ASH BENNINGTON: Welcome to the Real Vision Daily Briefing. It's Monday, June 13, 2022. I'm Ash Bennington joined today by Jared Dillian, editor of The Daily Dirt Nap and also later on, we'll be joined by Real Vision's own Weston Nakamura for an update from Tokyo on the BOJ and JGB yields.
Let's take a quick look at what's happening in markets. Not a good day to put it mildly. Starting off with Asia, Nikkei down 3% on the day, Euro Stoxx 50 off 2.6%, so down day in both Europe and Asia. NASDAQ off on the day minus 4.68%, S&P 500 off looks like nearly 3.9% on the day. Russell 2000, unfortunately, the big loser of the day here, looks like off 5%.
I want to bring in Jared Dillian. Obviously, Jared, lots of market volatility going on. You're talking about the recession trade in your Daily Dirt Nap newsletter. But I want to read from a tweet sent by you around 10pm last night. "I'm genuinely spooked, and I don't spook easily." Jared, tell us what you're seeing right now as you look out on these markets.
JARED DILLIAN: Well, this is a terrible day for me. It's a terrible day in the markets. It's a terrible day personally. Shit is just raining down on me right now. It has been a bad day, okay. But let's talk about what's going on.
There is an incredible amount of stress in short term rates, an incredible amount of stress. I'm looking at bills. One-year bills are up 33 basis points in a day, bill yields. 2Y notes, half a handle. Usually, you don't see moves like this on the upside in the frontend of the curve. In yields, you usually see it on the downside. There's a lot of stress in rates markets. And the problem is--
ASH BENNINGTON: Jared, let me jump in and just frame this out for people who may not follow the fixed income as you are, obviously. So, you're looking at the very short end of the curve, bills are traded discount on face. These are very short-term instruments. You're talking about very large moves in terms of percent change in yield rising, fall in price. What does that mean? Why does something like that happen?
JARED DILLIAN: Well, basically, Fed Funds expectations ratcheted up significantly just in the last 24 hours. So, I don't know if everybody saw it but there's a Wall Street Journal article, Nick Timaraos, basically, the Fed leaked that they're going to hike 75 basis points on Wednesday. It's not really a surprise. I'm pretty sure that's what they're going to do.
If you look at where Fed Funds Futures are trading, we're pricing in 4% terminal Fed Funds. And if you think about this in the context of what the Fed has said in the past, if you go back to the last Fed meeting on their dot plot, the highest dot, the highest dot was 3.5%, and the Fed Funds Futures are pricing in 4%. So, I don't think the Fed is going to be able to hike to 4%. I think if you could just naively buy these things and if you can withstand the volatility, I think you'd do okay. But we're in liquidation mode is what's going on, we're in liquidation mode.
ASH BENNINGTON: Let's talk a little bit about the drivers here for this perception that the Fed is going to basically continue to normalize from the ultra-accommodative monetary policy we've had now since the 2007, 2008 regime period. The driver on this is inflation. We got another brutal print on CPI, 8.6%. Give us a little bit of a sense of what the tensions here are, what the dynamics are at the Fed and why this is such a challenging meeting.
JARED DILLIAN: Yeah, first of all, I want to say I would be willing to bet my reputation, that CPI does not go above 9%. In fact, I think the next print is probably going to be lower. They have successfully engineered a recession, okay. And what's going to happen on Wednesday, when the Fed hikes 75, the curve is going to massively invert. The long end of the curve should rally, and that will be pricing in a recession. If you look where mortgage rates are, mortgage rates went up to 5.85% is the average on a 30-year fixed rate mortgage, like the economy is going to be slowing down massively.
ASH BENNINGTON: Let's talk a little bit about curve inversion. I think you're talking about 2s, 10s, which inverted briefly on very early hours of this morning. Then uninverted, I guess with a positive spread now, it looks like four basis points on my screen, 2s, 10s. What is the significance of that number? And why does it matter to people, particularly people who are in equity markets who don't often think about the different tenors along the yield curve?
