual replacement rates could be as high as 30% for products.

But item replacements are uneven year-to-year and therefore so too is the judgment component of reported inflation. As a result, price changes that are down or up a tenth or a quarter of a percent from year to the next should be considered nothing but statistical noise. But a rule-based inflation-targeting framework will compel policymakers to fiddle with the stance of policy to account for the noise in price measurement.

How is it that policymakers nowadays have fallen in the trap of placing so much importance on a single statistic to conduct monetary policy?

Third, the Fed’s inflation-targeting regime mistakes indirect measures of inflation for direct ones.

A critical aspect of the design of price targeting is the selection of the price series. The price series must be timely and a direct measure of inflation.

The consumer price index (CPI) is the only direct measure of consumer prices. But policymakers have opted to use the personal consumption deflator (PCE). The PCE deflator is not a direct measure of prices since 70% of the prices come from the CPI. The other 30% is based on non-market prices.

Four of the past 5 years, the core CPI has exceeded the 2% target. The only year it missed was 2018 when it was 1.8%. That small undershoot from the 2% target is not statistically significant and certainty not large enough to trigger a change in the stance of monetary policy.

Over the same 5-year period, core PCE ran nearly 75 basis points below the core CPI rate. Almost all of that difference can be explained by the “invisible” prices, or prices for items that are in the PCE but not in CPI.

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Does it make sense to base policy decisions on “invisible” prices?  

Fourth,inflation targeting lacks balance in anchoring consumer inflation expectations with investor expectations.

The announcement of an inflation target is intended to reduce uncertainty over the future course of inflation and anchor people’s inflation expectations. It is hard to prove that the formal announcement of inflation targeting has had any impact on people’s inflation expectations.

According to the University of Michigan’s consumer sentiment survey, people’s one-year inflation expectations have fluctuated between 2.5% and 3% for the past 20 years, moving above or below the range during an economic crisis or oil shocks. Perhaps people are unaware of the Fed’s 2% inflation target or that “experienced” inflation runs consistently higher than reported inflation.

But investors are readily aware of the Fed’s inflation target. Every little tweak in the Fed’s policy statement on inflation and its impact on official rates triggers almost an instant reaction on the part of investors.

One of the inherent weaknesses of inflation targeting is the inability to balance consumer and investor expectations. That is, as policymakers attempt to simultaneously hit an arbitrary price target and anchor inflation expectations they are inadvertently un-anchoring investor expectations as it eliminates the fear of higher interest rates, encouraging extreme speculation and risk-taking in the financial markets.

Why do policymakers only focus on people’s inflation expectations and not people’s/investor’s asset price expectations as well since both have become unstable at times resulting in bad economic outcomes?

Informal and formal price targeting has been in the Fed’s tool kit for the past 25 years or so. The effects on income and portfolio flows are not similar to conventional monetary policy. At the end of 2019, the market value of equities in people’s portfolios’ stood 3X times workers income, up from 1X times in the mid-1990s.

The shift to inflation averaging compounds the unevenness. That’s because inflation averaging will extend the period of low-interest rates, encouraging more speculation and risk, increasing gains in finance over the economy.

A critical review of the pros and con’s inflation targeting will have to wait for the next crisis. It usually takes three crises before policymakers realize something is fundamentally wrong with their framework.

By then there will be several new academic papers that will highlight the flaws of inflation targeting/averaging, expanding on those that are listed in this article while adding others as well.

After over 40 years researching in the field of economics, with experience on the buy and sell-side of Wall Street, government, and private industry and mostly focusing on financial markets and policy analysis, our long-time friend Joe Carson decided to share his research and opinion on The Carson Report. Please feel free to contact Joe if you have any questions or want to discuss any of his research or opinions. 

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Stupid “Rich” Skew in Apple, Greed Breaks Things

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Sept 6: What Just Happened over the last Nasdaq 14 days?

1. A Colossal buyer (SoftBank) distorted the price of upside calls on eight stocks.

2. Quants and Robinhood piled on, further distorting markets.

3. Dealers who have been destroyed in recent years (selling vol) holding a small deck, they had to get long more and more stock to hedge upside market risk.

