Twenty years.
It’s been twenty years since I’ve read a BIS (Bank of International Settlements) report which actually has created some level of concern for this author. In 2006, I was on the front lines. At that moment I was both working with a friend part time as a precious metals/coin dealership to help him out while working at a major distributor of construction materials in western Florida. While 2006 was an interesting year, 2007 became the year of great consequence and the parallels to the era we are in now are too stark and can no longer be ignored.
At that moment in late 2006, no one imagined the crash that was coming but talking to “average” investors, customers, and individuals gambling their life fortunes and pushing their credit lines to the limit to buy more homes seemed like a rational idea.
Until one took a step back and asked the question:
“What happens when the party is over?”
In January of 2006 the BIS published the following paper:
Housing Finance in the Global Financial Market
To save my reader’s eyes from bleeding, I’ll hit the high points so all of us can be on the same page as 2026 begins its relentless march into a brave new world.
From the article, the conclusion about financial markets concerns sounds vaguely familiar:
Another consequence is that housing finance may have become more sensitive to financial market
conditions. For example, changes in funding conditions for lenders may feed through more directly to
borrowers and, hence, also affect the real economy. Thus, even though credit risk held by mortgage
lenders may well be unlikely to generate systemic difficulties, as this would probably require both a
deterioration in collateral and a failure of households’ ability to repay debt, lenders are becoming
increasingly reliant on markets for funding. This raises the risk that weakness in these financial
markets could generate wider disruption across the financial system. Finally, should refinancing or
prepayment of housing finance loans become more widely available, the risk of more volatile bond and
derivatives markets in periods with prepayments becomes a broader issue.
Thankfully, America has learned our lesson and we no longer participate in NINJA loans, subprime financing, or wildly unrealistic adjustable rate mortgages.
Just kidding, we’re doing all of this and even more now.
The First Half, aka, end of Q2 is Over so Now What?
The stock market started the second quarter with a roar but ended with a whimper, closing below the 50 DMA and potentially indicating further problems down the road.
If this validates there is a lot of pain, potentially 38.2% or more, coming in the third quarter as economic stagnation for the lower economic caste continues.
Then again, I could be overreacting like I was accused of in 2006, 07, and 08.
Obviously it’s just an isolated incident this year and nothing to lose sleep over.
Yet.
A Potential Red Alert Flash Back to the Past
It’s sort of ironic that the Bank of International Settlements (BIS) would flash a “red alert” at the same time I’m listening to Distant Early Warning by Rush and they are coming to an arena near me this year.
But here we are again boys and girls, reliving the kind of nightmares we all thought that the financial system had learned a lesson about in 2009 yet instead just renamed the garbage, buried it in the litter box, and prayed the smell wouldn’t seep through to the broader economy.
In 2006, the BIS published the paper linked above. Today, the BIS published their Annual Economic Report which should send a chill up the spine of any rational investor or anyone who has survived previous economic crises:
Progress and peril
One of the first perils the BIS outlined was a resurgence in inflation:
An inflation comeback
The macroeconomic impacts of the Hormuz disruption may not have run their course. The ultimate consequences will depend on how long it will take for the Strait traffic to fully and sustainably resume, and for damaged energy infrastructure to be repaired. Meanwhile, the inflationary impacts are already being felt and could prove persistent, for several reasons.
First, a 10% oil supply loss was significant, and markets could take considerable time to rebalance. The disruption initially caused a violent shift in oil markets, turning the ample inventories prior to the conflict into an acute shortage. Brent prices surged by 67% to an intraday peak of $120 in less than two weeks and have since been subject to significant volatility. Physical crude prices have reacted even more to tighter supply conditions, with some regional crude oil prices matching mid-2008 peaks. Granted, recent de-escalation has brought relief and oil prices have pulled back significantly. But, as argued in Box B, large imbalances in the physical markets remain and could lead to further strains and volatility.
Second, there are already signs of rising inflationary pressures. Global inflation has jumped by half a percentage point since the conflict started (Graph 8.A). Several commodities have seen double-digit price growth. For instance, prices of plastics and fertilisers were both up by 50% – consistent with purchase managers reporting significantly higher input prices. Higher costs and shortages of key inputs could propagate through supply chains, raising the costs of other intermediate goods and amplifying price pressures on final goods (Graph 8.B). Given the time lags in production, the upstream cost increases could continue to pressure inflation well after energy flows and oil prices normalise.