JARED DILLIAN: Basically, the yield curve is a nearly foolproof recession indicator. So, if short term yields are higher than long term yields, basically what it means is that within that time span, you expect the economy to go in recession, and you're pricing in lower yields in the future. That's why it always worked. It's worked seven out of seven business cycles. The yield curve inverts, then you get a recession.
It inverted for the first time a couple of months ago, then it steepened a little bit. Now it's flat again, it's going-- one of the things I said at the Macro Experience out in San Diego, it was my opinion that not only would the curve flatten, but it would invert massively that you could have 2Y yields at 3.5% to 4%- and 10Y yields below 3%.
ASH BENNINGTON: Yeah, by the way, all of this, the perfect context and segue, let's cue up our conversation with Weston Nakamura, who has been talking about precisely some of these points, particularly from the perspective of the BOJ and how the Bank of Japan has effectively been putting this global yield curve control on. It appears as though we've had some change in that now, Weston.
WESTON NAKAMURA: Yeah. Hey, guys. Yeah, so basically, as you know, Ash, because you and I have discussed this for some time. But back in late January, early February of this year, I made a video on Real Vision YouTube called Why Global Markets Are Addicted to the Bank of Japan. And the entire premise of this video was basically that-- there's basically two things.
First of all, people are not paying enough attention to the Bank of Japan, it is the most consequential in terms of risk assets. And the reason is because they are the only central bank that is actively-- major central bank-- that's actively easing at a time when global central banks are withdrawing accommodative policies after a decade of providing it all at once, leaving the BOJ to be the only one left doing so. And the yield curve control, which keeps a lid-- a loose one, but a lid nonetheless-- on global DM sovereign yields.
ASH BENNINGTON: Talking about yield curve controls, for people who don't really follow macro the way that you do, let's talk a little bit about why yield curve controls are different from quantitative easing, the different points in the curve where the Bank of Japan is intervening where the Fed and other global central banks are not.
WESTON NAKAMURA: Sure. So, Brian, can you put up Chart 1, please. So, people who follow me on Twitter, you're very familiar with my putting up a chart of dollar/yen versus the 10Y Treasury yield, because they basically move in tandem. So, this first chart is just very simply, is just the 10Y JGB yield in green, the 10Y US Treasury yield in white. And that line that pertains to, that green is the BOJ's upper bound, the 25-basis-point upper bound.
If JGB 10s get to that level, the Bank of Japan steps in and conducts what's called a fixed rate operation in which they offer to buy an unlimited amount of 10Y JGBs such that the yield gets capped, and they fall back down. And so, they did that in February, if you go to Chart 2 actually, I've actually marked these on the same chart. So, you can see whatever that green just gets up to that 25-basis-point line, they conducted a fixed rate operation, they offered to buy an unlimited amount of JGBs. And then JGB yields fall, and then Treasury yields fall, and bund yields fall.
And that's because if you're not getting yield at home, you're going to send all this massive amount of Japanese capital overseas, and that caps US Treasury yields and European yields and so on, so forth. And then that line is when BOJ, the last BOJ meeting in which they basically effectively made fixed rate operations permanent, so there's now a daily bid for unlimited JGBs at 25 basis points. Today or yesterday, they were unable to hold that. And the premise of my video, as I was saying, was that if the big Japan messes up with yield curve control, if they can hold the line for whatever reason, you're going to see this massive spike in global sovereign yields and that's going to kill risk assets and well, here we are.
ASH BENNINGTON: Yeah, one of our regular viewers, CG, just pointed out. It looks like Weston is dressed for a funeral. And another one of our viewers asked if the funeral is JPY. Let's talk really quick about the dollar/yen pair, what you're seeing there and what it's signaling.
WESTON NAKAMURA: Yeah. So, third chart is basically just the same as the last, but I just put dollar/yen on top of it. So, dollar/yen did hit its millennium high, except when yields start to pull back and JGBs start to sell off during the cash session yesterday, dollar/yen actually fell. So, the dollar strengthened against everything, basically every other currency pair except for the yen. The yen actually was bid up.
