ASH BENNINGTON: Welcome to the Real Vision Daily Briefing. It's Wednesday, June 8th, 2022. I'm Ash Benington joined today by Darius Dale, founder and CEO of 42Macro. Let's take a look at the closing prices on US equities here as we have this conversation around four o'clock, closing out the day, it's a down one.

S&P 500 off about 45 points, 1%, 1.08%, 4115 on the close. NASDAQ also down on the day, off about 0.75%, closing the day out at 12,086. Dow Jones Industrial Average following suit, down eight tenths of 1%, closing out the day here at 32,910. European equity markets closed fractionally lower on the day ahead of tomorrow's ECB rate decision.

Talking of international markets, before we jump in with Darius, we're going to pause for an update on global markets by Real Vision's own Weston Nakamura who joins us live from Tokyo. Weston, welcome back.

WESTON NAKAMURA: Hello, gentlemen. How are you? How are we?

ASH BENNINGTON: We're doing great, man. Not like dollar/yen. Let's talk about it. It's ugly.

WESTON NAKAMURA: Yeah, I will. If you're long the dollar side, it's not so ugly. It's quite unwell. But we broke into the 134 handle on dollar/yen. Now, the yen is just continuing to get crushed after--

ASH BENNINGTON: For us who don't follow this currency pair, give us a sense of what 134 means and why it's so significant.

WESTON NAKAMURA: Yeah, so 133.80 was the resistance that was broken that then continued into the 134 handle. 133.80 was a previous high. Right now, we're looking at the next level being 135.18, the 2002 high. That's just a few ticks away. If that's broken, we're at a new millennium high. 1998, I believe. We're at the weakest levels.

And not just the level itself, but like Darius and I've talked about on the Daily Briefing before, it's not so much the level, it's the pace in which it gets to this level. It's the volatility, the velocity of the move in and of itself that is of concern.

ASH BENNINGTON: Yeah, looking at that chart, you can see the just extreme steepness on that curve. By the way, for people who are relatively new to currency markets, we should say, dollar/yen, this shows dollar strength, Japanese yen weakness. When you see that chart moving up into the right dramatically, it's the dollar strengthening when the yen plunging.

WESTON NAKAMURA: Yeah, this is chart one. I don't know if you're looking at that right now. But what I always go to, my go-to is looking at dollar/yen spot and the US 10Y yield. They move in tandem. That's why you should care about what dollar/yen is doing because it moves along with the risk-free rate and I don't care what you invest in, you need to know what the risk rate is doing.

However, as of late with this breakout, you're starting to see dollar/yen really push through to these, at least certainly year to date highs whereas the tenure yield is not.

ASH BENNINGTON: Talk to us about the directionality of that correlation, because it's an extraordinary chart when you show 10Y yield against dollar/yen.

WESTON NAKAMURA: Sure. If you look at chart two, okay, what that is, is these are weekly flow data from the Ministry of Finance in Japan that shows basically net foreign bond buying or selling by Japanese investors. And as you can see, throughout the bulk of this March, the surge in Treasury yields, that coincided with a massive, massive unloading of foreign bonds. This is not just US Treasurys, but a lot of it is from Japan.

Then you see these two weeks in which you actually see a bit of a meaningful inflow of net buying. That was when Treasury yields came down recently and then last week, we saw continued selling again. This is a one-week delay data, but you can really see that there is material impact from these flows that are coming from Japan, particularly, Japan lifers, life insurance companies, who are these massive capital allocators. A lot of them recently came out with their Fiscal Year 2022 Investment Planning if you will.

And it's interesting just to see these are always subject to change, they're not always followed but the ranges for what they're trying to do and all that is like-- their upper range, the highest estimate or highest outlook for dollar/yen by yearend is 140 for these lifers. 10Y JGB is 25 basis points, where the cap is. One of them was actually above that. One of them believes that it's not going to hold that.

