Raise rates until something breaks - Liquidity may be the catalyst

 

There has been the view that the Fed should raise rates until something breaks. We have precedence from the BOE with the recent gilt crisis. Investors should realize that we already have the catalyst for a break - the fragile liquidity in financial markets. The days with low liquidity in 2022 as measured through top of the book orders by SocGen are like crisis periods. 

The same can be said for bond liquidity especially in Europe. There will be a crisis event which will require investors to move asset to protect principal, yet the liquidity may not exist and there will be then a negative feedback loop. Sellers will not find liquidity which will push prices lower which will then attract more sellers. The only solution is for prices to decline to such levels that buyers will be found. If uncertainty is high, buyers will be scarce. If financing is scarce, buying bonds or any asset will be expensive. if volatility is high, the risk assessment will also be high, and prices will have to fall to compensate buyers. The only solution is for the central bank to again play the role of lender of last resort, end QT, and rethink rate increases.