I’m halfway through the new book, " 1929: Inside the Greatest Crash in Wall Street History–and How It Shattered a Nation," by Andrew Ross Sorkin. It’s not suspenseful, since we all know how it ends, but the details are interesting.
The 1920s bull market was driven by speculation. Margin up to 90% was allowed. In 1929 more retail investors piled in. Ordinary working people as well as the rich borrowed heavily and invested their savings. The margin debts were collateralized by their stock holdings. When the market plunged the baby was thrown out with the bathwater. All stocks plunged together.
The stock market is correlated with (and driven by) margin debt. Currently, Debit Balances in Customers’ Securities Margin Accounts is an astonishing $1.26 Trillion, which is 4% of GDP and up 30% in 2025.
This counts only margin accounts at FINRA member firms and doesn’t include money borrowed to buy other assets, such as bonds, cryptocurrency and precious metals.
Like 1929, today’s leveraged speculators are vulnerable to reversals. They are counting on greater fools bidding up investments. If buyers back off the price of an investment can drop suddenly and sharply. Investments without a yield to support their value (e.g. stocks without dividends, commodities, cryptocurrency) don’t have a floor. Even investments that do have a yield can be dragged down by selling pressure of margin calls.
The real news this week is the nomination of Kevin Warsh as the next chair of the Federal Reserve.
Warsh obviously convinced President Trump that he would cut the fed funds rate which is Trump’s primary objective. However, Trump doesn’t seem to realize that longer-term interest rates are set by the bond market, not the Fed. The Fed has repressed long-term yields by buying massive amounts of Treasury and mortgage bonds during Quantitative Easing (QE).
But Warsh hates QE and actually quit his job as a Fed governor in protest over QE. Warsh believes in strict separation between monetary (Fed) and fiscal (Congress) stimulation. If he sticks to his guns, Warsh will refuse to monetize growing federal deficits by buying Treasury debt. He will reject financial repression where the Fed bails out the Treasury.
Warsh has been a master of conciliation since his college days. So he will surely avoid upsetting the markets in the short term. He may even support a cut in the fed funds rate in April or June but of course the FOMC makes a committee decision. Current Fed Chair Jerome Powell moves out of the chairmanship in May but it’s likely he will remain on the FOMC.
The commodities market doesn’t expect a fed funds rate cut until June and even then only 0.25%.
https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
Far more important is the 10 year Treasury yield which impacts business lending, consumer lending and mortgages. Even though the fed funds (overnight) rate was cut the 10 year Treasury yield has climbed since October. The real yield has hovered in a channel between 1.5 - 2%. This isn’t much but it’s a lot higher than the post-GFC years when the Fed repressed the yield with QE and the real yield was usually under 1% and sometimes less than 0%.
If Warsh is true to his writings and beliefs he will refuse QE (barring a true emergency) and let the Fed’s bloated book roll off. That will result in higher long-term bond yields.
Higher long-term bond yields will make U.S. bonds more attractive and support the weakening USD. The USD bounced and gold and silver dropped as soon as Warsh’s nomination was announced.
Nominal bond yields are the sum of real yields plus inflation expectations. The 10-Year Breakeven Inflation Rate has been stable in a channel between 2.0 - 2.5% since 2023.
Multivariate Core Trend of PCE Inflation from the NY Fed has been declining and is close to the Fed’s goal of 2.0%. However, the Cleveland Fed’s Inflation Nowcasting shows a rising CPI. (Which impacts my TIPS and I-Bonds directly.) The Atlanta Fed’s Underlying Inflation Dashboard still shows a lot of red.
The Atlanta Fed’s GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2025 was 4.2 percent on January 29, down from 5.4 percent on January 26. Despite the small decline this is still a very strong growth prediction. With CPI still high and GDP strong the Fed will not have a reason to cut the fed funds rate.
Higher bond yields and a stronger USD are both likely to weaken stock prices. Bonds will be more competitive with stocks. A higher USD means greater competitive pressure for U.S. companies selling into international markets.
This is speculative…but we are talking about speculators, after all.
The Chicago Fed’s National Financial Conditions Index (NFCI), which provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets, and the traditional and “shadow” banking systems, showed that financial conditions got even looser. Financial stress fell back as the Fed pumped some money into the system to relieve liquidity in banks. This was short-term, not QE.
The stock indexes are still in a rising trend but Bullish Percent is languishing. VIX is rising. The Fear & Greed Index is slightly in Greed. The trade, which had been risk-on, suddenly turned to neutral to slightly risk-off. This is short-term and could be noise. Time will tell. SPX is in a historic bubble as the Price-to- earnings ratio based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted P/E Ratio (CAPE Ratio) is over 40 compared with the historic median of 16. Anyone who can read a chart will find this scary. Especially since the rah-rah enthusiasm of 2026 over AI is so similar to the rah-rah enthusiasm over the internet in 1999.
Energy prices are rising due to the cold weather. Gold, silver and bitcoin fell off a cliff. Time will tell whether the bubble popped or whether this is noise.
The METAR for next week is partly cloudy. The gold and silver bubbles may or may not have popped. It’s hard to know how that will affect the stock market which may ignore it and continue its rising trend. The METAR is a short-term forecast. If bubbles start to pop the METAR may change to a sudden squall.
Wendy
https://www.newyorkfed.org/research/policy/mct#--:mct-inflation:trend-inflation