And then the highest for the 10Y US Treasury yield was forecast somewhere around 3.4%. 3.4% for the 25 basis points JGB, pin 140 dollar/yen is basically what that means. 140 is really not that like doomsday out of the question, they're in the model forecasts for these major allocators.

ASH BENNINGTON: Weston, we really appreciate you joining us from the middle of the night from Tokyo, just to double click on it one more time, the significance of this to global markets.

WESTON NAKAMURA: Yeah, chart three is basically just the first two charts just combined. And you can just clearly see, I'm going to put this up on Twitter as well, but you really need to watch dollar/yen, because you really need to watch what-- to get some price signal as to what Japanese investors are or are not doing. It gets more complicated with currency hedge and all that thing, but by and large, just you need to keep an eye on this.

And also, simply because US Treasurys, the risk-free rate we're talking about. If you have something that is as closely correlated to the 10Y US Treasury yield, the dollar/yen, then you certainly need to look at that asset class as well.

ASH BENNINGTON: Yeah. And by the way, for people who are interested in more, they can follow you at Across the Spread on Twitter where they'll see many more of these charts and more of this analysis.

WESTON NAKAMURA: Indeed.

ASH BENNINGTON: Weston Nakamura, thanks so much for joining us.

WESTON NAKAMURA: Thanks a lot. Thanks, Darius for letting me once again.

DARIUS DALE: I love it, my friend, I love it. And Ash, one quick thing before we transition, I do want to make the key point in why investors should care about these dollar/yen, these cross-currency dynamics is because the policy divergence between the Bank of Japan maintaining its yield curve control and effectively unlimited buying of JGBs on the long end of the curve creates this massive spread between market implied interest rates in Japan relative to our interest rates and the Treasury curve.

As long as the BOJ is deemed to be maintaining that easy policy, it's an incentive for Japanese investors to go out and speculate abroad etc., etc. But the problem with speculating in the Treasury market, as we continue to see, is this market continues to underestimate the Fed's resolve with respect to tightening monetary policy and more importantly, the stickiness of inflation, as those are two things that I think we should touch on today.

ASH BENNINGTON: Well, Darius Dale, in many ways, that's the perfect transition from the dollar/yen story into the broader macro picture. Give us a little bit of context of what's on your radar and how you're thinking about these markets right now.

DARIUS DALE: Yeah, so it's a pretty quiet week. Obviously, we're in the quiet period from the perspective of FOMC speakers. We got the meeting next Wednesday. The key headline this week and it's going to take the headline this week is Friday's CPI report tomorrow. We'll get the ECB, I don't want to rain on their parade and also get the Chinese credit data for the month of May tomorrow night as well. We can touch on those, but I think very clearly, the number one thing that's going to rock markets this week to the upside or downside is inflation.

We'll get that print on Friday, I think consensus is expecting a tick down by 10 basis points. I saw a headline, a tick down by 20 to 30 basis points on core. But to me, I don't think the year-over-year rate of change, and we've been talking about this for nine months now, I don't think the year-over-year rate of change matters. What matters is the sequential momentum and inflation because that will be the clearest indication for the Fed and for financial market participants of receiving what "clear and confirming evidence" that inflation is either getting back under control or continuing to misbehave.

I'll throw a few statistics and charts out there at you. To me, I think the biggest risk with respect to Friday's print is this potentiality that we get overtaking of core inflation momentum by services inflation relative to goods inflation. Brian, if you go up a couple of charts, the first chart just shows-- the title is What If Disinflation In Core Goods CPI... What we're showing there is just the core goods inflation in the top panel, the middle panel shows that on a year-over-year rate of change basis, the bottom panel shows that on a on a three-month annualized basis.

And right now, we're seeing a significant slowdown in the three-month annualized rate of core good CPI. It's about 0.8% on a three-month annualized basis, that's all the way down from the year-over-year rate of 9.7%. That's what's really driving the disinflation we've seen in core inflation off the highs, the disinflation and core PCE we've seen off the highs. But the issue is, and the next chart is Is Overpowered By Accelerating Core Services Prices.

