MAGGIE LAKE: Are the markets breaking? Hi, everyone. Welcome to the Real Vision Daily Briefing. Raoul Pal is here with us. It's been one hell of a day, Raoul, so we're really happy to have you with us this Friday.
RAOUL PAL: It has been quite the day. It's been brewing for quite a while. And now it's quite the day.
MAGGIE LAKE: Yeah, it is. And I think it's important to say, we try really hard not to be alarmist here but it felt like that was the right question to ask today. I saw a huge amount of concern from usually pretty level-headed people coming through on Twitter, it was coming through in some of our editorial meetings, I saw your Twitter feed today. Just give us an idea of what you're thinking. What are you watching? What is your level of concern?
RAOUL PAL: Okay, so what I'm worried about is what is currently breaking. And people say what's going to break, what's going to break? My view is that in a massively indebted world, to put this in perspective, the US is some 370% of GDP in debt, as total debt to GDP. It is 100% of world GDP in debt. It's the most indebted any nation has ever been. And everybody borrows dollars.
And we're in a system where they're trying to act like Paul Volcker. Because basically, the Fed is run by a bunch of baby boomers and they want to get a book out where they're on the front cover like Paul Volcker to be the heroes. But I think what they're doing is fighting the ghosts of the past. The ghosts of the past, the 1970s, was wildly different. We talked about this in the Daily Briefing before, the demographic setup is different.
Also, the debt is different. The US is like 100% of GDP in debt, total debts at that point. We're now at least another 150%, maybe 200% of GDP in debt on top. With an aging demographic and high debt, it's very difficult to generate inflation. But the Fed are now convinced there needs to be Paul Volcker. And they are going to go and raise rates further than the market can deal with.
And we're seeing it, we're seeing it everywhere that the market is going, we cannot deal with rates like this and the liquidity that's happened. Liquidity has been drawn out by quantitative tightening, what they've done with the banks and what bank reserves have to be held has kept money out of the market, there's basically no buyer of the bond market. There's a few charts that Claire's going to try and share them.
Bond market liquidity is basically as bad as it was in the peak of the pandemic when the bond market froze, and everyone was worried Citadel had gone under, whoever had gone under. That's how bad the bond market is now. It is completely decoupling from anything. And I'll come on to that in a sec. The next chart, another way of looking at it is bond market volatility. But market volatility is higher than stock market volatility.
This is not normal. And again, we're approaching the peak of the absolute crisis when the entire world shut down, and we thought everybody was going to die. That's how bad the situation in the bond market is. What that's done is decoupled the bond market from the underlying inflation story. This is not a fear of inflation, really, because the Fed is saying we're going to do anything to kill inflation.
Well, what's happened is the breakevens rate has agreed with that and said, yes, inflation is not the enemy. And breakeven inflation, I'm looking at the five years, it's at 2.4%, which broke down today. And one-year is at 1.95. They're basically around 2%. The market's saying forward looking inflation is back to normal. Okay, but the problem is, if bond yields are going up, and inflation expectations are going down, you see this next chart, Claire, which is real rates.
Real rates have been trending lower over time, and this is five-year real rates. They trend lower because of debt and demographics. You need to have low real rates to stimulate the economy or run it normally. The trend rate of real rates is actually negative 1%. But we've just seen the fastest ever rise in real rates in history. You're raising real rates on people at a time when they can't afford to service their debt because there's too much debt out there.
It's creating chaos in the bond market because the Fed have essentially gone too far with this whole mechanism between how the banks can use their balance sheets, plus quantitative tightening plus raising the Fed funds rate and the market's freaking out. It's decoupled from the fundamentals as well. The bond market, Claire, if you bring up the next one, which is the ISM and the bond market are tied at the hip normally.
Basically, bond yields go down when economic growth is falling, because growth and inflation fall. And that's right. What's happened is bonds are pricing an ISM now in the 60s, high 60s, when the ISM in the next month is going across 50. The ISM is going to be pointing to recession, which we all know is happening from almost every single guest we've had on, yet the bond market is broken. It's saying the opposite.
Now, we've seen a few episodes similar, but this is the furthest it's ever been from the business cycle in bond market history. It tells you there's a massive dislocation that's going on. That dislocation has spilled through to the currency market as well. We've already been noting dollar/yen. That was a specific situation, because it was yield curve control so you're printing yen.
Then the UK, the UK starts cutting taxes whilst raising rates. And what happens is the currency collapse, and today, the pound was down 3.5%. This is in the top five largest currencies in the world. And it's down and more volatile than the NASDAQ. This is extraordinary. But it's not just that, the Eurozone has got the same problems. South Korea, it's a mess.
What we've got is a shortage of dollars. Something I've talked a lot about and many guests have talked about. There is a global shortage of dollars, the Fed are taking dollars out of the system. And what's happening is the safety valve is the US dollar is skyrocketing. Now, what that also does is export massive amounts of deflation. If you look at the nations who are suffering the most, It's the world's biggest finished goods exporters, China, Japan, Germany, South Korea, Taiwan. They're all-seeing massive currency declines.
