ALFONSO PECCATIELLO: Hey, everybody. Welcome to the Real Vision Daily Briefing. Today, it's Tuesday, January 11th, 2021. This is Alf, the author of The Macro Compass. And I'm here with the one and only Tony Greer, who's the editor of The Morning Navigator. Hey, Tony, how you doing, man?

TONY GREER: How are you today, brother? What's happening?

ALFONSO PECCATIELLO: It's all nice and dandy. We have all these rallies going on. Everything that has a name attached to it, it's rallying apparently. You want to call it, it's bonds, golds, Bitcoin, tech, cyclicals, so just call it everything is rallying, right?

TONY GREER: Yeah. We tend to have days like that whenever there's a presence of Jerome Powell on the tape anywhere if you ask me. If the Fed Chairman speaks, markets are buoyant. I think that's his job.

ALFONSO PECCATIELLO: Probably. So, today, he showed up at the Senate Banking Committee and he gave his speech there. And he said a couple of interesting things, but before we talk about what he said and the reaction of the markets, I just want to make sure that the audience actually listens to an interview I had, a clip to an interview I had with David Rosenberg, where we actually talked about his view of the Fed, and he thinks something's pretty interesting. Let's listen to him for a second.

DAVID ROSENBERG: I never understood why the Fed gave up on transitory. Maybe they just defined it, because to me, the overall realm of economic and financial history, one to two years to me is still pretty transitory or maybe we need another word for it. But you see, the household sector is telling you that beyond this year with the supply bottlenecks, and the commodity pressures that we've seen, that their two- to five-year view is inflation to average 2.4%, which actually is the low end of the range of the past several years and below where it was when the pandemic started.

Something's happening here that's very interesting. We all bellyache about inflation but then again, it's staring us in the face. But the bond market doesn't move on what is staring us in the face for the here and now, it's really looking out many years. And you got to believe, you got to believe that if the Fed starts to pull the rug on liquidity, and understanding that this has been a liquidity bull market in residential real estate, in cap rates, in corporate credit, and in the equity market, what is going to happen when interest rates start to go up?

And the key here again is the shape of the yield curve is half as steep as it normally is at this stage of the cycle before the Fed starts hiking rates. We might not be beyond three or four rate hikes before we start talking about recession pressures.

ALFONSO PECCATIELLO: And the full interview is available on the Essential Tier at Real Vision, but Tony, you got to believe, as David Rosenberg said, that if the Fed pulls liquidity out of the market and they try to hike three or four times, what's going to happen, Tony? David think everything's going to go belly up, do you have a different view?

TONY GREER: No. I think we're going to be in an extremely violent rotation, Alf. That's my plan for this year. Coming up until the first several sessions of the year, call it all five sessions of last week, essentially, we saw Natural Resources outperform technology. And I really think that technology is going to be at the center of the rate rising storm for equities. I do believe that it can have an ultimately negative effect on the indices.

But I still think that you're going to have some bull markets within the indices, in natural resources, in oil, in metals and mining, probably in grain sectors and a lot of ag sectors that are going to hold together just fine. And while net net, it may take the S&P lower, I don't think that we're in a curl over derisking phase by any stretch of the imagination just because we're talking about higher yields.

ALFONSO PECCATIELLO: Alright. So, let's talk for a second about higher yields, because that's the backbone of your bullish cyclical commodities thesis, Tony. I pulled up a chart for the viewers and for the listeners. I'm just going to walk you through the chart. It simply shows the number of 25 basis point Fed hikes that the future market is pricing in by December 2022.

And in October, we're talking literally about, something like three months ago, the market was pricing one hike by the Fed by December 2022, just one hike. And now, we are at 3.7 hikes by December 2022, which means three hikes for sure and 70% chance of a fourth hike in 2022. Obviously, Tony, the market is adjusting to this perspective that the Fed will deliver in tightening. Don't you think that this is already priced in the bond market to a certain extent and therefore, as well in the commodities market? Can this not be a headwind to your cyclical commodity bullish thesis?

TONY GREER: It sure can. It sure can, Alf. And I'm on the lookout. I guess I'm on the lookout. There's a lot to go over within there. But I guess I'm on the lookout the most for, for example, Powell's comment that anything about the balance sheet where he says the runoff may be sooner or faster than the last cycle. He said that the balance sheet is far bigger than it needs to be, which is God's honest truth probably. And when he lobs bombs like that out about actually taking down the balance sheet, the market seems to create the perception of the most hawkish scenario.

So, I feel like right now, as you said, Alf, three months ago, when Powell was hanging his hat on transitory inflation and not really changing his posture on that, we weren't looking at any rate hikes for this year. And now as soon as we get here, remember, that was via Jerome Powell very much pivoting the Federal Reserve ship into saying, okay, fine, this inflation looks like it's going to be with us for a little while. We're going to use our tools to manage it. And therefore, the market took a dip on that, just with the prospect of higher rates and a little bit less liquidity that we've seen.

