On Friday evening, we brought you some excerpts from the latest note by Deutsche Bank’s Aleksandar Kocic,in which the best analyst on the Street reminds you that the ECB decision represents a continuation of a regime characterized by a communication loop between central banks and markets.

That communication loop (call it “transparency”) effectively makes it impossible for market participants to form a long-term view, and thus it optimizes and entrenches “bad behavior” (everyone is a vol. seller, everyone is a carry trader, etc. etc.). Here’s where we left off:

This is a consequence of Central Banks’ complicity and shrinking of the horizons – the future is degrading into an optimized present. At this point, there is an implicit symbolic pact between Central Banks and the markets: The Fed knows that the market knows and the market knows that the Fed knows that the market knows, so everyone knows, but pretends that nobody knows and the game goes on. But what happens if there is an exogenous circuit breaker and we can no longer pretend?

That “exogenous circuit breaker” could be inflation or deficit spending – something that would bear steepen the curve and thereby force central banks to withdraw transparency, breaking the communication loop and ushering in a return of volatility in the process.

Well, Kocic’s next step is to trace the evolution of volatility in the context of leverage using a coordinate plane and quadrants while channeling Minsky and Maurice Sendak in a section called “The forgotten horizon: where the wild things are”. Here’s Kocic:

There is a relationship between leverage and vol which defines the dynamics of the economy. Generally, reduced uncertainty engenders higher levels of leverage which in turn leads to additional compression of risk premia and a buildup of risks. Ultimately the system becomes unstable and results in a crisis, which in turn forces the system to deleverage in a highly volatile manner. In a way, continued prosperity and stability in itself is destabilizing leading to riskier lending as the asset prices of collateral decline. This is the essence of Minsky’s take on financial markets.