MAGGIE LAKE: Hello, and welcome to the Real Vision Daily Briefing. It's March 17th, 2022. I'm Maggie Lake. You're Joseph Wang, former senior Fed trader. Hi, Joseph.
JOSEPH WANG: Hey, Maggie, thanks for inviting me. Great to be back on Real Vision.
MAGGIE LAKE: Great to see you. We are in day two recovering from the Fed, but there's so much else going on as well. We're going to walk through some of the events but US equities rallying for a second day in a row. The major indices look like they're tacking on about another three quarters of 1%. We have everything up. Oil is up nearly 10%, a big move. We continue to see those big moves on either side.
We have the 10 Year bond hanging around 2.194% on cryptos up, gold's up. We also have mortgage rates up. Joseph, mortgage rates in the US rose above 4% for the first time in three years. The Fed said that the economy can handle the higher rates. The markets seem pretty calm. What do you think? Do you agree?
JOSEPH WANG: Yeah, I definitely think so. One way to think about rates is you have to take into account inflation, as well. If you take into account inflation and inflation is very high, real rates are actually super low right now. As inflation goes higher, the rates become even lower. Definitely, if you raise nominal rates a little bit, the rates will still be very low. The company can definitely handle it.
The way that chair Powell describes it, we have a very, very strong labor market. So, people, they're getting higher wages, they're getting more money. And so, that to me tells me that they are able to high handle prices that a little bit higher.
MAGGIE LAKE: Yeah. It's interesting, though, because when you listen to everyone, because so much of this is commodity based, it feels everyone's not doing well. I have people telling me about grocery bills that I didn't even think they looked at them. It's you're feeling that kind of sticker shock. Consumer sentiment matters a lot to. Do you think that people feel like those wages are rising quick enough, or keeping up with some of the big spikes we've seen?
JOSEPH WANG: I think there's some subtlety to this, it really depends on which level of wages you're looking at. Some of the work that I've seen is that when you look at wages from the bottom, let's say 20%, they've actually risen more than inflation, so they're getting real wage gains. So, for them, it's actually things are working out quite well.
It's actually the upper income people whose wage gains have been lower than inflation. It does depend on just where you are in in construction. But I think you raise a really good point now. We have a labor market that's on fire, and yet consumer sentiment is really low. That's a conundrum. Maybe part of that might be reconciled by just who you're asking.
MAGGIE LAKE: Yeah, because you feel like you're living in a different country, not only in a different income class, depending on where you find yourself. Interesting that it's the higher wage people who are feeling, and maybe also feeling the volatility in asset markets, because we know, even though the amount of Americans, and this is a very strictly American centric conversation right now, but the amount of Americans who own equities has been rising, but traditionally it tends to be tilted toward the upper part of the income strategy. So, they are certainly feeling some of this or pullback we've seen in equities and just the volatility.
JOSEPH WANG: Absolutely. It's absolutely crazy. Listen, what happened the past few days, equity market just surging higher, today commodity is surging higher. There's a lot of volatility. I think a lot of it might have to do just some of the underlying mechanics within the market. Some of the things that I read that I find persuasive, for example, we've read a lot of commodity companies who are basically blowing up because a commodity company, let's say, produces commodities, and sells forward to their production to hedge it. It's a prudent thing to do.
When the market keeps rallying, they lose money on their hedges. And sometimes they need to get emergency liquidity lines. And if they can't take it, then they have to take their hedges off, that means you have to be buying those futures squeezing it higher. Some of the some of the volatility we've seen in the past, let's say, a couple months might have been just some of these commodity producers getting squeezed. And now perhaps they're out, some of the speculators come in and they're pushing oil higher.
If you look at some of the fundamental, a lot of people are looking at this and saying, well, Russia is probably going to be offline for a while. If you think of it as a supply and demand perspective, that has to have a big impact from a fundamental sense on a lot of commodity prices, not just oil. What's strange might not be that it imploded, but that it actually was got silver to begin with.
And now maybe it's going back to two more fundamental based. What the equity market, it might also be technical as well. One of the things that I've noticed is that the volatility has come down a lot. We had some tail events heading into the Fed meeting, a lot of people might have been hedging for a very hawkish Fed. Now, when that didn't materialize, and they got up the hedges crashing volatility lower.
When volatility gets low, some of those Vanna flows have come in. And so, people be basically, because volatility is lower, the dealers don't have to hedge as much so they can buy back their shorts, and that's upward fuel on the market. That could be some factors as well. So, when I look at these huge volatile events, I tend to think there's some mechanical basis for them.
MAGGIE LAKE: [?] like a true trader. And it's important to keep that in mind, I think, because we do tend to be looking for an explanation or looking to fundamentals to try to justify what's going on. Given that, do you think that those dynamics have worked their way through? And should we be looking at fundamentals now? And what does that tell you in terms of commodities and equities?