4. As stocks surged, dealers who sold upside calls – must hedge even more as – out of the money options they sold – pick up more delta. Banks buy more stock. Call-put skew reaches record territory on several big-name tech stocks, meaning the cost differential to buy upside vs. protect the downside, reaches all-time wide levels.

5. Nasdaq is nearly 60% 12 stocks, this “three-card monte” game above has a large impact on passive index funds.

6. The original, colossal upside call buyer exits some of their position.

7. Dealers / banks MUST sell stock in size, take off their hedges, sell Mortimer, SELL.

8. Selling brings out more selling, banks take off more hedges as the options lose delta, MORE selling.

9. The little guy / gal gets left holding the bag.

Alert: High and High Closes September 2, 2020
Wednesday, an All-time highest VIX reading on a day with the S&P 500 touching the highest level ever. Of the top 20 occurrences, there were 17 in the 1999-2000 period, and three over the last 7 days. When option traders receive colossal size orders to buy upside calls they have two choices. a) Have your sales force get on the phone to the largest holders of the stock (say Apple and Buffett) and convince them to sell upside calls. b) If they cannot find enough sellers of upside calls, they must buy stock in size to hedge the calls they are selling to the client.
This is taking the street short gamma – likely the largest way all time. As we learned with Lehman, greed breaks things. It’s “high-noon” – the only character missing is Gary Cooper. We are witnessing a battle of wills, high speculation where colossal call buyers are forcing the street to get long more and more stock to hedge their upside risk. It’s the March capitulation selling in reverse. Just the way the street had to BUY downside protection in late March (because put buyers outnumbered call buyers 10-1). Today, they are being forced to BUY upside protection in SIZE (call buyers outnumbered put buyers 10-1). It’s going to break!

Insanity in Options

This post is Part II of New Vol Regime

“As my first boss told me at Merrill Lynch in 1990, ´In options Larry, they show it to you (lush $$ green premium), and then they take it away.´”


The convexity skew picture on big-name equities like Apple $AAPL has gone parabolically stupid. Let’s keep this simple and draw a conclusion.

“Over the past few weeks, there has been a massive buyer in the market of Technology upside calls and call spreads across a basket of names including ADBE, AMZN, FB, CRM, MSFT, GOOGL, and NFLX. Our friends at Citadel calculate, over $1 BILLION of premium spent and upwards of $20B in notional through strike – this is arguably some of the largest single stock-flow we’ve seen in years, they noted. We agree someone is playing with House Money, and they’re rolling large.”

Bear Traps Report, August 24, 2020

Apple $AAPL Stock near $130

Jan $180 Strike Calls costs $4
Jan $80 Strike Puts costs $1

*Both options are $50 out of the money, approx data, BUT it is nearly 3x more expensive to buy upside risk in AAPL equity. Downside protection normally costs more than upside risk participation, NOT today. What does this mean?

“The public is trapped long and institutions are trapped long and the snowball that was pushed very quickly up the hill and got big is now at risk of becoming an avalanche.”

Julian Emanuel, chief equity and derivatives strategist at BTIG, Bloomberg

Nasdaq Whale Makes a Splash

One large buyer has made a colossal splash in the market and the scent of greed has drawn thousands of other market participants into the dangerous game. Several clients in our institutional chat on Bloomberg have cited SoftBank as the original size buyer. We have NO IDEA if this is true, just that highly credible clients have made this reference several times over the last week. It’s a high-stakes game of musical chairs, the ultimate greater fool theory moment. The colossal call buyer has thrown meat in the water and drawn in the sharks, but unfortunately thousands of Robinhood minnows at the same time. When the large players’ exit, the little guy and gal will be left holding the bag.

Apple closed near $130, while the cost of speculative upside calls is weighted heavily against the buyer. Someone must have reached out to Buffett today because he can make a fortune in selling $AAPL upside calls. Let us explain.

