MAGGIE LAKE: Hello, everyone. Welcome to the Real Vision Daily Briefing. It's Thursday, June 16th, 2022. I'm Maggie Lake. And here with me today is Darius Dale, founder of 42Macro and RV's own Weston Nakamura. And I'm so glad both of you are here with me today because we've had huge moves and important developments across so many asset markets and geographies. I want to try to touch on as many as possible.
So, we're closing out the US session with major losses in equities. It looks like in the last few minutes, they may have ever so slightly come off their lows. I don't even know if we could say that's a good sign or just exhaustion, but the NASDAQ closing down 4%, S&P somewhere around 3%, and we had small caps getting killed today. But I think again, they're a little bit off their lows.
Yields on US Treasurys fell, backing off those 11-year highs as recession fears increase. We saw a plunge in US housing starts, a spike in mortgage rates, a weak Philly Fed, add to that an emergency ECB meeting and an announcement that they're putting a tool in place to limit bond spreads between countries like Germany and Italy. We saw the Swiss central bank hike rates for the first time in 15 years.
I didn't even get to everything. Darius, the magnitude of the moves, the confluence of all these headlines, it makes me worried. It seems like things are very fragile right now. Can financial markets have handled this all at once?
DARIUS DALE: No, absolutely not. And I think that's exactly what we're seeing on the tape. Obviously, a big down day in stocks, a big down day in crypto, following some pretty big down days obviously. I think what's happening right now is the entire professional investment and retail investment communities are readjusting their exposure to markets to acknowledge the fact that this is a Federal Reserve that's comfortable with engineering a recession in order to get inflation under control.
And that's a little bit different than where a lot of investors have been, and certainly not us. We've been warning you guys about this for a long time. But that's a lot different than where a lot of investors have been throughout this year.
MAGGIE LAKE: And so, Weston, the thing that I didn't add to that list, and what I want you to really talk about is the Bank of Japan meeting today-- today your time, tomorrow for us, because it's morning in Asia-- you have been talking about this and preparing us and telling us we needed to pay attention to this and why it was so important. And this meeting I think comes at a time that we couldn't have even anticipated, it's so fragile with so much happening right now. So, walk us through what you're watching as we wait for this really important policy announcement and why it matters so much.
WESTON NAKAMURA: Oh, sure. So, basically, timing wise, it's funny, just because the Bank of the Japan is the last of all, like it's laughing when you're going through all of these central banks and SME and all that hiking rates, and BOJ is the last one to go. So, what I've been saying, since late January or so was flagging that you have to watch the Bank of Japan. They are the only major central bank that is going to easing, not just not hiking or tightening policy, but easing into global inflation, and they're going to be the only central bank left providing accommodative policies after a decade of doing so. And then having every central bank just remove it.
And so, what are the consequences of that? What's going to happen? Can the Bank of Japan and their yield curve control and holding 25 basis points cap on their 10Y yield? Can they do that? Will they do that? What happens if they cannot or will not? You're going to see if they are unable to hold that 25-basis-point line, then you're going to see a pop in JGB yields, obviously, and then you're going to see a massive spike in sovereign yields globally, and then that's going to destroy risk assets.
And then Monday of this week, we saw a throat slitting cross asset globally of everything. And that was coinciding with, of course, triggered by CPI on Friday from the US but that was triggered by the BOJ lost control of yield curve control on Monday. And that's when you saw-- because Monday was especially bad. We're used to selloffs year to date, but Monday was especially bad. That is what happens, this is what I was worried about.
So, this is why you should care. The meeting hasn't even happened yet. So, the meeting is, yeah, in a few hours later today. Kuroda press conference is going to be at 3:30pm after market close and then we'll see what happens after that.
MAGGIE LAKE: So, Weston, as you're talking, I can't help but notice that we are the doom squad here. I, everybody knows I like to rock some color. I just couldn't pull it out today. I was like, I have anxiety about what's happening. I'm nervous. I don't like what I'm seeing. But we look like we're all attending a funeral. That's my excuse. What's up with your-- are you vibing that as well?
WESTON NAKAMURA: Yes, this is funeral-esque, so that's Mr. Kuroda. A nice little candle and some roses. So, basically what this is, is I was trying to work on a video for a guide for BOJ beforehand, couldn't have done this one. But my point is that people are putting on the Widowmaker trade. And for those who are not familiar with that, what that is, is shorting JGBs. If you're short JGBs, you will die essentially and leave a widow. And so, people are putting that trade.
MAGGIE LAKE: If you trade the Bank of Japan, right? Is that why? So traditionally, that's why no one wanted to do that. Because you'd be [?].
WESTON NAKAMURA: Yeah, fundamentally, it makes perfect sense, right? With 200% debt to GDP, look a little like Greece, when they were blowing up the European Union, they were like 120% debt to GDP. Japan is twice that. Japan will default on its debt, they're not going to be able to pay back its principal. So, short JGBs sounds like a fundamentally good answer, until you have people like this, running the central bank, and buying up half of JGB issuance, and so that the most indebted country in the world can borrow far cheaper 40 years out than the United States government can for six months out.
