Economy

Clock is Ticking for US Recession and Return of Fed’s QE, Says Black Swan Fund – Reuters

By Davide Barbuscia and Carolina Mandl

NEW YORK – The initial interest rate cut by the Federal Reserve indicates that a U.S. recession is on the horizon, with a significant decline in financial markets that may compel the central bank to intervene by purchasing bonds, according to Universa, a tail-risk hedge fund.

Recently, the Fed announced it began reducing rates to adjust monetary policy and support the labor market. As inflation decreases and the economy remains relatively stable, many observers interpret the onset of this easing cycle as a precursor to an economic "soft landing."

However, Mark Spitznagel, chief investment officer and founder of Universa, views this development as the beginning of a steep interest rate reduction. He argues that the highly indebted U.S. economy, which has so far defied expectations, is likely to falter under the strain of historically high interest rates.

"The clock is ticking and we are in black swan territory," he stated.

Universa is a $16 billion hedge fund focused on risk management against unpredictable and impactful market fluctuations. The fund employs strategies such as credit default swaps, stock options, and other derivatives to gain from major market disruptions.

Tail-risk funds typically serve as low-cost bets on significant, unlikely payoffs that would otherwise negatively impact portfolio performance, similar to the expense of insurance premiums. Universa stood out as one of the significant beneficiaries during the market turbulence that followed the onset of the COVID-19 pandemic in 2020.

Spitznagel noted the recent "disinversion" of a critical segment of the U.S. Treasury yield curve, a significant bond market signal of an impending recession, suggesting that a severe economic decline may soon occur. "The clock really starts when the curve disinverts, and we’re here now," he remarked.

The yield curve comparing two and ten-year yields had been inverted for approximately two years but has recently turned positive as short-term yields fell faster than those for longer durations, driven by expectations that the Fed would cut rates to assist a weakening economy. Historically, this yield curve reversal has preceded the last four recessions.

He suggested that the intensity of the upcoming credit crunch could mirror the "Great Crash" of 1929, which precipitated a worldwide recession. "The Fed raised rates into an enormous, unprecedented debt structure… That’s why I anticipate a crash we haven’t witnessed since 1929."

A recession may occur as soon as this year, prompting the Fed to significantly lower rates from the current range of 4.75%-5%. This could eventually lead the central bank back to quantitative easing (QE), a strategy typically employed in tumultuous markets to enhance monetary policy when rates approach zero.

"I strongly believe they will intervene again… I feel confident that QE is returning and rates will revert to something close to zero," Spitznagel asserted.

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