And the reason I bring this up is because we continue to see evidence of an incremental acceleration in services prices, which is what this chart is showing. Top panel is core services, core services prices year-over-year in the middle panel and the three-month annualized in the bottom panel, and if you notice a three-month annualized there not only is accelerating to 7.5%-ish on a three-month annualized basis. That's significantly faster than the year-over-year rate of 4.9%.

It's telling you we're continuing to build momentum to the upside in that time series. And oh, by the way, we still have things like energy prices climb to new highs, agricultural prices grinding higher. To me, I think the key takeaway before we pause is if we get inflation statistics misbehaving by this dynamic, we're going to see an incremental step function higher in bond yields, and policy rate expectations, etc.

ASH BENNINGTON: Darius, it's a striking chart, walk us through it, particularly for people who don't have extensive macro backgrounds. What are we seeing there? What's the driver? What's the broader implications?

DARIUS DALE: Absolutely. The top panel is just showing the time series in a non-stationary manner, so core services inflation, so things like housing, rent, utilities, etc., it's basically all the stuff we consume from a service and medical consumption, most services generally tend to be core, fall in the core basket in that regard. This is the larger lion's share of inflation. It's basically 60%, 65% of the overall CPI basket.

The fact that it's being overpowered by goods disinflation is anomalous, which tells you that if goods disinflation slows at any point in time in the next few months, what's more likely to happen is that this does, in fact, become the dominant driver of inflation as it traditionally is, and it'll likely keep inflation, particularly core inflation operating in a more sticky level for the summer months.

ASH BENNINGTON: Yeah, the only thing that's striking to me about the lower two panels is what every serious macro person will tell you the same thing. It's not just absolute levels, rate of change matters.

DARIUS DALE: Rate of change, rate of change, rate of change, man, it's the secret to the universe, it's the secret to financial markets. Most economic statistics for those of us who aren't walking economists, they tend to get measured, at least on a year-over-year rate of change basis. That tends to matter a lot to financial market participants, and obviously market and policymakers as well.

What I think has mattered most throughout this particular cycle, just given the unusual nature of this pandemic recovery, we've seen two massive stimulus, we've seen the roll off of massive stimulus, we've seen several fits and starts from a COVID perspective. What it's put a lot of onus on, tracking time series from a sequential momentum perspective, month-over-month, three-month annualized, etc., to get a cleaner read on the data, because there's been so much lumpiness in the year-over-year time series.

When you look at things like core services inflation at 7.5%, three-month annualized, median CPI, which is the median inflation rate of everything in the CPI basket at 6.2% annualized or a sticky CPI, which is one of the statistics down the Fed calculates, they're probably as close to the inflation, the measurement as is any of the Federal Reserve Banks, that 6.5% three-month annualized, these numbers are all extremely inconsistent with the Fed getting core PCE back to its 2% target anytime soon.

To me, I think the risk in financial markets particularly from anything north of 4000 on the S&P, or anything north the three and a half on maybe one-year forward Eurodollar pricing, Fed Fund Futures pricing, etc., to me, it's the risk is to the upside on rates and to the downside in risk asset market pricing.

ASH BENNINGTON: Yeah, so let's walk through that a little bit. Try and explain it a little bit, particularly for people who are not macro focused. I'm curious about this. There's this old phrase out there, kind of a joke, kind of not a joke that the cure for high prices is higher prices, meaning that as prices begin to rise, there's a natural decrease in demand that happens, you start to see some contractionary risk in terms of growth, in terms of productivity, in terms of a whole series of other variables.

One of the stories on the wire today that's really interesting is that mortgage demand right now has fallen to 22-year lows, a pretty striking number. Again, to get back into the thesis cure for high prices is higher prices, this idea that one of the things that you've been hearing everyone talking about the last six to 12 months is how rents have been increasing. Here in New York City, it's a constant topic. My landlord wants to increase my rent 15%, 20%, 25%.

