MAGGIE LAKE: Hi, everyone. Welcome to the Real Vision Daily Briefing. It's Wednesday, July 21st, 2022. And today was all about the central banks, the Europeans hiked, the Japanese did not, and weak US data raise serious questions about the Fed's policy. What does it all mean for the markets and the economy? Here to discuss is David Woo, macro strategist and founder of David Woo Unbound, and our very own Weston Nakamura.

Great to see both of you. Weston, let's just jump right in and start with you. The European Central Bank moved, seems like it's further isolating Japan and its insistence on keeping rates negative as you had been pointing out all the time on Twitter. So, what jumped out at you from both of these decisions? So, help us unpack them.

WESTON NAKAMURA: BOJ, nothing changed, policy unchanged. They basically have yield curve control in place. 25 basis points is the upper bound for yield curve control on 10Y JGB. What they did was they did lift their fiscal year 2022 inflation forecasts, which are above 2% target. But apparently, that's something I've never heard before in modern central banking, had to look it up with transitory I think what it was, basically.

MAGGIE LAKE: Yeah, that word, yeah, I think I might have heard of that.

WESTON NAKAMURA: BOJ first of all, isn't over, in the sense that CPI comes out in a few hours, comes out later today in Japan on Friday. So, if central bank policy is based on CPI, then well, CPI is about to come out. They may be frontrunning CPI, they could potentially-- whatever it is, I'm sure that they have the number already. And it was a convenient timing for them to do so. But that's still left out there. So, BOJ isn't particularly over. But what I'm looking at, and so what I'm looking at in terms of BOJ is I'm looking at it in the context of the ECB, which did this historic hike.

So, now that ECB is plus 50, they are officially out of negative rate land. And so, if you then combine that with the SNB, the Swiss National Bank, which did a 50-basis point hike this past meeting, and if they follow through with the September 50 basis points, which is what's priced in the markets, that leaves the BOJ as the only central bank left, who is in negative rate territory. And so, that further isolates BOJ even more so.

So, BOJ, once again, just being on pause isn't necessarily no action taken, or of no consequence if everybody else is moving in the exact opposite direction.

MAGGIE LAKE: Yeah, it's interesting. So, the ECB hiked rates and as you said, it was a shocker. Really, no one was expecting, at least vocally, 50 basis points from them. But they also at the same time, put a tool in place to prevent the Eurozone from breaking up. Isn't that an acknowledgement of the risks that they're creating themselves? Did the market have any reaction to that, or did that mute any reaction we would have seen?

WESTON NAKAMURA: So, the way that I see-- so, you're basically talking about this TPI, this transition protection instrument. What that is to me is, so BOJ has yield curve control. ECB as I see it, what this instrument is, is ECB's yield spread control. And by that, Brian, if you pull up that chart, what that is, is essentially the spread between yield spread, nominal yield spread between 10Y German bunds and BTPs, Italian yields.

And so, that's basically the dilemma of the ECB, the periphery versus the more creditworthy more developed or like the Germans and so on and so forth. And how to sort of marry that under one giant monetary policy. How that's going to be transmitted and all that, we'll see. But if they want to take any lessons from the BOJ and yield curve control, which was revolutionary at the time, that was also rolled out initially as a very-- purposely, a opaque instrument. And then when they first instituted yield curve control, they did it when the market was at-- JGB 10s were yielding at around 10 basis points.

And once they did that, that's when the markets assumed, okay, that is now the level in which the yield curve control is and then they set this level, these bands and since then, they've been trapped in the concept of these bands to this day. So, the moment that the ECB does use this yield spread control, that will be seen as, okay, that is the threshold. That is the line in the sand. That is the put, whatever you want to call it. So, they have to be very careful in which to do that. But it really resonates a lot with when-- it took me back to when the BOJ rolled out yield curve control.

MAGGIE LAKE: I think that's a super, super important point. The other important point you continually make with me, and we appreciate you for it Weston, is that let's not be US dollar centric about this, you're actually watching the Euro/yen cross.

WESTON NAKAMURA: Yeah, yeah. So, what's interesting, too, in terms of timing, not just with CPI coming up in Japan ahead or behind the meeting. But the fact that for once, we actually have two of the largest central banks, besides the US Federal Reserve, releasing policy on the same day, while the Fed is in his blackout period. So, this is an ex-Fed, a non-Fed central bank policy and central bank market. And that's why I'm not looking at it, because everyone looks at, Brian, if you could pull up that chart of the Euro, everyone looks at the Euro versus the USD and then the yen versus USD, and they're both getting hammered.

But what about Euro/JPY, which is a significant cross rate. That is not performing obviously, against each other in the same way that they would against the dollar. So, it's important to look at that in context, too. So, that's really what I'm looking at in terms of currency pairs of crosses, rather than just against the dollar. So, that's a significant thing that I'm looking at.

