ANDREAS STENO LARSEN: Good afternoon, everyone. And welcome to the Real Vision Daily Briefing. I'm Andreas Steno sending to you live from Copenhagen, Denmark. Today, it's Thursday, the 23rd of June. And we have a very interesting macro backdrop to discuss today. And with me today is Weston Nakamura, the global markets editor from Real Vision in Tokyo. Weston, a very warm welcome to the show.

WESTON NAKAMURA: Thanks a lot, great to be on with you.

ANDREAS STENO LARSEN: It is, what a macro backdrop to have on a day like this. We've had basically a landslide in European interest rates on the back of disappointing PMIs out of Europe. But otherwise, I'm basically curious whether the market is slowly but surely changing its narrative towards a growth scare instead of an inflation scare. Let's start with that million-dollar question, Weston. What do you make of that question?

WESTON NAKAMURA: Yeah, I think that that's probably been underway for the last few weeks and starting to pick up steam. I think that still though, by and large, it's still mostly an inflation scare thing, because simply because of the fact that, as we saw with Chairman Powell for his second day in front of the House this time, but it's just the Fed is just inflation, inflation, inflation, and so are the rest of the central banks, global central banks with the exception of one central bank.

I think that yeah, they're going to express concern about recession, about growth slowdown, but they really need to get inflation under control. But that's just my-- what's your view on that tilt?

ANDREAS STENO LARSEN: Well, I think it's interesting that we've seen cracks appearing in the commodity space. We've seen oil prices retracing from highs we've seen the copper price retracing from highs, et cetera. We've seen the first signs of the cycle turning against us in the commodity space. And what I find really interesting is that we have this very close relationship between inflation expectations and commodity prices overall across the globe. And that's one thing that could eventually lead to some kind of topic within the central banks that commodities have started to turn. What do you make of the pricing in the commodity space that we've seen recently?

WESTON NAKAMURA: Okay, so I'm just going to lay this out. Markets are extremely confusing right now to me. It's like everything that I am accustomed to, I'm always very much on my toes, I'm always trying to question my own thesis, I'm trying to on a daily basis almost, just to try to reprove if I'm in the right direction or not. But really, since the SNB, the Swiss National Bank, when they suddenly hiked rates last week, that is when things just really fell apart.

Even basic things like dollar/yen and 10Y US Treasury yields and just basic yield spreads between-- nominal yield spreads between US and Japan, all that kind of thing, they have nothing to do with one another anymore. With regards to commodities, copper, when I think of copper, I think of USD/CNH. Those correlations has broken down as well. So, I'm very lost. So, I'm hoping you can have some answers for me, especially with copper.

ANDREAS STENO LARSEN: Weston, I've been banging the drum for quite a while that if you look at the credit cycle, so the amount of credit available to the private sector across the globe, we've seen a material slowdown in that metric over the past two, three quarters in a row. And to me, that's usually the typical Harbinger before you see a slowdown in the commodity pricing.

And the reason is that credit is a leading indicator of growth. And we've had the PMIs out today from the Euro area, but also from the market in the USA basically pointing south. No surprise to me, but compared to the surprise to the market, given what we've seen in interest rates space, and particularly in Europe. But to me, it is the first sign that the cycle is clearly rolling over on growth. And I think that will turn into a topic for central banks eventually during the second half of the year.

The tricky thing here is timing. Because they have high inflation and a growth cycle that is clearly weakening. What do you make of that cocktail, basically, high inflation and slowing growth? It's tricky to maneuver as a central bank, right?

WESTON NAKAMURA: Yeah, it certainly is. I guess in the Jim Bianco camp, in which at the end of the day, well, as far as the Fed is concerned, they do have the dual mandate and growth is not one of those two mandates so US certainly at full employment. And so, they have one job, and that is to tackle inflation. And if that means that they need to break things, then they're going to have to break things. Because it's not their job.

Despite the last decade or so of artificial intervention, and QE and so on and so forth, it is not their job to support asset markets, it's their job to maintain price stability, and clearly, we are not expecting. I think that, yeah, again, it tilts more towards that way. But I want to actually ask you about especially like Europe today was, it seemed just horrendous with especially German PMIs. And you had some thoughts about manufacturing PMIs and services PMIs, can you elaborate on that a little bit?

ANDREAS STENO LARSEN: Well, basically, I think it's a done deal that manufacturing PMIs will look horrendous over the next couple of quarters. That's basically just the lag effect of interest rates rising. We know that manufacturing PMIs are very sensitive to interest rates. So, when we see interest rates rising in the way we've seen over the past couple of quarters, it will eventually lead to very, very negative manufacturing PMIs.

But until now, we've cling to the straw that the services PMI would stay positive due to the reopening effects on the economy, tourism booming, traveling, booming, etc. But the first sign today from the German PMI was basically that the service sector is also underwater, which is a gamechanger to me. And I think that's why we have this very theist reaction in the interest rate space in Europe, we've had a double digit move in 10Y Euro swaps as a consequence of this PMI figure.