Very Expensive Upside
Call it extremely unusual activity. We have a higher stock price in Apple AAPL with a much higher cost of equity upside. Equity vol usually explodes higher in market crashes, NOT bull markets. As you can see above, in normal Apple equity bull markets – see all of 2019 – AAPL implied vol has been CHEAP, NOT RICH (expensive) like today! In March and April, near the market bottom – the price for puts was more than 4x the price for calls, today we have done a 180, extreme fear to extreme greed. 

In our institutional client chat on Bloomberg, a hedge fund put on this trade and we are sharing it with permission. 

With Apple stock near $130, think of the January 2021 expiration. The client bought the $200 call and sold the $250 call, 1 x 4, and got paid $3.50 to put the trade on. What does this mean? See below.

Extreme Premium to Extreme Discount
Apple $AAPL is near $140 pre-market on September 2nd. In July, the Street’s 12-month price target was $85, now $116. In March, the price target commanded an $18 PREMIUM to the Apple stock price, NOW it’s close to a $24 discount. In classic 1990s fashion, the mad mob of Wall St. analysts cannot raise their stock price targets fast enough to keep up with the equity price appreciation. That is from 44 analysts, Bloomberg data.

The Trade

Apple was worth $1.5T at the end of July and today she stands tall at $2.2T. In order for the client to lose money* at January expiration, the stock has to breach $270 ($130-$136 this week), which would put the company’s market capitalization very close to $5T, by January 2021, that is a little over four months away.

*The mark to market in the short run can be extremely painful though – if Apple equity soars another 10-20% (Apple is up 50% since late July), that is indeed the catch. AAPL is trading nearly 65% above its 200-day moving average vs. 42% in February’s great bull run. 

Cost of Upside is Insanely Expensive
There are a handful of quant funds pushing around a few stocks (with high impact on QQQ, NDX, SPY) in the options markets. The dealers are getting very nervous.  Last 15 days – Imaging being a large market maker in Apple and Tesla equity options. You make a market, bid – offer, you get lifted and lifted over and over again by buyers to the point where you have raised the price of calls vs puts to multi-year extremes. How short is the Street gamma? VERY.

The Ultimate Lesson From Stan

“So, I’ll never forget it. January of 2000 I go into Soros’s office and I say I’m selling all the tech stocks, selling everything. This is crazy at 104 times earnings. This is nuts. Just kind of as I explained earlier, we’re going to step aside, wait for the net fat pitch. I didn’t fire the two gunslingers. They didn’t have enough money to really hurt the fund, but they started making 3 percent a day and I’m out. It is driving me nuts. I mean their little account is like up 50 percent on the year. I think Quantum was up seven. It’s just sitting there… So like around March I could feel it coming. I just – I had to play. I couldn’t help myself. And three times during the same week I pick up a – don’t do it. Don’t do it. Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks. and in six weeks I had left Soros and I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew that I wasn’t supposed to that. I was just an emotional basket case and couldn’t help myself. So, maybe I learned not to do it again. but I already knew that ”

Stan Druckenmiller

When call vs. put skew gets this extreme it can be a solid leading risk indicator.  Join our live chat here,



New Vol Regime

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September 2, 2020: All-time highest VIX on a day with the S&P 500 touching the highest level ever.

Equity Market Volatility Divergence

Strange times indeed. This week we observed two spectacular divergences. First, single-name equity option activity relative to indices was near all-time, historic extremes. Second, Nasdaq volatility (VXN) traded at a multi-year premium to the CBOE VIX. What is going on here? This post is from August 28, the latest update is here. 

Nasdaq Volatility Trading Very Rich to the S&P 500
With the Nasdaq QQQs up close to 40% this year, there are lots of gains to protect.  Nasdaq vol has been trading very expensive relative to the VIX. Investors are paying up for protection.

Climax Points

Think of bull and bear market capitulation climax points. At the end of a bear’s mauling, dozens if not hundreds of rallies have failed. Long, exhaustive bear markets break the hope and spirit of more and more investors – until the point of maximum capitulation. There is NO one left to sell, think March 2009. Each failed rally delivers deeper losses to the market participants and every one of the “fast money” tourists have run for the hills. All that’s left is an empty meadow, the genesis of a new bull market is born.