And so, this short JGB trade is a Widowmaker trade. What that is, is there are people that are betting that in a few hours, the Bank of Japan will be forced to expand the yield curve control band. That's currently set at 25 basis points, and they're going to move it to wherever it is that they move it. And should they do that, that's negative for bond prices. And that's why you're also seeing a bid in the yen.
So, dollar/yen had been surging. The endorsed foreign currency, major currency against the dollar year to date. And that's because you can do one or the other, you can either cap JGBs and put this artificial lid on the JGB market, but then the currency gets destroyed because yield spreads widen between the US and Japan, or you allow JGB yields to climb up alongside in tandem with the rest of the global yields, yield spreads collapse, and dollar/yen would fall and the yen would weaken. So, that's why the yen's unstable.
But the reason for this whole funeral setup is that, indeed, I agree that widows at the end of the day will be made. The question is, will they be widows of traders' spouses, or will it be Mrs. Kuroda? And we'll find out.
MAGGIE LAKE: We will grim as that is, grim is that gala humor is, it does feel like we are in this battle. The market is in a battle with the Bank of Japan.
WESTON NAKAMURA: Yeah, so what the bank Japan does is there's two ways that they buy JGBs. One is called a competitive auction. That's a pre-scheduled auction, pre-scheduled a set amount of we're going to buy X amount of JGBs at this tenor on this date. And that's what we do. Fixed rate operation is when they are targeting the 10Y year JGB yield, and they bid for unlimited. We will buy an unlimited amount of bonds to make sure that 10Y JGB yield stays at 25 basis points, or lower.
This week, on Tuesday and Wednesday, they did a record amount, the most they've ever done, something along the lines of 2 trillion or 3 trillion-yen worth of JGB buying. They did additional buying. They're basically really just running out of options. Like what I was saying on Twitter, it was just like when you run out of shampoo and then you just basically fill the shampoo bottle with water, and you shake and lather. That's what the DOJ is doing right now.
DARIUS DALE: You don't just rub a bar soap in your head?
WESTON NAKAMURA: Yeah, they're really in a tough spot right now. But if the BOJ doesn't-- if they maintain the current policy, the yen will continue to get destroyed. And that's bad for everybody, not just for Japan. And then if they do buy the band, then you're going to see a fixed income duration selloff and that's going to continue to be bad for risk assets as well. So, it's very, very tough to see what-- like I don't really care what the policy is going to be, but what the market response is going to be is very--
MAGGIE LAKE: Yeah, and again, coming at a time when we've got all these other shocks to the system I think is what's worrying. Darius, weigh in here. We have a question from DJW on the RV site. What happens to US bonds if Japan can't hold the yield curve control? I think this is where it all ties together. That's what you're worried about, Weston. Darius, do you share those concerns?
DARIUS DALE: Yeah. So, in my opinion, that's the last remaining tail risk as it relates to the overall bond market. If you go back to Wednesday-- and oh, by the way, before I even go there, the Bank of Japan could do whatever it wants. They're not constrained by any bounds. It's more just a political decision to remove the yield curve control policy or intervene in the end in terms of the Ministry of Finance.
But just going back to answering the question, I think that's the last remaining tail risk that the market is concerned about with respect to pricing in the growth slowdown at the long end of the curve, because I think one of the chief tail risk was the bond market undecidedness around whether this was a Federal Reserve that was committed to quashing inflation and ultimately doing whatever it takes to borrow a line from our friend Draghi in order to get that done.
I think prior to Wednesday, the market was 50/50 on that in terms of, is this Fed going to back off too soon, and allow long term inflation expectations to remain unanchored? Or is this Fed willing to do what it takes on the growth slowdown side to get it done? I think Powell was very clear about that. The last, and this tail risk outside of the BOJ, clearly with the Bank of Japan, having the second largest sovereign debt market in the world, they're a very important player in terms of institutional allocations with respect to sovereign debt exposure.
You think about pension funds, and including Japanese pension funds, insurers, asset managers, etc. So, if you had a sharp repricing lower in price in JGBs or a sharp repricing higher in yields, that's going to have cavernous ripple effects all across global sovereign debt markets, and obviously, across global equity markets, etc., just from a valuation perspective. So, we got to get through this catalyst, I'm not even sure that this is the appropriate catalyst, because they may choose to do nothing, and this may remain a risk or an overhang on the market for the next few months.
MAGGIE LAKE: Yeah, that's a great point. And so, Weston, that is the other option, right? Somebody is, and people presumably will have to cover some of their positions if nothing happens. Does it feel like that's also a real possibility? And before we let you go, where are we going to see this? Aside from following you on Twitter, because I know you're essentially going to be live tweeting this, which we thank you for. But where are you going to see-- is it Forex? Is it bonds? Where are we going to see the break if it happens?