JOSEPH WANG: I never look at fundamentals only. Only the sense that some people act on fundamentals. For me, fundamentals mean who's buying and who's selling and how much money they have. If you have some people who look at "fundamentals," then you want to see how they're playing their game and how much money they have, because that's how much they can influence prices. When I look at what happened--
VIX basically down to, let's say, the mid to low 20s, I think that phase is over. So, we can basically continue to go down or we can continue to go up. The same thing for the oil market. When you see the open interest going very low, that means that more people can come back in and maybe that can begin a new cycle. So, that's how I look at that. Just looking at the geopolitical situation, I think that's probably going to be the bigger driver of how markets behave in the coming weeks.
The thing is that what's happening with Russia, I think of it as a regime shift. You can't just destroy someone's economy, and then turn around and be like, hey, we're friends. Don't take it personally. Now, there's a lot of bad blood there. I think that is going to make it very difficult for things to get back to where they were before the Ukraine incident. And so, that's going to mean ongoing commodity shortages. That's going to mean higher commodity prices. That has an effect throughout the markets, most notably in inflation.
If you have a money higher commodity prices, usually you have higher inflation, which in turn hurts fixed income prices, which through risk parity, or let's say 60/40 portfolios hurts equity markets. They're all connected in that sense because the people who buy bonds also buy equities. So, just from my perspective, I think we're still in a very risky negative regime and will be for the foreseeable future.
MAGGIE LAKE: Interesting. We have a question from Florian asking, what's the best asset class to invest in now? And since we're talking about that portfolio construction, I thought it'd be good to get that question in. If you feel that way about risk assets, what is the best asset class to be in right now?
JOSEPH WANG: I like energy a lot, and I've owned a lot of energy. It depends on who you are. You can buy a producer. They will give you good income. Dividends are likely rising. Or if you like futures, if you buy for delta curve, you get some roll yield, I think the curve, it's heavily backward dated. You could get some roll yield, and of course, you get the tax treatment if you're in the US. Futures contracts are taxed differently. Commodities energy, and if you want, you could I think that-- if you have such a mandate, you can also just sell tech or the indexes, for example.
MAGGIE LAKE: It's funny because this is a day when we've got some-- this always happens, doesn't it? I think it was folks at JP Morgan coming out and saying, okay, the stock bubbles burst. Now's a good time to be going back into these high beta stocks. The worst of it's over. It sounds like you fundamentally disagree with that.
JOSEPH WANG: I look at things from the mechanics of the financial system. If you have higher inflation, that's one thing. And the other point you're having is you're having a very hawkish Fed. Those two things mechanically hurt the fixed income market. You're basically haircutting fixed income assets. And that has to through these portfolio managers who own fixed income and risk assets necessarily implies that they're going to have to sell some of their risk assets.
You can think of the Fed basically, indirectly pushing down risk assets, so I don't think that we're going to go and go back and have like a bull market and go to all-time highs. I think that the trend is still lower. And honestly, that's kind of a pulse your choice as well.
MAGGIE LAKE: Yeah, that's the thing, isn't it? If they're trying to tackle-- It's interesting, we were just talking about the dynamic. I think you rightly point out, if you force a major because of what's happened with Russia, it's hard to imagine you're going to bounce back in the way that you would if you were talking about another cycle. This has the potential to realign things in a geopolitical way that we haven't seen in some time.
And so much at least in the commodity space and inflation, it was already clearly happening. But you put that on top of it. The Fed in its debut yesterday talks all about trying to get a handle on inflation. This is we're behind the curve, price stability is our mandate. How are higher interest rates going to do anything about what's driving commodity prices higher?
JOSEPH WANG: It's great a great question. I think you could even take it even broader. How do higher interest rates work at all? Let's say that you have, instead of-- Let's say the Fed raises interest rates by 2%, are you actually going to change your spending differently because interest rates are a little bit more? If you're a company, are you going to invest less? If you are a retail person, are you actually going to put it into your money market account, earn 1.5% rather than go and buy a new car?
It's hard for me to see how that actually makes a difference. From my perspective, the biggest impact Fed policy has is through the financial markets. I don't really think that the Fed has that much of an impact on the real economy as LSE does things vary drastically. The easiest way to see this, in my view, is to look what happened in the Post-GFC World. We have 0% interest rates. We have quantitative easing, and yet the real economy didn't even do all that much.
I think the truth is, when it comes to real economy stuff, purchasing, buying, investing, the prices money is just one input of many considerations. For the Fed to think that makes a big difference, I think is to vastly overstate the power of the price of money when it comes to the real economy.
MAGGIE LAKE: That's a fantastic observation. And one that that seems to be to prove true when we look at look at what's happened. The Fed has signaled-- what's that?