And the reason that's happening is because either the Bank of Japan caps yields at 25 basis points, and therefore the yen weakens, or vice versa. You can't do both. And so, in this case, when you're seeing the yen finally strengthen or get short covered, what that is, is the markets who are betting on Friday's BOJ meeting for them to make a tweak in their policy to widen out the yield curve control band. And that's why you see that dynamic happening right now.
ASH BENNINGTON: Yeah. Really quick, Weston, final point, significance. You've talked about this here before, the global transmission mechanism, this idea that the BOJ by YCC is keeping a lid on rates globally, what's the transmission mechanism for people who are looking at their US equities portfolio trying to make a connection?
WESTON NAKAMURA: It's simply that Japan has the largest net international investment position in the world. They deployed most capital overseas, much of it goes into fixed income because Japan is cash hoarding deflationists and very elderly. And so, they're in need of yield. And they're not getting any in Japan, because of BOJ's yield curve control. So, that's what BOJ YCC does it, it indirectly caps yields globally, and therefore leaves everything in a low-rate environment, even in a rising rate environment.
And so, with the removal of the BOJ's yield curve control, that's going to have much more of an impact on global risk assets than, say, the Fed or the ECB because those things are well known and more or less priced in. The Bank of Japan, however, lifting rates, that's something that hasn't happened in decades and something that the world is not accustomed to. And that's something that can create trillions of dollars of capital to flow around and reprice things.
ASH BENNINGTON: Weston, very elegantly framed and concisely said. Thank you so much for joining us.
WESTON NAKAMURA: Thanks a lot. Thanks a lot, Jared.
ASH BENNINGTON: So, Jared, as Weston points to lots of moving parts here today, this is obviously a global rate picture that Weston brings up. Any thoughts or anything that you'd like to add on those points in terms of what you're seeing here in US fixed income markets?
JARED DILLIAN: Well, I want to say that if you go back in history for any downturn, if you're preparing for a downturn, what do you do? Well, you lighten up on stocks, and you buy bonds, and you buy gold. And that playbook has not worked this time at all. It has not worked at all, everything is going down. The possible exception of energy, but even energy stocks were down 4% or 5% today.
A lot of the communication I'm getting from people, I get emails from subscribers all the time, and I must have gotten half a dozen emails like this sucks. Everything sucks. This market blows. Like everybody is feeling it. Usually, there's some person on Twitter that is taking a victory lap, they were in the one thing that went up and it's not happening. It's hitting everybody.
ASH BENNINGTON: Yeah, I'm looking here at a WTI chart on the day closing at looks like flat around 120 but it bounced around earlier in the day.
JARED DILLIAN: Yeah, bounced around a bit. But yeah, oil still lunged.
ASH BENNINGTON: Yeah, basically, lunged on the day. But other asset classes, Jared, you bring it up, you mentioned gold, what are you seeing there?
JARED DILLIAN: Well, I'm seeing the same thing that everybody else is seeing. On Friday, gold was up a lot on the CPI print. Everybody shorted gold into the print overnight, and then it ripped up to about 1870 and it completely reversed and gave it all up today. If you look at a long-term chart--
ASH BENNINGTON: Went as low as 3%, 2.8%, some odd percent down, yeah.
JARED DILLIAN: If you look at a long-term chart of gold, it looks more attractive. It's a big cup and handle, the uptrend's still in place. And look, to be fair, gold is still up on the year. It's really one of the few assets-- it's up 1% or 2%, but it's still up on the year.
ASH BENNINGTON: Well, and it's especially up on a relative basis where everything else has lost.
JARED DILLIAN: Yeah, that's the point. Yeah.
ASH BENNINGTON: Yeah. So, Jared, how do you frame this? You were writing about the recession trade as I mentioned earlier in Daily Dirt Nap. How do you think about this? How do you process all of this?
You mentioned this notion that the historical correlations are breaking down here. It's just ugly across the board. How do you begin to think about what you do? You asked the question, what works in a recession? So, what does work in a recession? And is that where we're headed?