And I think it's a fair move given what we've seen from these PMI is because if both services and the manufacturing part of the PMIs are moving down, then it eventually means that the GDP number will look very bad. So, the ECB is now basically stuck between a rock and a hard place because inflation is still running hot, but growth is looking exceptionally lackluster already.

And that's a tricky thing to maneuver, because especially within the Euro area, what do you do when inflation is hot and growth is not? When you have a couple of countries within the Euro area dependent on very low interest rates, it's not an easy decision. So, I'm happy that I'm not on the board of the European Central Bank this summer, because it will be an extremely tricky decision.

I want to ask you a question on another central bank currently also being discussed across the macro landscape, and that's the Bank of Japan. I know that you've been following this central bank very fiercely. And we've had a lot of debate going on whether they will need to increase the ceiling on the yield curve control in the 10-year point. What's your take on that? Is it a feasible scenario at all?

WESTON NAKAMURA: Yeah, of course, it's feasible. I mean it's certainly feasible. The question is how and when, but they cannot cap 25 basis points forever in a rising yield environment. When you're getting, last week, you had a record amount of fixed rate operation, and JGB buying from the Bank of Japan matched with foreigners record net selling JGBs to the Bank of Japan. And you saw insane volatility in JGBs as well. I think that they were dating back to maybe even above the March 2020 levels.

But my overall takeaway from BOJ not having changed the 25-basis point band on yield curve control, and thereby I guess a few widows were made that day to add to the large graveyard of widows, but basically, Japan, when it comes to the yen versus like JGBs, they have to save one to burn the other. So, currently, they're supporting the JGB market, and they're going to burn the yen in order to do so.

And I think that this question of FX intervention, that is not coming for-- that's very far away. And I don't mean it by in terms of time, I'm measuring that in terms of circumstance. And so, it's not a certain level. There's a lot of people who say, like, 135, 140, 150, it's not a certain level that's going to be some line in the sand. It's the velocity and the volatility in which it gets to that level.

But the way that I see it is you have less than one year left for this gentleman, Mr. Kuroda, as the longest running Bank of Japan governor in history, and at that point, you're probably going to get a major policy shift. But before then, as of yesterday, we had the upper house election campaign season start, and that's coming in early July. And then depending on how that goes, that's going to maybe influence who's going to take the helm at the BOJ.

Until then though, the message I'm getting is just very clear. The yen can go to hell, the Bank of Japan is going to cap 25 basis points, or they're going to defend the JGB market above and beyond anything else. And even if that means the dollar yen at 140, 150, the alternative is that you have borrowing costs spike, and more so than that, if the Bank of Japan essentially is perceived to be giving into market forces, foreigners selling, shorting futures, JGB futures, and if that's what can basically drive the central bank policy, then the central bank has no more policy credibility ammo left.

The BOJ can do whatever it is that they want to do, and they don't really care about foreigners that much. But the reason it's different this time is because for the first time since I've been on this, really, people on the ground in Japan are feeling inflation, and they're pissed off, and they are going to express that view at the ballot box. And you're starting to now get Japan to join the rest of the Western democratic capitalist nations in the non-independence of central banks and the politicization of central banks. But that's basically my view.

Kuroda is basically planted his flag down. The more that the foreigners push on JGBs, the more firm he has to be. And so, it just got to be this reinforcing thing. He cannot give in at any point. So, what are your thoughts? I know that you're closely watching it too.

ANDREAS STENO LARSEN: Well, I'm tempted to take the opposite side of this bet, basically, because it is very tricky to defend an easy monetary policy stance as soon as the inflation is running above target. And in that regards, we have an inflation report out tomorrow, as far as I'm concerned, in Japan. The 24th of June.

WESTON NAKAMURA: In a few hours, yeah.

ANDREAS STENO LARSEN: Yeah, exactly. I mean just after midnight, my time, I'm in Europe. So, that's why I'd say tomorrow. Point being that on my models, headline inflation was priced towards 3%. It's not massive compared to what we see in Europe and what we see in the US because that's almost close to double digit territory, but 3%--

WESTON NAKAMURA: Massive in Japan.

ANDREAS STENO LARSEN: It's massive in Japan, because you've been used to like, say 0% and 0.5%, stuff like that. What do you make of the debate as soon as inflation turns above target? Is that something that could alter the picture?

WESTON NAKAMURA: Yeah, so I think that you're spot on with your understanding of that, like, if headline CPI in Japan goes from 2% to 3%, that would be much more of a global macro shock datapoint than the US CPI going from an eight-handle to a 10-handle, because what's a 10-handle? It's already terribly high and yeah, that's going to move markets. But just as you said, it's generations, it's three decades, generations of people who are accustomed to prices do not go up. Cash is king.

The yen has maintained purchasing power, and all that. Well, not so much anymore. And you have huge, huge increases in just basic cost of living because of imports of energy and food and all that. You have absolutely no wage growth top catch up with that, you have real wages that are just plummeting. And people are pissed off for the first time. So, the Bank of Japan did that survey in February of 2022, right when the dollar was 115, right before takeoff.

