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Need to Know: What’s going to break next? Look for leverage and artificial constraints, says this fund manager


There seems to be a competition between U.K. fiscal and monetary authorities as to which can cause the most turmoil in financial markets, in light of Bank of England Gov. Andrew Bailey telling a conference in Washington D.C. that pension funds had three days to sell U.K. government bonds.

As of Wednesday morning, the pound

was back over $1.10 though the yield on the 30-year gilt

crossed 5%, as the market debates a report suggesting Bailey didn’t really mean what he said. (The Bank of England this morning tweeted that he did.)

A question that’s going around is what breaks next as central banks across the globe keep raising interest rates in a bid to get runaway inflation under control. “The place to look for breaking things are wherever there’s leverage, and wherever we have artificial market structure maintained by the authorities,” said John Ricciardi, head of global asset allocation at Deuterium Capital Management and a long-time industry veteran.

One place to look: Japan, where the yen

has declined in value by 27% against the dollar this year while the Bank of Japan keeps rates at zero. “One thing that could break, and it’s something we discussed internally, is the ability of the Japanese to maintain a zero interest rate policy,” he told MarketWatch in an interview.

Betting that Japanese interest rates would rise is a classic “widowmaker” trade in that it hasn’t succeeded in decades, and its unwinding would boost the beleaguered Japanese currency.

Another place to look is Europe, where the European Central Bank is trying to keep sovereign spreads in the eurozone anchored but periphery CDS, in Greece and Italy, are widening. “Should this continue, it won’t be just the euro — which is kind of helpful that it goes down — but it will be in interest rates and interest rate differentials,” he said.

Ricciardi is the lead manager of the Deuterium Global Dynamic Allocation Fund, where investments are primarily dictated by its model of the global economy, with inputs for central bank policy, market valuation and price trends.

Valuations aren’t much of a problem, and in fact look attractive outside the United States, according to Deuterium.

That fund is anticipating a rough fourth quarter both for U.S. stocks and commodities, forecasting consumer spending will finally turn, industrial output will decelerate, and earnings growth expectations to ratchet down. The firm is expecting the fastest fall in U.S. consumption and retail sales since the 2008 financial crisis, as workers react to falling incomes adjusted for inflation.

“You see it in the drop in the savings rate, you see it in their maxed-out credit cards,” says Ricciardi. With mortgage rates surging, refinancing isn’t an avenue that consumers can turn, either. “The big damage is still to come in the equity market for the next month or couple of months,” he said.

Ricciardi notes that this year, bonds sold off first, then non U.S. currencies, before stocks starting swooning. He said it’ll probably reverse in that order as well, when either the Federal Reserve will pivot or the labor market will turn — but that won’t be until next year.

He referenced the 1985 Plaza Accord, when global central banks got together and took orchestrated action to lower the dollar. “I don’t know if something like that would ever be on the table, but I could certainly see that the moment of a Fed pivot, that the authorities in one way or another would come together to find a way to ease the pressures on global liquidity from the appreciating dollar.”

The market

The S&P 500

has dropped for five straight sessions, and, technically, the Nasdaq Composite

entered a bear market on Tuesday. Well things are looking up on Wednesday, with stock futures


higher, and the dollar

slightly weaker. The yield on the 10-year Treasury

was 3.95%.

The buzz

The U.S. economics calendar includes producer price data, and the release of the Federal Open Market Committee minutes. Bank of England chief economist Huw Pill is due to speak at 7:35 a.m. Eastern.


reported better-than-forecast earnings and lifted its outlook. Health technology company Philips

lowered its sales outlook and said supply-chain challengers impacted deliveries and installations.


may lay off thousands of jobs when it reports results later in the month, according to a Bloomberg report.

Coal producer Peabody Energy

is in talks with merge with Coronado Global Resources

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