But as you can see, for example, I do believe-- yeah, I do think that these rate hikes are very much getting priced in. I do believe that we'll hit rough patches in the economy and even for the inflation cycle. Next year, that will swing that pendulum maybe back to, oh you know what, maybe it's just two or three rate hikes this year, maybe four was a little bit aggressive. Because I still think that this year, Alf, we're going to see the push and pull of the inflation and deflation.

And what I can get excited about if the Fed hikes are priced in is what I'm seeing today where the dollar can back off a little bit. Because if the dollar can, God forbid, back off, Alf, then I am going to step on the gas pedal with both feet of my natural resources trading.

ALFONSO PECCATIELLO: Well, I can see why you would do that. The point I'm trying to pass across to listeners here, Tony, is that as I tweeted today as well, actually, it's very difficult to jump on a trade if the news is already out. And the news that the Fed will hike is already out and it's fully priced in the market. There are 3.7 hikes priced in. 10 Year bond yields and 30 Year bond yields, they tried to bridge 1.8% and 2.1% to 0.15%. Well, they hardly could.

Of course, they could go a little bit further, but it seems that the market are tough, woke up all of a sudden to the idea the Fed's going to hike and it's going to taper their balance sheet, reacted accordingly in the bond market, and commodities as well. Actually, cyclical commodities overperformed defensive commodities like gold. I pulled up another chart and I want your opinion on that, Tony, which shows the oil to gold ratio.

So, I literally measure oil prices instead of dollars, I measured them in gold. It just shows the over or underperformance of oil against gold, that's the blue line, and 10 Year yields in America. You can see they correlate very well. Not a big news if the economy's pretty hot, and it's running nicely and nominal growth is price to go up, then oil consumption is also priced to increase and therefore oil prices go up, its actually [?] and actually, gold doesn't perform very well in that environment and vice versa.

The economy's slowing down. Real rates are dropping. Aggregate demand is not that strong. Then gold tends to perform oil and yields drop. But look at basically the [?] which is opening in this chart between 10 Year yields and oil to gold ratio. So, oil has overperformed gold over the last few weeks, few months actually, as you have pointed out. The 10 Year yields cannot keep up the same performance on the way up. Why is that?

TONY GREER: That's a great question. For the inflation people like me, that's the question that's plaguing us about the bond market, Alf. Luckily, I don't try my hardest to understand the bond market. I don't have that kind of capacity. I just tried to use it as a mechanism to help me understand what the world thinks right now. And when I look at 2 year paper which has gone bidless with this most recent leg of the commodity rally, and maybe the 10 Year there at the center of the curve isn't going along with it as much. maybe there's a lot of curve adjustment going on right now.

But I feel like when I look at-- I still see 10 Year yields breaking out of a pennant flag and going higher. We're just bumping into some resistance at 1.75 where we had high in the middle of last year, early in the year. That makes sense to me for the bond market to slow it slide as yields get to that price. I think that no matter what the long end is probably going to be kept in check as it always has been because that's really the mechanism by which the whole mortgage application and housing boom has been running.

So, I think that they'll be loathed to take that punchbowl away in the long end, while in the short end, they have to just really make sure that they're making adjustments for the inflation that's hitting the tape and the commodity inflation that we see. I'll be really interested, Alf, to see where bonds shake out at the end of this week. We've got CPI and PPI coming up tomorrow and Thursday. And the reason I focus in so much on those numbers more as an equity ranger is because if you remember last May, we got that first headline CPI number that was way above expectations.

We had a huge sell off in the stock market and we registered the most significant downside tick extreme of the year where just everybody was bailing out of stocks. Now, that was at an S&P price of 4000. We're much higher than that. So, it proves that the market can bear higher yields and all this inflation. I just think that we're at a little bit of a crossroads trying to decide what the Fed is going to actually do, and what they're going to be able to do in terms of tapering and maybe bringing down the balance sheet a little bit.

To me, that would be something that would cause me to make a lot of sales in stocks and lighten up the load a little bit. But the way things have gone now, it feels like the market can bear really whatever the Federal Reserve is throwing at us. We've got a lot of economic cyclical pent up strength that I think is going to be let loose as we come out of this pandemic. And I'm just hoping that things hold together, and we can get cyclicals holding up while technology falls and equities. And that's really the way I'm looking at it if that's fair.

ALFONSO PECCATIELLO: Wow. So, much truth in this answer, Tony. So, let me try to break it down a little bit.

TONY GREER: Okay, let's do it.

ALFONSO PECCATIELLO: So, one more interesting thing that you said is when we talk about the bond market, you're literally talking about two different beasts, the short end and the long end. So, 2 Year yields are now 0.9% pricing in basically four hikes by the Fed by the end of this year. So, that part has reacted. And also, the fact that consumer spending and the labor market is still relatively buoyant. So, it's true that the fiscal stimulus effect is probably fading away a bit, but the consumer side of it and the labor market side of it are picking up the tab.

