MAGGIE LAKE: Hello, and welcome to the Real Vision Daily Briefing. It's Monday, July 11th, 2022. I'm Maggie Lake, and here with me today is Michael Howell, the CEO of CrossBorder Capital. Hi, Michael.
MICHAEL HOWELL: Hi, Maggie. How are you doing?
MAGGIE LAKE: I'm doing okay for a Monday. Although, I have to say it feels like a little bit of a stressful one. Investors definitely seem on edge. We have US stocks trading lower than Aztec bearing the brunt. And that selling seem to accelerate a little bit in the afternoon. We have the 10 Year Treasury hanging around 3% as everyone waits for the big CPI inflation data PPI that's coming later this week, Wednesday, CPI. And we have the US dollar continuing to strengthen. So, as you look across the dashboard, what's really top of mind for you?
MICHAEL HOWELL: Dollar, I think unquestionably. Dollar is going up. It's going up more. It's, I think, as your colleague Raoul said, it's a wrecking ball. And it's likely to cause the euro to trade below one. I think the Euro was testing parity today. It's probably going to go a long way below that. If you want to forecast the euro, just take a look at the Japanese yen. See what that's done. Dollar is definitely going higher. I think that's been the policy of the US authorities this year. It's simply going to question getting the balance sheet down the Fed's balance sheet down and the US dollar up. It's straightforward as that. Mark is one like that. They don't.
MAGGIE LAKE: We throw around that term that the US dollar wrecking ball, but why is it? First of all, why is it top of mind for you? And why is it so concerning when you see such, and it's been rapid, hasn't it? That the strengthening to, it's going to move in quickly, which I know worries people as well. What are the some of the implications of that? What worries you about that? And why do we think of it as a wrecking ball?
MICHAEL HOWELL: Well, I think the implications are pretty huge. I think you've got to think outside the box in many ways. But I think as a starting point, let's go back to the international monetary system. And let's quickly dismiss these ideas that there's a Bretton Woods three or a Bretton Woods two. There's only ever been a Bretton Woods one. And that Bretton Woods, one, which was established back in 1944, put the US dollar at the center of the international monetary system.
Transactions were centered in dollars that enabled the free flow of capital and trade around the world. The US economy may well have shrunk in size, since that point, in terms of percentage of the world. But the dollar has maintained its role as the premier currency. And it keeps getting stronger. And a lot of economists have predicted the demise of the dollar, all too frequently over the last three or four decades. They've been absolutely and completely wrong.
So, the fact is the dollar is still there. It's still the primary currency worldwide for transactions purposes. And I think you've got to start to look at what the Federal Reserve and the Treasury have been doing. Maybe surreptitiously slowly but definitively in the last decade since the global financial crisis. And what they've done is put it in maybe a neat way as to say they've opened branch offices around the world. So, swap lines are the critical way of now America controlling the flow of dollars worldwide.
And you could argue that in this context, the rise in the dollar means quite a lot. Now, if it's a wrecking ball, the question is, where is that wrecking ball pointed? And I would venture it's pointed at China. And one of the things that the Chinese have been trying to do, deliberately, for the last five years to stabilize the Chinese yuan, because there is a platform for financializing their economy which they need. The US, if he wants to compete with China, cannot allow that.
Now, I'll take you back to February of this year and look at what happened to the Japanese yen. Japanese yen in 40 trading days devalued in the annualized rate of 82%. In my time in markets, I have never ever seen markets do that. Only governments have done that. This must be a deliberate act. There must be complicity in that. I think the Yen is a Trojan horse. It's trying to shake up or shake the tree in China.
And look at the outcry that the US Treasury made when the Vietnamese Dong devalued, okay, unfair trading that was manipulation of currency. Has anyone said anything about the Japanese yen? This is one of America's biggest trading partners, and you've seen an absolute collapse in the Japanese currency. No one has muttered a word.
MAGGIE LAKE: That's so interesting, Michael. So, your theory is that the US and Japanese officials are working in tandem, that this is policy to try to contain China.
MICHAEL HOWELL: That's an implication, for sure.
MAGGIE LAKE: The difficult thing about doing something like that, though, is of course, there's risk everywhere, whether it's unintended consequences, or once you open that Pandora's box, what happens? Raoul, as you mentioned, we were talking about, he was on the Daily Briefing on Friday, and he's also watching the currency markets really closely, and in particular that the rapidly strengthening dollar. And he's worried about the impact. But I think that the Fallout he's thinking about longer terms, is longer term, is a lot wider than that. Let's have a listen to what he said. And I will talk on the other side.
RAOUL PAL: But it looks like we are in the dollar wrecking ball cycle, where if we're not careful, we are going to repeat 1985 all over again, which is when we ended up into the Plaza Accord. So, I urge anybody to reread the book, the Alchemy of Finance by George Soros, because he keeps a trading diary of the whole period of 1984 to 1985, which was very similar.