This is finished goods, this is TVs and computers and chips and all of that stuff. The US likes it. It also, geopolitically, they like it because they exert their power, which is the biggest power they've got is the US dollar, 87% of world trade is in US dollars, even though the US has 25% of GDP. But you're choking the entire system.
If we look at the next chart of Asian currencies, this is the ADXY, less looked at than the DXY, it's a basket of Asian currencies. That is breaking a head and shoulders top of a terrifying magnitude. I don't know what this is telling us. But it's telling us that there is no dollar liquidity in all of Asia. And this is a problem. It's a structural problem, not just the cyclical one that's happening now.
The moves that we're seeing in the bond market and the currency markets are becoming unprecedented. The sort of unprecedented we saw in March 2020. The knock-on effects are things like mortgage rates are exploding still. It's having a real impact. This is not a financial thing, this is a real thing here. It's becoming an enormous problem for people.
We're already seeing house purchases coming down, prices coming down, rents coming down. We're going to start to see unemployment from the housing sector, which is a huge employer of average Americans, for example. Europe is in this huge grip that we know about. My working hypothesis, oh, sorry. And oil broke today as well, which is something I've also been on here and talked about.
My working hypothesis was I'm not sure the equity markets are going to make significant new lows and I'm still not. They may break the low, go a bit lower and then break higher, back higher again, because the sentiment in equities is unparalleled and I better write this in Global Macro Investor. It is the worst sentiment in any measure of any survey in the history of equity markets.
People are record bearish. They're terrified because of what's going on. The bond market, which is the anchor pricing for everything, is unhinged. And the dollar, which is the big daddy of all macro assets, has become untethered as well. It is a scary situation. But how I look at this is okay, and I had a great conversation that will come up in next week, I think, with Arthur Hayes from BitMEX.
Arthur said, listen, there's two games at play here. One is those guys who want to be Volcker. And they've having their day in the sun. But in the background, there's a much more powerful group, and that is the politicians. The politicians are the ones that actually set policy. When the politicians decide that economic growth is gone too far, they will change the game, and I believe that.
And that's where quantitative easing direct handouts and other stuff to alleviate the pain in what's going on, they can't have mortgage rates like this for very long before unemployment starts coming and this becomes a big problem for the Biden administration, or whichever administration, whichever country you got to deal with. Therefore, the propensity for there to be if this trend continues that we're seeing, there is a propensity for the market soon to start pricing in somebody's going to have to step in here, much like they did in 2020.
That still remains my view, is the politicians will end up pushing the Fed around, I think the Fed have created this by fighting the wrong battle, because the battle they remember was the Battle of their heroic hero, Paul Volcker, for. It ain't that battle, they're fighting the wrong thing. And so we've got a big problem on our hands but over the next few weeks, as this pushes to its logical conclusion, you can hear in the background, the people coming to the rescue because somebody is going to have to do something about this.
It may start with changing the reserve requirements of banks, it may be swap lines for the foreign central banks, it'll start somewhere, and it will grow. But this can't continue for long.
MAGGIE LAKE: it sets up an interesting situation, because the politicians, and we do see a dichotomy. I think the politicians are the ones who got the Fed into this inflation mode in the first place. That was front page news when everyone was suffering in the US feeling inflation for the first time and you had the White House talking about it constantly.
And a lot of people fell behind the scenes pushing the Fed to get more aggressive when they were in that transitory state. Do you think it will be after the midterms that we see that political pressure--? There's a feeling that it's pivoting already maybe, but.
RAOUL PAL: Yeah, politics is a narrative game. That's all it is. Where does the narrative lie? That narrative lies with the path of most pain until you're in a situation where you can use optimism. The path of most pain is what they will focus on, because that's what gets votes. Human psychology is anger, resentment, fear tend to get you votes better.
What they will do is, if unemployment starts rising, which I think it will, they will start pivoting to inflation is dead, the new enemy is growth. Jobs for America. We need to help you with your bills, even though bloody, all the commodity markets are down 50%. We need to do something to help you or we need to get your mortgage rates down.
Honest, working hard working Americans, how can they afford their mortgages? This was the mess that came from the pandemic. But we need to get that down now. We need to get interest rates down. Now, you can hear the narrative change. It's easy to make, right? It's all narrative.
MAGGIE LAKE: So you are thinking that there will be a pivot? Which would put you in the camp, a very contrarian camp, right? Because all we hear from everyone is that the Fed has made it clear that there is no pivot, the pivot is dead, that this is a new era, this is the new normal for the Fed.
RAOUL PAL: Yeah. And I don't believe that. I think people are projecting what they want. Not what is. What is, is the Fed have got breakeven rates of inflation down to the twos and if this continues for the next few weeks in the vein that it is and if oil continues to trade towards $60, which I've been saying it's going, these breakeven rates have come down to 1%, so the battle is won.