JOSEPH WANG: However, the Fed has a lot of control over financial assets. And that I think is how Fed policy actually works in the Post-GFC World. In the post Post-GFC World, you see Bernanke being like, oh, let's have a wealth effect. I can't encourage investment descending, maybe I will make everyone wealthier. Maybe you own that house. Maybe you own that stock. Maybe it goes up a lot. Maybe you go and take that money and go buy something. Maybe that will stimulate the economy.
And so, I think of monetary policy as primarily impacting the economy to the financial wealth shadow. And that's where they could do something, they could make the stock market go lower, making make housing prices go, maybe not down, but at least not rise as much. When you do that, though, that affects aggregate demand because people have less wealth to spend. If you have less wealth to spend, less demand. In theory, I think you could at least slow inflation down a little bit.
MAGGIE LAKE: Yeah, that may be what they're trying to do but that's a that's a tricky one, isn't it? Because that suggests they can soft land things, and that's where a lot of the skepticism comes in. I actually want to play a clip because we were talking about this-- I was talking about this yesterday with Jeff Snider from Alhambra Investments. I know that you and Jeff have talked in the past.
He is looking at the Feds narrative and then putting it against the bond market and the yield curve, and suggesting that the bond market is also skeptical of the Fed and telling a different story. Let's have a listen to that clip.
JEFF SNIDER: Yes, the Federal Reserve does see these things in the marketplace. How can you not? When the 5 year or 10 Year's inverted in the yield curve, that's something you have to pay attention to. But they have grown very comfortable, entirely too comfortable, just setting aside the bond market signals and saying, well, we're going to do this because we believe it's the correct action, and we think the bond market is eventually going to agree with us.
Their conception is that the yield curve is inverted today, but that it'll steepen tomorrow once it gets on board with a message that the Federal Reserve is sending. When that's completely backwards as history has shown time and time and time again over the last 15 years. Pay attention to the Eurodollar Futures Curve. Pay attention to the yield curve. Because what happens in those curves is what the Fed is going to be doing, whether it thinks it will today or not.
That was absolutely the case just a couple years ago, Eurodollar futures inverted in June of 2018. The Fed was hawkish to the moon. And what happened in June by 2019? The Fed was cutting rates when they thought it was going to be hiking rates. So, the Fed has everything backward.
MAGGIE LAKE: And that full interview is available on Essential Plus and Pro Tiers on realvision.com. The Feds got it all backwards. Or the other way to say it is that they know, but they don't want to say exactly what they think they know. I don't know, what do you think?
JOSEPH WANG: I think a lot of people look at the yield curve as giving you information about what the Fed is doing right or wrong or what the economic condition is. I respect that, and I think that the yield curve has a very good track record. But I think that things are really different if you look at Pre-GFC and the world Post-GFC. Pre-GFC, you had a lot of basically the market was private participants, a lot of people trying to make money. And so, you can have a lot of people who are very keen on economic conditions, going and trading the yield curve.
Post-GFC, things are completely different, they're different in two ways. One is that you have a lot more official sector involvement. The Fed, for example, is there buying Treasurys. It holds $5.5 trillion, and that's a big number. And you look at across the pond, ECB does something similar, the Bank of Japan goes one step further, and has yield curve control, it's putting down its 10 Year. Now all that in my view has to have some impact on the price of, let's say, the price of bonds.
Not just that, though, you have a lot of regulation that basically forces a lot of very, very big players to buy a lot of bonds. Banks, for example, they're incentivized strongly to hold Treasurys, and that's to the [?] trillions. When you look at bond prices, I think it's very careful to not try to reach too much into price, because everyone buy something for a different reason.
Now, another analogy that I like is that if you look at Tesla when it was trading above 1000, would you look at that and say, obviously, the market, assuming Tesla is going to take over the entire electric car sector. In fact, everyone else is going to be pushed out Tesla, everyone would have just as in the future. I don't think you would assume that, right. It's just a whole bunch of people buying for whatever reason.
If you look at any financial asset, that's really all it is. It's just a bunch of people buying and selling with the different views of the future, different mandates, different risk preferences. And this is especially true in the bond market because we know who participates in them. A whole bunch of people who are not in there to make money, who are in there because they have to, who are in there because of policy reasons. And because of that, I don't actually take the yield curve very seriously. I just don't see any reason to.
More importantly, I think there's a couple ways you can look at this. If you have an inverted yield curve, do you think of it as actually causing a recession? Or do you think of it as a signal for recession? Now, if you think of it as a signal for recession, I don't really worry about that. To be honest, I think the Fed is going to fix that through quantitative tightening. They're going to vastly increase the supply of bonds, and that will just straighten it out and so, that will disappear, yield curves inverted and invert all the time.
Now, if you think of it as a cause for recession, I think that is also not true anymore in the Post-GFC World. In the Pre-GFC road, you can think of it potentially as a mechanism for causing recession, because you had a very bank centric world. A