Saturday, July 25, 2015

Predictable surprises and rate normalization - not clear what will happen


“The nature of predictable surprises is that while uncertainty surrounds the details of the impending disaster, there is little uncertainty that a large disaster awaits.”  
-Nassim Taleb 

Taleb states predictable surprises have three characteristics: 1. there are some who are aware of the problem;  2. the problem gets worse over time; and 3. the problem explodes into a crisis. 

The Fed has been trying to telegraph its intentions so has to minimize a surprise vent when they start to raise rates but this is likely to be a predictable surprise. There are many who are aware of the problem if the Fed starts to raise rates. The Fed has actually argued that everyone should have had enough time to prepare for the increase but it still seems as though many will be sensitive to the event. We first heard about a change in policy with the Bernanke "taper", yet it seems as though the market is still sensitive to Fed comments and potential changes. The problem may have gotten worse as market participants have tried to determine how the Fed is actually going to cut its balance sheet. The greatest fear is that the actual event will still have a sizable impact on market which could spill-over to a crisis of selling in a market that does not have liquidity.

We know the event is coming, yet even with a lot of forewarning it is not clear how the market will react when the rates start to move higher.

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