The Hard Sell

“Mnuchin warns of equities fall without tax reforms”

One of the commenters says it best: “This is the hard sell on tax reform??”

This is just the latest example of how financial market performance has turned from output to input for policymakers in recent years. Granted, Mnuchin’s comment is more political propaganda than policy prescription. It’s worse at the Fed. At the Fed, preemptive strikes on market volatility have become standard operating procedure.

From Chris Cole’s excellent research piece, “Volatility and the Allegory of the Prisoner’s Dilemma” (linked above):

Pre-emptive central banking is a very different concept than the popular idea of the “central bank put”. The classic “central bank put” refers to policy action employed in response to, but not prior to, the onset of a crisis. Rate cuts in 1987, 1998, 2007-2008, and Quantitative Easing I and II (“QE”) programs were a response to weak economic data, elevated financial stress, and large drawdowns in credit and equity markets. To differentiate, pre-emptive central banking refers to monetary action in anticipation of future financial stress to avert a market crash before it starts,even if markets appear healthy and volatility is low. In executing a pre-emptive strike on risk, policymakers rely on changes in faster moving market data (e.g. 5yr-5yr breakeven inflation) rather than slower moving fundamental economic data (e.g. CPI and unemployment). Although well-intentioned, their actions have created dangerous self-reflexivity in markets by artificially suppressing volatility and encouraging rampant moral hazard. Central banks have exchanged ‘known unknowns’ for ‘unknown unknowns’ creating the potential for dangerous feedback loops. A central bank reaction function is now fully embedded in risk premiums. Markets are pricing the supportive policy response before action is even taken. Bad news is good news and vice versa because the intervention is more important than fundamentals. Pre-emptive strikes on risk are contributing to the massive growth and popularity of any asset or strategy with a short convexity or mean reversion return profile. The unintended consequences of this massive short convexity complex will be born from phantom liquidity, shadow gamma, and self-reflexivity.

Anyway, Mnuchin’s comments have nothing to do with tail risk. He is just beating the unwashed masses with a stick to keep pressure on Congress to deliver juicy tax cuts.

This is classic dumb money messaging. You know it’s dumb money messaging because it focuses on market prices and not valuations (traders and arbitrageurs should consider themselves exempt from my nasty sarcasm by definition). Hard selling works well with dumb money because dumb money doesn’t understand how cognitive and emotional biases impact financial decision making, or how to formulate capital market expectations. Mnuchin is basically saying to Average Joe, “if tax cuts don’t go through your 401(k) is going to crater.” That’s the true message and the true target.

See also: literally every penny stock promotion. Or the movie Boiler Room.

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