When I walk down the streets, there's a building on the corner that's been vacant for the 16 years that I've lived here. They're now renovating and rehabbing those apartments. Why? Because it's become economically advantageous to do so. It's such a seller's market right now. And then you see this print showing that there's a significant decline, a 22-year low, in fact, in the rate of mortgage consumption. What's happening there, Darius? Help us understand it.

DARIUS DALE: Yeah, the housing market, you're absolutely right. Higher prices is the cure for high prices. We've seen negative year-over-year mortgage demand for basically about six, nine months now. And that's likely to continue. You look at the last few prints we've gotten out of the housing market from a home price appreciation standpoint. When you look at the CoreLogic Case Shiller numbers accelerating to an all-time high north of 20% year-over-year, the FIFA which tends to measure housing prices in the middle to lower income's cohort, that's also accelerating to an all-time high. That was Q1 data a couple of weeks ago.

And the issue with that as it relates to inflation, going back to this discussion between core goods and core services inflation, is something like shelter inflation is about a third of the basket. And owners' equivalent rent, which is a function of shelter, or one of the features of shelter inflation, that's about 75% of that particular component in the CPI basket. As long as we have home prices continue to accelerate, it's likely to have a tail in terms of perpetuating the acceleration we're observing in owners' equivalent rent, and by extension, shelter inflation.

We've done an analysis that shows that the lag between peaks and troughs in housing price appreciation on a year-over-year rate of change basis tend to be about 12 to 18 months ahead of the peaks and troughs in year-over-year rate of change in owners' equivalent rent. That's suggestive just based on these peaks, we could be seeing an acceleration in shelter inflation, particularly through owners' equivalent rent, which is calculated on a much longer lag than observed home price changes for extended periods, or for over a year from now.

And to me, I think that's a real big issue. If you think about a Fed that's hoping and praying that inflation is still transitory, that's where this whole concept of a September pause came out and, fortunately, Brainard has walked that back pretty forcefully. I think they're going to do a lot more walking back if these inflation statistics over the next couple of months don't do what I think the markets are really hoping that they do.

ASH BENNINGTON: Yeah. Darius, obviously, when we're talking about monetary policy, we have a global view here on Real Vision Daily Briefing, I know that you have a global view at 42Macro. Obviously tomorrow, one of the topics of conversation, ECB rate decision expected. What's your take on what's happening in the Euro area?

DARIUS DALE: Yeah, the situation in Europe is fascinating. Because on one hand, it's pretty clear that Europe's engaged in a cyclical slowdown. When you look at the furthest leading indicators, the ones that have the longest lead times, like the [?] index, or the Sensex index, these things tend to lead the PMIs over in Europe, these things are in recession mode. You're even seeing some of the lagging hard data already started to break down in Europe.

It's pretty clear that Europe is having a much more adverse response to the geopolitical consternation, the inflation dynamics in Europe have obviously been even more off the charts than they have been in America. I've showed a chart a few times in this program, where we show the inflation surprise indices for US versus the Eurozone and the Eurozone inflation surprise index is literally like several times higher than the US inflation surprise index. And you're obviously seeing European inflation accelerate to an all-time high in the most recent month, in the May data.

There's very clearly a bigger issue. The inflation is a surprisingly a bigger issue in Europe than it is in America, which I think it's pretty hard for most American people to believe that, but it actually is true. That puts a lot of pressure on the ECB, and they've acknowledged it and they're likely to do something to really giddy up in terms of tightening monetary policy, tightening financial conditions, to the bare minimum, put a floor in the Euro.

What's likely to happen tomorrow, they're likely to end their asset purchase program, because they've guided two rate hikes starting next month, starting in July, and so they got to get that done in order to give them some policy space to do that, because they've guided to not wanting to do both of those things at the same time. Doesn't make any sense. Why would you be doing QE and then rate hiking at the same time?

I think it's preposterous that they're ending QE a month before they start hiking rates, but that's neither here nor there. The Europe have a different mandate relative to the Fed in terms of keeping the European project together.