Oil price recession, blah, blah, blah. But the issue was the dollar. And the dollar backed off for a while as the Fed started cutting in 1984, which was part of his big trade, his big trade was the bond market trade. The dollar backed off, and then it rocketed higher, which is the way that we see it now. There's a shortage of dollars. And if it rockets much higher, then we start breaking parity against the Euro, the dollar/yen started moving along.
This is a bad setup, and there is a probability, and I don't think it's my base case, that we have a real problem with the dollar. And in which case, we end up with having to have some Plaza Accord agreement, which is something we should be nervous of, because that agreement is not going to be with the US talking about reducing the dollar as much as other saying we need to move away from the dollar, which is something I've talked about for a long time.
One of the whole thesis behind the Bitcoin life raft video that many millions of people have seen is about this very situation of the strength and the dominance of the dollar. The US economy is 25% of the world's economy, and 87% of every single trade transaction on Earth. So, it's everybody else's problem. And the world has had enough of it. And a lot of people think the dollar dies from weakness. But I think the dollar dies from strength.
MAGGIE LAKE: And that full interview, the full show available to everyone on the platform and on our YouTube channel, free. If you miss it, I encourage you to go check it out, because Raoul kind of in depth lays out his macro framework. But Michael, the dollar is problem and demise might be Raoul's probability that he's toying with, might be its strength, not its weakness. Because it's just unsustainable for this rapid, I mean, maybe the policy with Japan.
But everywhere else, you see what's happening in Sri Lanka. Things break when the dollar is this strong, especially when you're looking at emerging markets. Is that something you're worried about? Could we see financial systems strain, just because countries are unable to deal with this rapid appreciation of the US dollar?
MICHAEL HOWELL: Absolutely. It's a huge risk. And I think what Raoul is just settled to be listened to. He makes an awful lot of sense in what he's just said. If you take a look at global liquidity, and there's a chart you can flash up looking at the global liquidity index. Our remit of CrossBorder Capital is all about understanding liquidity flow. Markets is driven by liquidity.
And if you look at what's happened, there's been a roller coaster ride lately in terms of liquidity. Liquidity shot up during the COVID crisis. It clearly elevated asset markets. That's why everything's gone up so much in the last two years. And now liquidity is crashing. And that's why you've got a bear market in most risk assets. And, as you rightly say, Maggie, at some stage, somebody's going to break. And when it breaks, the Federal Reserve will pivot.
Now, one is that pivot coming, who knows. I would guess it's going to come sometime around the turn of 2023. So, we're probably six months away. But in that time, what you're going to see is a lot of damage done. In our estimation, the world economy is already in recession. Asia was there probably a month or so ago. Europe's probably there this month. The American economy may be a month or two behind. But we're definitely looking at a global recession. And that's what the slumping commodity prices are basically telling us.
Now, if you look at what has really mattered in this. It's not simply the Federal Reserve, but it's also what the People's Bank of China has been doing. And I'll link back to what I was saying about shaking the Chinese tree and the dollar going up. Well, what the Chinese have been trying to do is to stabilize the Chinese yuan currency against the US dollar. They're struggling. But in terms of doing that, they're taking liquidity out of their financial markets.
There is a myth going around. That myth has been perpetrated for years that China is always on the brink of easing. I don't know how many times I can count hearing that in recent months, but they just simply are not. There's another chart which will show you the damage that China is doing. What the people's banks liquidity injections are basically highlighting is a very close correlation with commodity prices. The footprint of the Chinese economy is huge.
The People's Bank of China controls the Chinese economy. And if the People's Bank of China squeezes liquidity, you're going to get commodity prices going down. And you can see evidently from the chart, there's a red line which is People's Bank of China liquidity injections going south very quickly. It's been followed by the dotted line, which is basically looking at non-oil commodity prices. And even if you include oil in that equation, which is the yellow line, you'll see that the correlation is pretty close.
And China matters for the world economy. The Federal Reserve matters a lot for financial markets. And I think if you want to split it, from an equity perspective, the Federal Reserve controls the PE on the market. Well, that's been going down because the Feds been squeezing. And China basically controls the E. Now, the message from the E is still got to hitters. But believe me it's coming. Earnings is going to be decimated in the next six to 12 months.
The Federal Reserve has already caused a lot of damage. But you can just take a look at the Federal Reserve liquidity injections, which I think I put forward on another chart, which basically shows the movements of what we call the effective Fed balance sheet, which is the amount of liquidity that the Federal Reserve actually puts in to American money markets on a weekly basis, and the S&P 500. And you'll see that the correlation is just remarkably close.
If you don't believe the liquidity matters, you just take a look at this chart. The red line is Federal Reserve liquidity injections. And the yellow line i is the SPX, the S&P 500. And it's been just moving absolutely in step over recent months. Now, it's interesting to discuss the inflection point. The inflection point came on December 15. That was the time when Jay Powell was basically appointed again. It was the time when they dropped the transitory narrative from inflation.
And it was when you got a couple of big prints on the CPI and unemployment. That was the FOMC that mattered. And basically, since then, they've taken liquidity out of the system. And hence, the markets gone down. A trillion dollars has come out of US money markets, courtesy of the Federal Reserve. They've done that surreptitiously. It's not the public QE that they figure we're starting this month, it's already been going on for six months. That's why the market's down.