The other thing I'll say about the Euro too, and I have a video coming out in a little bit on Real Vision YouTube about this, but the thing about the Euro is, like, don't be too short term, like intraday short term and attribute movements to events that are happening, because going into this, first of all you have just from the timing of it, you have at 3:30pm, you had BOJ Kuroda, and his press conference, and 3:30pm is 7:30am London. That's when London is the FX trading hub of the world, that's when traders get in, that's when they start to move markets. So, that time overlap.

Then you also have the Nord Stream I coming back online right around that same time. And the gas supply has been a significant factor and driver within the Euro in and of itself. So, that on top, and then on top of that, you have Italian political environment just blowing up and Mario Draghi and all that, too. So, it's very difficult to discern what is moving, I sense that that's why the Euro is flat, because there's just too many inputs, and people don't really know what to make of it. But implied volatility is very high for both the Euro and the yen. So, just keep an eye on those as well.

MAGGIE LAKE: Awesome. Awesome stuff, Weston. Thank you so much. On YouTube, it's Weston Trading. And of course, I know you're going to be breaking it all down on Twitter for us as that CPI comes out. I swear this guy never sleeps. One of these days, Weston, we're going to catch you asleep on air with us because we keep you up all hours, but we appreciate it.

WESTON NAKAMURA: Yeah, sure. Oh, sorry. One more, just regarding forward guidance. So, Christine Lagarde basically killed forward guidance, basically saying like, whatever we're saying about September, scrap it. And by the way, we're going to go meeting to meeting month to month and we're going to be data dependent. And then if you look at the Fed the last FOMC meeting or the weekend before, you had that Wall Street Journal article just doing this unofficial intermeeting 75 basis point rate hike to price in. So, forward guidance is dead in terms of traditional banking, except for ironically, the Bank of Japan.

The Bank of Japan is the most clear in terms of what their stated policy is. 25 basis points is the cap on the 10Y JGB yield. That's what it will be. That's what's going to be the most transparent and clear of all of them. So, it's funny how, once again, they're isolated, but in a different, I guess, more transparent way. So, I just want to throw that in there.

MAGGIE LAKE: Yeah, great stuff. All right. Thanks so much, Weston, appreciate you. So, David, Weston, just really set the table for us so nicely. So, let's dive in. And I'm so curious with your macro overview about what you think about this. On the back of the ECB, what do you think of this decision and this concept of spread control that Weston just brought up?

DAVID WOO: I think first of all, if you look at the action of the Fed, ECB and the BOJ, actually a great deal of sense, just apply some common sense and you'll see it's actually quite obvious what the central bank is actually doing and how the market is responding. In the case of Japan, there's no inflation. Japan is the only country in the world where inflation is not a problem.

Sure, importing prices are going up like everywhere else in the world. But Japan is not seeing basically acceleration of wage growth, they're not seeing basically service inflation, basically getting out of control. So, from that point of view, they're the only central bank that can sit there and say, you know what, we think this spike in inflation is going to be proved to be transitory. And this is also the reason why Kuroda has decided that this is actually a great opportunity.

In fact, for the last 20 years, the Bank of Japan, by being the first central bank to raise QE has been trying to drive up inflation expectation, which in Japan was always much too low for their own good, you know what, Kuroda is thinking, finally, whatever, because of Russia, whatever, COVID, that's going to help me finally achieve something I've never managed to do myself. And this is the reason why I think in some sense, especially with the new prime minister in town, I think the BOJ is actually doing the right thing.

Especially given the fact that the US is giving them basically a free pass if you like, okay, and what do I mean by that? Let me tell you this, if this were basically still Trump who's president, well, for that matter, Obama, for that matter, the fact that the yen is so weak against the US dollar, the BOJ would have gotten a call from Washington already blasting them saying, well, the yen is too weak, you got to do something about this. Okay.

But because Biden is so desperate right now needing to basically keep all the support he has right now from his European allies and Japan and Korea, in terms of supporting the sanctions against Russia. So far, I guarantee you, the Bank of Japan has not heard a peep out of the US about the yen being too weak. This is the reason why the Japanese haven't had to do much to shore up the yen. Okay, and this is the reason why the Bank of Japan can sit there and do nothing, which is the right policy for Japan right now.

MAGGIE LAKE: It is. Michael Howell also, just on air a few weeks ago, suggested the same thing. That this is not accidental, that there have been conversations and that this is coordinated. You say it because Biden needs support for sanctions. I just want to throw this theory past you, he was thinking perhaps it had something to do with putting pressure on China, a way to contain China by letting the yen weaken so much.

DAVID WOO: No, I don't think-- Japan and China, the direct trade now is very limited. I don't think the Chinese really care which level the yen is trading? The yen is 20% weaker, does that mean that you're going to see more basically onshoring by Japanese companies from China? I'm not sure. That's already been ongoing, by the way, because of the whole supply chain disruption as a result of COVID.