Now, I actually think and I've said this before on the show, I think actually inflation is negative in 18 months' time. I think they completely misread the bullwhip and the bullwhip was post pandemic, spikes the inflation because everyone comes in the workforce, no supply, overreact to the supply. Yes, they should have raised rates but not like this. They've misread it. They want to be Volcker. And before they know it, they've destroyed the economy and inflation as well. And they've got their old friend back, deflation.
MAGGIE LAKE: Anthony's asking why are you saying that it's the worst sentiment you've ever seen? And we do have people pointing out that although professionals have sold and are in cash, we haven't seen massive retail redemptions for equities. Do you worry about that, especially if you start seeing growth slow, substantially?
RAOUL PAL: Two things, retail don't matter in the equity markets, never have. And the only retail that does count in the equity markets are the millennials who are 401k dollar cost averaging. They're not selling. They're not punters, so that flow is slow. But if I look at every single part of the Merrill Lynch survey or the AAII survey or the institutional investor survey, they are all-time record lows, below 2001, below 2008 on every measure. I've never See anything like it.
MAGGIE LAKE: We have another question from-- because I'm going to get right to the questions because this is what we do, right? People are nervous. They've been looking at Twitter, looking at the headlines, looking at the read hours all day. Guns, dogs and coffee, do foreign central banks sell to repatriate their US equity positions, aka tech stocks, to fortify local domestic balance sheets given QT?
RAOUL PAL: There is a theory of the game and I'm not sure, I'm sure that some of it, but I haven't seen wholesale ECB selling US bonds. Are the European banks selling US bonds? I don't know. But there is some doom loop. Andreas Steno Larsen put something out about the doom loop of currencies.
MAGGIE LAKE: We've got that. I think we read your mind. I think we've got a little-- the graphic he tweeted out or that he made and he called it the Forex doom loop I think, right?
RAOUL PAL: Yeah. And that's basically the selling of Treasury to raise stuff, then dollar goes up, makes it worse, and you keep repeating it. And that doesn't stop until the Fed offer at swap lines. But the Fed hadn't yet realized that they've broken the bond market. They have to realize that first.
MAGGIE LAKE: We know that you often talk about the chart of truth. That's it. If I understand you, it's not the chart of truth right now, is that correct?
RAOUL PAL: The chart of truth, there's two ways I've been looking at this is one, it's clearly broken out. The question is, does it go back in, and then just broaden the regression channel over time? My view is yes. I think this is a breakout based on liquidity issues. And I think it actually goes back into the channel and nobody wants to realize that. Have we frozen?
MAGGIE LAKE: No, you're okay. We're all freezing a little bit but the audio is fine. Then it's not even the hurricane that's headed toward Raoul yet. But we're not really sure what that's going to be like, right, Raoul?
RAOUL PAL: Yeah, exactly. I don't think it's my intent to have this frozen, actually. But the chart of truth, if I look at it in terms of deviation from trend, this is one of the highest ever. Normally, that should mean that we come-- I think we're going to mean revert. And I think we're going to mean revert massively and really fast.
Now, again, I've been wrong on bonds for a while now. You can just count me to zero if you want. And that's fine. I'll take it on the chin. I honestly think that this is a mean reverting massive decoupling followed by a recoupling that's going to happen at a very fast speed as soon as one of these liquidity mechanisms changes, whichever one it is.
MAGGIE LAKE: Yeah. Which sets up a scary situation, because when things are moving that quickly in markets that are not used to moving that quickly, that's where you get issues.
RAOUL PAL: Yeah, but don't forget the equity markets, I'm looking at the NASDAQ, it's down 30% already, what more do people want here? Yes, they want 50% because they want blood? Will they get 50%? I doubt it. We go back to the Volcker era that everyone so loves is the market was down 27%. If we go back to the 1940s, post-World War II, the market was down 22%. 1990, nice, big regular recession, ISM went down to 30.
Where did the stock market go? Down 20%. Everyone's convinced talking themselves into being more and more and more and more bearish. There's a probability, and for me, it's probably 30% or 40% that it makes significant lows, but I think it's 60% more likely that we don't make significant new lows. But let's wait and say. The bond market keeps breaking and we're at 4.5% yields in three weeks' time. Yeah, maybe we will.
MAGGIE LAKE: We've been talking a lot and Weston has been on this. We've been looking at the BOJ and the yen and really flagging this early for members. We've continued to see huge moves and there's a lot of people with the intervention this week saying, oh, hang on a second. They're doing yield control, curve control, and they're intervening in the market as well.
You mentioned Asia before, what are you watching there? How concerned are you about the pressure that's building?
RAOUL PAL: Well, the one that I've looked at is the Korean won, screeching higher. The dollar/won is going higher, so one is collapsing. Look, the problems are everywhere. They're literally everywhere. And the Fed is going, well, I can't hear you. I don't think it's really realized because they're still based on the narrative of we need to fight inflation until they realize they've broken the system.