Sitting at home in Amsterdam with much of the country shut down to deal with the corona virus epidemic gives time to think. Looking at current markets and the impact of corona led to thoughts of butterflies, black swans and canaries. The butterfly effect is at the basis of chaos theory – not a bad theory to consider at this time. Chaos theory led me to me to black swans – which according to Forbes is what the markets are experiencing. But at the same time I thought about canaries used in mines to warn of lack of oxygen and the danger it posed to miners.
It is the canaries that have been signalling to me market challenges that existed before the corona virus emerged as a serious economic threat. It is those market challenges that may make the economic threats even more dangerous. It is not clear that governments and regulators understand what is happening in the markets so that they can effectively intervene. A canary warning first emerged in September with stress in the repo markets. The Bank of International Settlements reviewed this market disfunction and analysed its causes. But do they have the right analysis?
Recent events in the markets create for me more uncertain canary moments. On 13 March the Financial Times reported that the Federal Reserve was intervening in the markets to address disruptions in the US treasury securities. The Fed noted that this was related to the corona virus. But the following day the Financial Times reported on disruptions in the mortgage backed securities markets quoting an analyst; “Liquidity in mortgage-backed securities market, which is usually the second-most liquid market in the world after Treasuries, is on par with, if not worse than, what we saw during the financial crisis.”
The ultimate impact of the corona virus on the economy is uncertain but it looks to me like there are substantial underlying risks of disruption in the market that may make the impact even more negative. Clearly a time of heightened risks on many fronts – financial as well as physical as the corona virus works it way around the world.