The charts the BIS references in Graph 8 are somewhat disturbing because in the short term (Q3 per this author’s predictions) there appears to be some validation for what is coming:
If the theory presented by the various sources listed above in the BIS article are correct, the idea that the consequences of the oil shortages and supply disruptions impacting during the third quarter of 2026 are not totally insane nor that of a short term inflationary spike as this author circled in the third graph above. On a global scale it will have a far greater impact than the United States but one has to be believe that the new Federal Reserve Chairman will be paying strict attention to potential fallout from this spike and attempting to interpret if this is going to become a systemic issue or just “transitory” as prior Fed Chairs promoted.
Where oh where have we seen the implications of a late stage economic inflationary spike right before a massive financial correction and economic disruption again?
In the midst of the Great Financial Collapse/Crisis of 2008, oil spiked higher, commodities spiked a lot higher, which was followed by an epic deflationary collapse. However, staying true to tradition it was the first of two waves and the second wave of deflation was much harsher, not for hard or real assets, but for pricing power for American companies and the assets that the average American owned.
This brings us back to the BIS and their warnings in their paper tonight especially the warnings about the speculative explosion in artificial intelligence malinvestment:
In the near term, the ongoing AI investment boom raises questions about the sustainability of the current economic expansion. The five largest hyperscalers are set to spend over a trillion US dollars on AI-related capital expenditure from 2025 through 2026. These commitments are outpacing earnings and the free cash flow of these firms, leading some to issue debt to raise additional financing (Graph 11.A). This investment race may be partly driven by the perception that only a small number of players with superior technology will ultimately dominate the market shares. The intense competition raises the risk of firms over-committing resources to investment projects with still uncertain returns, leaving all firms vulnerable to disappointments in AI payoffs. Model analysis based on such contest motives highlights the downside risk of current AI exuberance. As competitive pressure drives capex higher, the net economic surplus – the total payoff less investment costs – declines for the sector as a whole and could turn negative in adverse scenarios (Graph 11.B).
Emphasis once again is from this author, not the BIS. Graph 11 highlights what most of us already know; overly speculative periods almost always conclude with a crash regardless of the productivity or technological gains extracted from the new product.
(click to enlarge)
There are other booms not highlighted by the BLS, such as the “transistor” boom which happened as a lead up to the 1962 flash crash, the 1907 Panic where like now financial innovation was thought to be infallible, and of course the Covid crash created by overreaction to a common flu.
The one thing the BIS does highlight is a consequence and a warning as the conclusion for their report, and once again all of the emphasis is this author’s, not the BIS:
Private credit has grown rapidly and extended into retail channels; leveraged hedge funds have taken on ever-larger roles in core funding and treasury markets; and AI-related financing has become more concentrated and circular within the ecosystem. These interlinkages could turn into powerful amplifiers at times of stress.
The Crash Conclusion and Word of the Day: Macroprudential
Do what you do best was a lesson I learned the hard way in financial markets.
After losing a substantial sum thinking that I had figured out the widowmaker trade (natural gas) I elected to return to something more steady that I understood better, precious metals. It is why I rarely write about other commodities and only comment on macroeconomics as a whole based on my study as a historian and observer of life.
The word that was bandied about by the BIS in the annual report, which is a must read by the way, is macroprudential. Google it if you do not understand why it is crucial heading into the last six months of this year.
After America recovers from its 250th birthday hangover on July 7th, reality will return but not to the extent many think it will.
There is a geopolitical risk of Iran and the US restarting hostilities, but it is this author’s belief that that will be postponed until early September and more so due to domestic Israeli politics than any desire by Trump to restart the conflict. This begs the question: Where does the crash risk emerge from?
Unfortunately for the new Chairman of the Federal Reserve Kevin Warsh his own statements in an attempt to browbeat the inflationary impulse might just be enough, especially after Jackson Hole, to enhance market volatility, especially in credit. Add in a dash of President Instability throwing gasoline on the fire plus an exhausted bull finally keeling over into the slaughterhouse assembly line, and odds are mistakes will be made at every level.
I’ve been fairly confident of a Fibonacci retracement of at least 38.2% from the all time highs and with the Mag 7 rolling over even more so. But now that semiconductors have started to decline and market internals looking worse heading into the end of Q2, the thought that the AI trade will spike one more time with the Anthropic IPO, which this page still believes happens in August, followed by a panicked rush for an OpenAI IPO in September will mark the top.
Just like when this stock hit the tape almost a century ago:
Enjoy the holiday week, pray for peace, and buckle up.
Q3 and Q4 are going to be historic in so many ways and historic events are fun to witness.
At least until the banks close.