And so, the Fed can literally try to react to the front end and tighten monetary policy. So, that's one side. But the other side is actually the long end of the bond market, which isn't following up that much, which is making the curve very flat. That one is driven by long-term forces. And there, the market is much more dubious that things have actually changed in the long term.

But what drives commodities, as you were saying before and we are trying to overlay these two components, the bond market and cyclical commodities and events in commodities, is more about the supply and demand imbalance short term, at least for the front contracts of these commodities. So, those two things can actually square. Commodities can rally, even if the long end of the bond market doesn't manage to break on the upside. So, that's quite important.

And the other thing is obviously quantitative tightening, which is the topic du jour. And a few months ago, nobody was talking about it. And we were even doubting whether the Fed would go for tapering. Quantitative tightening is a quite a different beast compared to tapering. You're not increasing at a slower pace the purchases, you're literally holding the purchases and you are reducing the size of the balance sheet, which means the mechanism for which before you drew collateral away from the market, you just put it in the black hole, which is the Federal Reserve balance sheet.

You just removed it from the private sector risk bearing capacity, and you gave the private sector reserves, just zero duration, zero risk stuff that sits there on the balance sheet. You created this imbalance and now you reverse it. So, you basically say, sorry, guys, I'm going to take the reserves back and you have to absorb the private sector, more bonds, more duration risk, more credit risk, and it's all back to you guys. That's quite a different dynamic. That's pretty relevant.

TONY GREER: 100%. I operate every single day, Alf, from the perspective of two things. Number one is waking up bullish, because I'm a secular bull and I try to keep that position with me no matter what I'm doing. And number two is the Fed is inflating assets. And if you have assets, you're going to be okay. So, if they start cutting down the balance sheet, you can make the argument that they are obviously not in the mode of inflating assets as much on their own, but rather letting the market do it where the market can.

And so, I think that they're benefiting a little bit from that commodity strength that's been ignited. That was the strength that they've been trying for for since the great financial crisis. And it has been nothing but a deflationary war. Deflation story winning that war for so long. Now, we've got a couple of different dynamics with a much different energy market than we've had in 10 years. We're heading into the-- not a switch, I guess I'm switching back. I don't want to switch to different asset classes like that on you.

But we've got a very different situation under the hood than we had even a year or two ago where, well, it's hard to compare it to the lockdown situation, but there's a lot of economic momentum coming out of here that quite honestly, it seems with the S&P at 4,700, and 2 Year Notes yielding 90 basis points, the market is okay with it. So, like you said, I'm dying to see what is going to be the direct cause and reaction to what happens if they start nibbling away at that eight point something trillion dollar balance sheet.

That to me will be something that will definitely cause me to hit some bids with my natural resources trades and take a fresh look. I think that's what the whole predication of this bull market move has been about. So, I am definitely on my toes given that's a new topic that we're talking about now.

ALFONSO PECCATIELLO: Yeah. And actually, we often talk about indexes, too. We talk about the S&P or the Dow Jones. But as you said, under the hood, a lot is going on. There's a lot of rotations. There are a lot of sectors that are overperforming or underperforming. And the topic of the last two weeks has been the underperformance of the tech market, or we should say actually, the highly overvalued non-profitable crap which you're seeing in stuff like Ark and the like.

Basically, the financial theory behind that, supporting those valuations, extreme valuations, should be that because the cash flows are so, so much further in the future, you can't even see them in some cases, like Rivian for example. But because they're so far away in the future, and you're discounting them by a certain discounting factor, then if this discounting factor being risk-free real interest rates goes up, then the present value of these cash flows goes down, and therefore stock prices go down.

So, these are the highest beta sensitive asset classes to rising real interest rates. I just plotted this chart as well for people that are listening and not seeing it, it shows how real interest rates inverted in the chart, actually lead tech stock valuations. So, I just took the 5 Year real interest rates in America, that's blue, I inverted it. So, if the line is going down, then real interest rates are actually going up. And well, basically, I plotted it against tech valuations.

So, there's quite a good correlation if real yields go down and tech valuations go up, and vice versa. Now, real yields have been moving higher by 40 basis points year to date, which has obviously made valuations on-- well, the most valuation intensive side of the stock market nosebleed, and therefore, stock prices also move down. So, this rotation under the hood, Tony, what do you think about that?

TONY GREER: Yeah, that's the call for the year really, Alf. That's where I've got my chips placed on the table right now. I've begun shorting some technology. I didn't short it well, but just decided that as yields are obviously not backing off, that that might be a decent place to have a more balanced book by putting out some technology. Obviously, we got to this point where Cathie Wood's Ark became a focal point. And everybody is going through the due diligence of understanding all of her withdrawals at the end of every day, and it just must be really hard to operate under a microscope like that.