MAGGIE LAKE: So, if you follow that along, there seems to be no signs of them turning the liquidity spigot back on. You've got fiscal contraction potential at the same time, especially if the Republicans get take over control of Congress, which they look likely to do. Does that mean more downside for the S&P and how much more pain could there be ahead?
MICHAEL HOWELL: Well, you just draw it, take a ruler of that and draw a straight line on that graph. And you'll see that if the Federal Reserve intentions are taking another walk between one and 2 trillion out of their balance sheet over the next 12, 18 months, you're looking at an S&P 3000. If they make a mistake, hey, as possible, they're only human, you could be down 2500. And this could be-- this is a severe test of the market. And against that backdrop, you've got the potential of a US recession. It's the recession or credit crisis and a recession that will cause the Fed to pivot as it always does.
MAGGIE LAKE: I want to [?] in some questions here because we have some great ones. I think we answered this one already. But Paul E. on the exchange, China's factory inflation cooled in June to the lowest in 15 months, which appears that the country is bucking the global trend of accelerating prices. What are your thoughts? Is this due to where you see they are in terms of recession?
MICHAEL HOWELL: Yeah, absolutely. China's not only got the COVID crisis to cope with. He's got the People's Bank of China squeezing liquidity, on the squeezing liquidity, comes back to the fact that the US dollar is strong. Years ago, when I worked at Salomon Brothers, the motto of the firm was there is no unrelated event in financial markets. And that's absolutely spot on. That's what's going on. It's a strong dollar. It's affecting this. It's causing China to tighten, and hence, factory prices are down.
MAGGIE LAKE: Any sign that if the dollar remains strong, does that tie China's hands? If they see the economy weakening, they've got this rolling, there are new variants over there. They're still in severe lockdown. We saw protests on the streets in China, which is unheard of. After some deposits were frozen, it seems that the frustration is really building that is something that Chinese authorities have to be extremely aware of it uncomfortable, any chance that we could see a change in their policy in terms of stimulating their economy?
MICHAEL HOWELL: Well, will come. There was an announcement or a rumor, let's say, on Bloomberg that they're slated to enact a 1.5 trillion yuan infrastructure package. The markets breathe a great sigh of relief. But, hey, let's put that in context. That's one half of a percentage point of overall Chinese liquidity. Big deal. Okay. That's not going to change the dial at all. What they need to do is, first, substantial easing of liquidity. And that may happen.
But I think that's going to awake Xi Jinping appointment once again as supreme leader. And that may be an October, November event. But I guess behind the scenes, as most communist regimes, there's a lot of a similar table of deals going on to basically promised money for different areas if people vote for him. So, I guess you're going to see these speakers open there later this year. The Fed will be doing a similar exercise, maybe early in 2023.
MAGGIE LAKE: Yeah. A horse trading around politics is something I think we're all familiar with. Yankee Duke on the exchange asking, what's the most effective way other than through futures markets to position for the coming credit crisis?
MICHAEL HOWELL: Oh, I think it's an easy one. Buy US Treasurys. Yeah, all cash, but you buy the 10 Year old or the US long bond, I think pretty good trade there. Because as far as I can see, inflation is stubborn, we got to appreciate that. But if there's a recession in the magnitude we're thinking of, that's going to crush price increases pretty quickly. And people want bonds. And the fact is, there is a shortage of safe assets out there in the system.
Look, the other alternatives may have been the Japanese yen, but hey, look, that's just been trashed. It could have been the bund in Europe, German bund, but the Euro is weak. And you look at the performance of the bund on the price charts, it looks pretty ugly, that's no longer a safe asset. So, you're back to the US dollar being the only safe haven worldwide. So, it's going to be a lot of international money moving into Treasurys.
MAGGIE LAKE: People have been looking at that bond trade. And then it's been a little tough because there was a feeling that bonds had peaked, people got stopped out of positions, because we've seen that pull and push between recession, but then we get these big inflation prints again. Do you think we've seen the peak in the 10 Year bond yields? Or is it going to be a little volatile as we look at those two factors?
MICHAEL HOWELL: I think we have famous last words. I hope that the 3% barrier would hold it broke. Above that we know it's come back, it's currently around 3%. I think that's a pretty good level to be buying US Treasurys. The reason for that is that the way that we look at the curve is the split into two halves. We'll look at the front end, which is all about forward guidance and rate expectations. And we look at the back end, which is all about the term premium.
Term premia, a negative, but they're going to go a lot more negative if you get a recession in the US and the demand for Treasurys would jump, that will push term premia lower. So, I think what you've got is basically the prospect of a flattening at the back end of the curve. I think in terms of the front end [?]. I think that basically 3% is the limit as far as the Fed probably will be able to go. So, I think you're probably looking at a peak in REITs there. You're going to get some flattening of the front end too.
So in my estimation, the long end of the markets worth buying