This Isn't Our Lehman Moment (yet)

Here's how I know...

Investors,

Hopefully for obvious reasons, recent newsletters have been predominantly focused on macro dynamics, contagion events, and the Earthquake Effect. Technical analysis, statistical indicators, relative strength, and on-chain data don’t operate in a vacuum absent of macroeconomic events. At times, these forms of analysis can help to provide additional context to understand how macroeconomic events are more acutely impacting market conditions, but extreme fundamental events will outweigh everything else when they do occur.

The goal of these weekly premium reports is to contextualize market dynamics and to identify hints about the sea floor of the market is (potentially) shifting. By properly understanding these key developments, we can diagnose the degree with which macro is influencing risk appetite, market psychology, valuations, etc.

At the moment, investors are hyper-focused on liquidity (as they should be); however, it’s important to recognize that the Fed’s new BTFP facility is a brand new form of monetary intervention. The Federal Reserve is acting as the lender of last resort, as it is designed to be, but the impact on liquidity will depend principally on how much demand there is to use this backstop and the degree with which banks fear their deposits are at risk of a bank run. In other words, this will require a “wait and see” approach to analyze how the Fed’s discount window is used by commercial banks.

So far, it’s pretty clear that demand is skyrocketing and banks are either fearful or being opportunistic:

Usage of the discount window has notoriously carried a negative reputation, because banks who use it couldn’t get funding in the private markets and were backed into a proverbial corner, with no other option but to use the Fed’s funding. This generally had a connotation that the banks using the Fed’s discount window were in distress, putting a “scarlet letter” on the bank that it should be avoided by other banks.

Based on the chart above, it’s clear that usage of the discount window predominantly occurs during periods of severe financial stress and/or recessions. If we perform a thought experiment where we had no access to news headlines, Twitter, or had zero knowledge about Silicon Valley Bank, Silvergate Capital, Signature Bank, Credit Suisse, or First Republic, this chart alone would tell us the full story. In other words, cracks in the financial system are becoming ravines.

The Fed is now tasked with the responsibility of filling these ravines back up and creating a seamless surface for our financial system to operate smoothly. This will be tough, particularly in light of +6.0% YoY headline CPI data, but they can do it. Investors seem to have full faith in their ability to manage this situation, or perhaps they don’t fully appreciate the magnitude of the ravine.

At the moment, the market is solely focused on the fact that liquidity is returning; but seemingly ignoring or underestimating WHY liquidity is returning.

I genuinely hope that investors are right… I’m not cheering or hoping for a crisis in order to validate my Earthquake Effect theory, but I’ve certainly struggled with the bullish silver-lining here. Today’s newsletter will focus on primarily on intra-market dynamics by comparing key developments that are happening within the market. Most notably, I’ll be evaluating a critical relationship to understand how the current environment, so far, is completely different than the market dynamic that was unfolding around the time of Lehman Brothers’ failure.

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