And they did a survey of just regular people, not within the financial universe. And they asked them, do you know what yield curve control is? And about a third of respondents said they've never heard of it before. Another third said they're familiar, but not really, or whatever. Well, now, everyone knows what it is. So, now for the first time, it's become, yeah.

So, if you have a 3% handle CPI, that is going to mean you don't really even need that number printed, people are already feeling it. However, what you're going to get from the Bank of Japan is transitory.

ANDREAS STENO LARSEN: We've heard that phrase before. Weston, a question from my side, I'm based in Europe, we have a lot of the audience based in the US, the topic of Bank of Japan and the yield curve control, is it something that we should care about if we're not based in Japan?

WESTON NAKAMURA: Yeah, absolutely. Absolutely. So, James Aitkin was on Real Vision recently with Raoul talking about, I mean there's a lot of guests who come on to really to talk about this very topic, because this is the global macro trade right now is the dollar/yen. That's, by the way, just so everyone knows, that is also the FOMC play because there's so much uncertainty with FOMC policy in the near term and frontend rate vol is so high.

Rather than making a bet on FOMC policy, people are instead just shorting the yen against the dollar. And they're playing the policy divergence rather than the US policy itself. So, dollar/yen is like the macro trade right now. But the reason that yield curve control matters is because Japan is the largest in net international investment position, it deploys most capital overseas, it is the largest foreign creditor to the United States in terms of as a country and all that and BOJ's yield curve control is indirect US yield curve control.

If you have yields capped at zero or around zero and an ageing society that's cash rich and yield starved, you send that, that capital goes overseas and buys Europeans-- like terrible credit, like high yield, negative yielding high yield debt in Europe and stuff like that, as well as US Treasurys and so on, so forth. And so, that's been keeping a lid on risk free rate for the last half decade plus and that has allowed for a low-rate environment that has therefore ripple effects across risk assets.

And so, when you are now currently in an environment where every central bank is removing accommodative policy, BOJ is only one left, and then they are unable to or unwilling to maintain that peg at 25 basis points, then that's when the bottom really falls out under the fixed income market. That's when you get sovereign yields spike, credit spreads blow out, and risk assets just plummet. So, that's the significance. I don't know if I missed anything, did you--?

ANDREAS STENO LARSEN: You're perfectly right. One thing that I would like to add is the discussion on commodities and the link to Japan and also Germany. I lived as I like to put it on the outskirts of Germany, just north of it in Denmark. And I feel the pain right now of being a commodity importer. I know Japan feels the exact same pain of being an energy importer right now.

WESTON NAKAMURA: Not as bad as Europe but yeah.

ANDREAS STENO LARSEN: Surely not, surely not. But you come secondly in line, basically. And point being that it hurts on the currency side when you are basically stuck in a commodity importing regime during a time of rising prices in commodities. And that's exactly why we see the European weak and the Japanese yen being weak. What's your take on this whole commodity regime and how it plays into Bank of Japan policy, and maybe even fiscal policy in Japan, and maybe even Europe?

WESTON NAKAMURA: So, on Europe, I'm going to have to defer to you on that. But for Japan, in early June, you start to see a decoupling of 10Y US nominal yields and dollar/yen which were lockstep tick per tick movement. And so, they are decorrelating, that was largely because the dollar/yen started to move alongside crude oil prices, rather than the yield spread. So, being short the yen isn't just a monetary policy divergence play, it is also a, like you said, a commodity-- being short commodities and having to buy at like spot market in ever-higher prices just to keep your basic grid running.

Aussie/yen, AUD/JPY, that's my go to like, if you're going to short the yen against something, you should-- AUD/JPY, although it did have a pullback, would probably be your best bet to do so because you have RBA who is also hiking rates. And so, you have a monetary policy divergence there. Plus, you got the commodity upside kicker from there as well. But in terms of fiscal policy, too, you're starting to see some measures from the government trying to subsidize a lot of this energy as well.

But it doesn't matter if it's the government or if it's privately owned companies, somebody has to buy spot LNG and sell yen to do so, then buy Aussie/dollars, or USD, or whatever it may be. But what's going on in the European side?

ANDREAS STENO LARSEN: Yeah, it's a big mess. If you look at the German energy policy, they've closed nuclear plants of the past three, four years in a row. And now, they are slowly but surely reopening coal plants. And they are basically buying indirectly at least coal from Russia, even though they tell the public that they're not doing so. You cannot make this shit up. It's not pretty.

In Denmark, we are basically based on renewables, but we are a small country. So, that's much, much, much easier. But the big countries within the Eurozone, they are still very, very reliant on Russia. That's the sad truth.

WESTON NAKAMURA: There was a Bloomberg article out, which I just wanted your thoughts on, I'm not necessarily saying that, believe it or not either way, but they were basically saying that Germany is basically calling this a Lehman moment in terms of-- Yeah, yeah. What are your thoughts on that? It's a really far out there analogy, but--

ANDREAS STENO LARSEN: Well, if we assume that the current energy resource storages are intact until winter, they're basically not sufficient. So, if we don't get sufficient supplies from now on until October, November, then we should basically fasten the seat belt in Europe. That's the consequence of that. And it is an ongoing