The Forward Guidance Crystal Ball : Excessive Risk ? Big Deal ?

We all need something to believe it and we now have the Fed’s Forward Guidance to show us the way for us to pretend that the future is here.

That is what the currency market has been doing for the past days since the FOMC – pretending that the rate hikes have started and rate cuts too although I am not sure about the -5.33% change in the price of Silver.

The rest of the market is sitting tight and pretty, with another record high for the S&P 500 Index last Friday and bonds holding onto their gains.

So what is prompting the sudden barrage of comments out of the BIS, IMF and the G-20 finance ministers and central bankers with warning statements, all within less than a fortnight, that the markets are carrying on too much risk ?

The IMF warns, “financial market indicators suggested investor bets funded with borrowed money looked “excessive” and that markets could quickly deflate if there were surprises in U.S. monetary policy or the conflicts in Ukraine and the Middle East.”” http://www.zerohedge.com/news/2014-09-18/imf-admits-qe-encourages-excessive-risk-taking-warns-sharp-downside-risks-are-rising

Central banks inflating ‘elevated’ asset prices: BIS
LONDON (Reuters) – Financial asset prices are at “elevated” levels and market volatility remains “exceptionally subdued” thanks to ultra-loose monetary policies being implemented by central banks around the world, the Bank for International Settlements said on Sunday.  http://reut.rs/1qzkS0D

said low interest rates are contributing to a potential increase in financial market risk, as major policy makers rely on monetary stimulus to bolster growth.” “We are mindful of the potential for a build-up of excessive risk in financial markets, particularly in an environment of low interest rates and low asset price volatility,” http://www.zerohedge.com/news/2014-09-21/people-photo-have-warning-market-there-build-excessive-risk

My questions.

1. Who ?

2. What and where risks ?

3.  How ?

Note that I am skipping W-for-WHY, because we all know why. Thank you FOMC, thank you QE1, QE2, QE3, Thank you BOE, Thank you BOJ, Thank you ECB, Thank you Goldman Sachs.

You cannot help but feel that there is just a bit too much risk taking around you as your friends and family all talk about leveraging up their bond portfolios and crowd funding is raising money to build human catapults as Alibaba ups their IPO ante to a new record $25 bio.

But even the most conservative are not spared.

Corporations, businesses, fund managers and all are all on the same boat.

Reading about Pimco’s Bill Gross advocating that it is time to lever up on credit investments and lifting his gains by US treasury futures, reinforces the risk taking mindset that is gripping the markets. http://www.bloomberg.com/news/2014-09-11/pimco-s-gross-says-good-time-to-lever-up-on-credit-investments.html

http://www.bloomberg.com/news/2014-09-17/bill-gross-used-45-billion-derivatives-to-lift-fund-gain.html

Listed companies in Singapore are borrowing up to venture into Chinese real estate, even if they are not in the business of real estate.

Private investors are listing properties through reits and business trusts to free up capital for more investments.

Individuals then buy these reits and other investments by borrowing on them.

It is an endless cycle.

But what is the risk involved ? Higher interest rates ?

Higher interest rates = higher returns required = lower asset prices

There is also the other risk of lower credit quality being passed on as good as investors loosen up their investment criteria.

Yet, all these risks can more or less be quantified. If you have the models for them. Plug in the numbers and out comes the results.

The biggest risk we all know for a fact that cannot be addressed or quantified is the market contagion cascading risk because companies, banks and investors have become more intricately linked than ever in an inextricable web of relationships that we do not even know where to start looking.

And thinking about risks tantamount to losing out against the risk takers because the central banks have effectively shot the black swans. The beauty of forward guidance is that it has not happened and may be changed when the time comes.

What I believe will happen in the weeks ahead about be the break up of market solidarity in the case of excessive risk. Do you think Bill Gross would want you to know that leverage is good unless he is selling out ?

You see, the Forward Guidance crystal ball is the new religion of the markets.

The risk takers will be taking a punt against the crowded positions of the marketplace. Crowded positions like in the case of the mighty AUD carry trade as we speak.

CFTC POSITIONS

Net positioning shows AUD as the biggest long around whilst the EUR is showing the largest short.

The favourite trades of the year has also been credit and junk as well as equities.

Excessive risk works both ways. Long and short.

And the losers will always be the ordinary folks, whether it is passing the buck to the taxpayer, losing on their insurance policies and mutual funds, losing on their property values or losing their jobs.