JARED DILLIAN: Well, I think one of my problems is just in general, is I think too far ahead. Like, I'm several months ahead. So, as of Friday, as of the CPI print, we went into the recession trade, okay. And that was exacerbated today. In a recession, long term yields should come down, okay. I think if you bought bonds, and if you could withstand the volatility, six months from now, you'd be happy, okay. That's what I think.
Equities are going to struggle, but at some point, it's interesting. I'm looking at Twitter right now on my other screen, there's a tweet, White House watching stock market closely, okay. So, that's very important, because there's two competing interests here. One, we're trying to get rid of inflation, the Fed is trying to get rid of inflation. But if there's a threat to financial stability, the Fed will step in just as they have stepped in at every point in history.
The White House and the Fed doesn't want the stock market down 50%. This is a welcomed decline in asset prices. They're happy to see this. But if it gets more disorderly, sure, absolutely. They'll pause rate hikes or hike 25, or stuff like that.
ASH BENNINGTON: Yeah, we've talked about it here on the show before this, the Scylla and Charybdis, they're trying to steer between these two very unappealing alternatives. This intense inflation we see, 8-plus-handle on the one hand, and it was our favorite drinking game, Scylla and Charybdis, you have to drink. And also, this contraction of the economy. We're not in recession yet, or not officially according to NBER. But we have seen one quarter of growth contraction. How do they weigh that out? How do you weigh the balance of terror there between those two extremely unappealing options, and what implications does that have for markets?
JARED DILLIAN: I think inflation is going to go down. I really do. One of the most fascinating things I've read about economics was that we have the CPI, which is computed by the Bureau of Labor Statistics, but we also have the Google price index, and we have something called the MIT billion prices index, okay. So, back in the financial crisis, September 15th, the day that Lehman went bankrupt, prices started to come down online within hours.
Within hours of the Lehman bankruptcy, prices started to come down, that deflation was already happening, right? So, it's my belief that the shock that we've had in the rates markets is going to have ripple effects across the economy, and it's going to happen very fast. People as we speak, are being priced out of mortgages today. It is happening, it almost happened to me. I locked in my rates the day before the payroll report, I got 4.25% on a 10Y arm, that would be 5.5% today. So, it's happening.
ASH BENNINGTON: A big move, 100 basis points on a mortgage rates material.
JARED DILLIAN: Yeah. I would be one of those people at the margin, I probably wouldn't be able to do it.
ASH BENNINGTON: Yeah. So, let's talk also places where we're seeing a lot of pain today. In crypto obviously, it's just been a brutal and ugly period. Bitcoin now trading at 23,453, Ethereum at 1,249. Just some perspective here, Bitcoin on 24-hour trailing basis, off nearly 15%, seven-day basis, off over 25%. Ethereum off 15% 24-hour trailing, seven days, off just under 33% call it. You mentioned on Twitter, Jared, everyone seems to be sick of crypto, you don't want to see it on your screen any longer. Give us the 30-second version of why.
JARED DILLIAN: Every everybody is in crypto, you get to this point you're so unhappy, you're so demoralized. Look, most people own a little bit of crypto, and everybody at this point is, what do they say, they're like, I'm not looking at it. I don't even log into the app, I don't look at it. And I'm just going to pretend it's not there. And people don't want to hear about it. They don't want to see tweets, they don't want to see videos, they don't want to see these commercials for the exchanges. It's just we are in the revulsion stage where people just hate it.
And after the revulsion stage comes a period of neglect, where nothing happens, which was the period of 2018 and 2019. That was the neglect phase where Bitcoin was 3000 and didn't move and people left it alone. And that was the best time to accumulate a position. So, that's what's in the future.
ASH BENNINGTON: Yeah, this so-called crypto winter, something we've experienced before. By the way, fascinating thing, for someone who's in the news business who covers both crypto and macro slash capital markets, the fascinating thing about crypto is precisely what you just said. When prices decline