Now, let us think of the beast inside a great bull. Dozens if not hundreds of dips have been bought. With each victory, fast money rookies share their battle stories with more and more friends at cocktail parties. Tourists arrive, busload after busload empty into the market, it’s all good, “this is easy.” With each triumphant buy of the dip, investor confidence turns into a dark shade of hubris and more and more capital pours in. Why not, the mad mob is playing with the house’s money. Now think of 100 hedge funds, all up 3% for the month. Why not take 1% of those gains and buy calls on the largest, highest momentum equities. Worst case you end up 2% for the month, best case you deliver 5%, after all, you take home at least 20% of the profits. One conclusion, month-end (Aug 31) / quarter-end (Sept 30) is about to get very interesting.

August 2020

The first 20-ish days of the month were the quietest in a long time. If we look at ten-day, realized equity market volatility, it plunged to nearly 6 vol, 2020’s nadir. On the other hand, this week as month-end drew closer – we experienced two, 1% trading range days with close to forty handle swings in the S&P 500. For sure, someone is monetizing gains.

VIX Up – S&P Up
On Wednesday and Thursday this week, the  Chicago Board Options Exchange’s CBOE Volatility Index (VIX) was more than 5% higher each day, with the S&P 500 up both of those days. How rare is this? Very. We could only find ten days in the last decade with the S&P up 1% with the VIX closing higher. This is especially rare with the market at all-time highs. In a healthy bull market at its best levels, the VIX should be in the low teens, NOT the lows 20s. 

Two Month vs. 8 Month VIX Futures Contracts
One of our 21 Lehman Systemic Risk Indicators are found in the trading spread between the two and 8-month VIX futures options contracts. To keep this as simple as possible, all we are doing here is measuring the cost of protection. How much more expensive is buying short term vs. long term insurance? The above data is mindblowing. This week, the cost to buy the two-month VIX future reached nearly 5 handles more than the eight-month contract. Elephants leave footprints. When large hedge funds need or want to pay-up for short term protection from a market crash that is one thing, BUT the price they are paying this week is VERY extreme with a market at all-time highs. As you can see above, the 2-8 spread is wider today than nearly every financial panic in the last five years. In a healthy, “risk-on” (where risk is being put on) bull market – this spread should be in “contango” – the two-month VIX futures contract should be ALOT cheaper than the 8-month variety. 

 Paying Up for Upside Risk

Over the past few weeks, there has been a massive buyer in the market of Technology upside calls and call spreads across a basket of names including ADBE, AMZN, FB, CRM, MSFT, GOOGL, and NFLX. Our friends at Citadel calculate, over $1 BILLION of premium spent and upwards of $20B in notional through strike – this is arguably some of the largest single stock-flow we’ve seen in years, they noted. We agree someone is playing with House Money, and they’re rolling large.

“The average daily options contracts traded in NDX stocks to rise from ~4mm/day average in April to ~5.5mm/day average in August (a 38% jump in volume).  Given this group of 7 stocks accounts for a ~40% weighting in the NDX, the outsized volatility buying in the single names is having an impact at the Index level.  So why are Vols moving yesterday/today when this call buying has been taking place for weeks?  Yesterday CRM, one of the names we have seen outsized flow, rallied 26% on earnings – a less than ideal outcome for those short volatility from all the call buying.  As the street got trapped being short vol, other names in the basket saw 3-4 standard deviation moves higher as well – yesterday FB rallied 8% (a 3 standard deviation move), NFLX rallied 11% (a 4 standard deviation move), and ADBE rallied 9% (a 3 standard deviation move).  The most natural place to hedge being short single name Tech volatility is through buying NDX volatility.  As such, there has been a flood of NDX volatility buyers with NDX vols up about 4 vol points in 2 trading days. And if NDX volatility is going up, SPX volatility/VIX will eventually go up too.” Citadel

What are the conclusions? What does this tell us about the path forward? What other instances of this occurrence have we seen historically? Email for our full report.