But I don't think that is the reason-- I think listen, the bottom line here is there's no doubt the Americans, for example, Yellen, just last week, was trying to talk the Japanese into basically joining this whole basically, cap for oil price for Russia, for example. And the Japanese, by the way, because they're very dependent on Russian oil. So, from that point of view, you can understand that actually, the Japanese supporting Biden is very, very important, okay for the Americans.

So, I think that probably has more to do with anything else. But [?] has made the point here is that in the past, any time over the last 25 years, if the yen had weaken this much, the Japanese would have really basically [?] from Washington to get their act together to shore up the yen, the fact that the calls have not yet come give them a free hand in terms of pursuing very, very easy monetary policy for now.

MAGGIE LAKE: So, they're doing the right thing. Is the ECB doing the right thing by being more aggressive with this 50-basis point rate hike?

DAVID WOO: Listen, the ECB has no choice. Because I told you before, at the end of the day, at the end of the day, central banks, they all are facing the same shock when it comes to food inflation, energy inflation. The difference, okay, in terms of the reality that each of these countries are facing is with respect to wage growth, with respect to the tightness of the labor market. Now, in the case of the Europe, the most unique aspect of Europe is the fact that every time, every year come September, you have major wage settlement negotiation that happen across Europe, first of all, starting in Germany.

Now, I can tell you already, there is no question that this year, basically, the unions are going to be a lot more aggressive in terms of demanding higher wage growth in order to compensate them for the massive spike in inflation, the erosion of their standard of living. Because last year, they already asked, they didn't get it. So, this year, they're going to be pounding the table. Now, I can tell you generally speaking, wage negotiation, the starting point is wherever is CPI inflation is at the time of the start of the wage negotiation.

Now, unfortunately for the ECB, European inflation is accelerating right into the beginning of the wage negotiation season. And this is the reason why the ECB today have to basically surprise the market with a few basis points, not because they wanted to, but because they have absolutely no choice. This is the reason why the Euro didn't do very much on the back of the surprise 50 basis point move, because the market understands the ECB is actually hiking rates basically from a position of weakness, which is quite different from the Fed, which continues to be in the position of strength, because there's no doubt there's still more life in the US economy than in Europe.

So, I think Europe with all the problems, especially the market is looking ahead, this winter is going to be a total disaster for Europe, just look at where natural gas price is trading in Europe right now. Okay, in July, we're still in July, this should be a relatively low, basically a low season for natural gas, and yet they're trading at basically levels that are not far from what we saw last basically, January, okay, immediately, just before the invasion.

So, from your point of view, and on top of that, the market also realizes that Europe has committed itself to phase out completely its oil imports from Russia, which means that who knows how the Europeans are going to heat themselves this winter, how they basically drive their car, the whole place might just collapse. So, from our point of view, this is the reason why I think the foreign exchange market at least is not that impressed by actually what the ECB did today, because it realizes that in some sense, this is basically just going to drive Europe closer to the cliff from which it will basically struggle to recover.

MAGGIE LAKE: And let's talk about that cliff. In earlier weeks, we would look at this and say, wow, are we going to return to a situation where we're talking about whether the Eurozone can stay together, because of the pressures of what we're seeing? And it seemed not extreme, but it seems quite frightening. Because, now, we have ECB basically saying, listen, we're putting an instrument, like we see that there's going to be pressure that it could fragment. How bad does it get? And is the fragmentation of the Eurozone a real possibility?

DAVID WOO: No, I don't think in that sense. Listen, Lagarde is a smart woman. She understood, and everybody understands, anybody who's been around, basically, the bloc for the last 10 years saw what happened, for example, back in 2011, 2012 with the Eurozone crisis and the spreads widening out and so on and so forth. So, the ECB is going to be there to make sure it doesn't happen.

So, they're basically saying, you know what, if spreads were to widen out more than we would like, more than we think can be justified by the fundamentals. And then we're going to be there to basically drive down the spreads. In other words, they're going to be buying more Italy, Spain, wherever, whichever country that's currently under-- or they will pause regular tax. So, I'm not putting you-- there's nothing new there. Again, they're basically trying to-- in fact, when ECB is really trying to do is, you know what, if we do that by basically putting this protection mechanism in place, it's going to help them to raise interest rates more easily.

Because normally, when interest rates go up, you will see spreads widening, because when interest rates go up, people feel like, oh, boy, if I can get basically positive bund yields by holding German government bonds, well, I would want to have a lot more basically yields on my Italian bonds, if I ever going to basically buy them or hold them. So, from that point, that's already a given.

Now, the ECB is just trying to basically in some sense, they're buying themselves an insurance by putting this yield-- basically, spread control mechanism in place. I don't think it's such a big deal. I really don't think it's such a big deal.

MAGGIE LAKE: Based on the outlook and the trouble that the Eurozone is going to be facing with fuel shortages, with slowing growth with wage pressure from unions. Is there a trade around that-- are you shorting or negative Europe? Or do you see a buying opportunity someplace in what is about to come? How are you addressing that from a portfolio point of