What are the lessons from past recessions?

Is it possible to predict the timing and magnitude of the next recession? complex narrative simplified

It all starts with easy credit, the market gets flooded with free money nearly 0% interest rate.  Since 2009, the Fed funds rate has been the lowest in the past 50 years.

Inevitably, lower interest rate drives up leverage in the financial system. Leverage flourished in the long era of low-interest rates but will cause instability when the environment changes.

The higher interest rate means lower asset prices and higher debt servicing costs. Suddenly, risk arbitrage trades will break down resulting in collateral and margin calls.

Liquidity in the market will disappear overnight.

It is impossible to predict the origin of cracks in the system during the quantitative tightening cycle, it sure will break something somewhere, if it is likely to be a contagion then central banks will intervene to stabilize the system for the greater good.

So far in this cycle, central banks’ timely intervention in UK GILTs has done the trick, the crypto meltdown is not a contagion yet.

The best-case scenario is a soft landing and the worst-case scenario is stagflation. The markets will be on high alert for the next few quarters, and some long-held correlations are likely to break down.

The pattern is always ultra-low interest rates, high leverage, Fed Pivot, credit crisis, liquidity problems, contagion, and bankruptcies across multiple industries. The difficulty is always predicting the timing and origin of the crisis and whether it will translate into contagion.

we do live in interesting times. I was based out of Silicon Valley during the dot com crash and at GE Capital Treasury during the 2008 crisis, experienced liquidity disappear overnight, front row experience of key chapters chronicled in “Too big to Fail” and “On the Brink”.

There are some fascinating books I have enjoyed reading over the years, recommend
1.     Den of Thieves – Junk bond crisis of the 1980s
2.     When Genius Failed – The rise and fall of Long-Term Capital Management (LTCM)
3.     The smartest guys in the room – The rise and fall of Enron
4.     Too big to fail and On the Brink – The great financial recession of 2008

Also enjoyed reading Liar's Poker and the big short.

Take it easy until next time.

Note: Views are personal and certainly not investment advice. Blogs are my weekend exploration.

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