WESTON NAKAMURA: Okay, so first of all, I just want to say, because this came up on Twitter earlier, the JGB market, the yield that you see via Trading View, wherever it is, there are so many different sorts of fixed income. It's not like stocks, or like listed areas like options and all that kind of thing. There are many different prices, so don't anchor yourself to one price and think, okay, they've broken the-- just check on different sources, just want to put that out there.
But Darius is totally right. Think about if you're a fixed income manager, you're basically having a worst year of your career year to date. And JGBs actually have been the safe haven for fixed income, because there's been an actual Kuroda put. So, if you're relying on that, and you've maybe even become complacent, and then suddenly, JGBs are not only blowing past above that 25-basis point supposed floor, but now, this guaranteed policy is now in question for Friday and all that, that's going to have markets extremely jittery, because that was not something that people had been even considering, let alone pricing in.
So, I think that there's a lot of people on the fence right now. And so, there's going to be a lot of volatility either way. The thing that I'll say is that if they do expand the band with regards to institutional capital flows, originally, my answer would have been like, yeah, then you'd probably see a selloff in Treasurys and a spike in yields. But again, if the reason that they were not buying, the Japanese pension insurance community, if they were not buying US Treasurys and selling US Treasurys throughout March and all that, because of an FX volatility issue and a hedging cost issue, and the BOJ does expand the YCC band, then the yen will stabilize.
And if the yen stabilizes, you might actually get a bid into Treasurys. That's why it's very-- I'm very split on the outcomes. What I'll be watching for the most part is the futures market, the JGB futures market which represents mostly foreign investors and the spot dollar/yen rate as well as trading activity from Japan retail on the currency as well, as well as Treasury futures and all that and to see how much they're correlated.
But last point, Maggie, is that, yes, tomorrow is a-- or today is a BOJ policy meeting day. However, when you have a central bank that is involved, actively involved in the markets every single day, putting out statements, changing policy statements intraday, and all that, the Bank of Japan has a monetary policy meeting every day. Multiple times a day. So, this doesn't end on Friday. This doesn't end-- this really is just the beginning, this is not going to quell anytime soon.
MAGGIE LAKE: That's an excellent point, Weston, and you've just been all over this, it's been such a fantastic work. I know that you're going to have a long stretch ahead of you. So, everyone, follow Weston. We'll have him on Real Vision, of course, but follow him on Twitter for the very latest. And he doesn't give you investment advice, he's just telling you what to pay attention to and why it matters to your portfolio so you can prepare yourself and adjust your risk. Weston, you're awesome. Thank you. I'm going to let you go.
WESTON NAKAMURA: Thanks a lot. Thanks, Darius.
DARIUS DALE: I appreciate it, bro.
MAGGIE LAKE: Darius, let's dive into some questions here. Because there's just so much to cover. And Ross from the exchange asking, you've been flagging a transition from inflation to deflation in the US markets. What do you expect to see in market price action or market response that would confirm your view? He's also asking if there's another leg down in the S&P. Is that something that would confirm it? And what would be driving that? So, it's a twofold question.
DARIUS DALE: Yeah, so I'll start with the easy answer. First is yes, it's very likely there's another leg down the S&P. For most of this year, we've put out a 3200 to 3400 zone for a double bottom in stocks within the S&P 500. Obviously, you could infer what that means for other assets like Bitcoin, crypto, etc. So, yes, I do believe there will be another leg like lower, doesn't necessarily mean we have to see that over the next several weeks, there's a couple of big dynamics with respect to the options market in terms of how chunky, how large this opex will be on Friday.
It's as big as it was going back to March 2020. And obviously, as we know, that was a big catalyst in terms of sparking the triple bottom on stocks back then, certainly was in 2018 as well. Obviously, the macro setup is very different. We're very far away, in our opinion, from a Federal Reserve dovish pivot. So, if we do see any relief rally on opex, that's got to be sold if you want to protect your portfolio.
In terms of the transition to deflation, we monitor all the same things that we monitor every morning at 42Macro, we refreshed all the exact same models, and one of the most important models to determine that would be our global macro risk matrix. In that matrix, there are 42 different market indicators that we score from the perspective of our volatility adjusted momentum signal. And right now, the most important set of those that will give us a clear indication on the market starting to pivot to pricing in deflation rather than inflation, that deflation is where both growth and inflation are slowing, as opposed to inflation, which is where growth is slowing but inflation is still accelerating to the upside.
That pivot will be foretold by some breakdowns, at least from a bullish band's perspective to at least a neutral band's perspective across the rates and spreads currencies in our model, and we're just not seeing that yet. It's still quite early in that process.
MAGGIE LAKE: A lot of market veterans say it's never this time is different, there's always lessons to be pulled through and not to get hoodwinked by the idea that things are completely different this time, but is it going to be harder for inflation for that deflationary to set in? Growth could slow but is inflation likely to slow in the way it normally would when we have all these other factors that are influencing it? Could we be in that more stagflationary situation where growth slows, maybe even slams lower, but we're stuck with high inflation because of the supply side that the Fed can't really address?
DARIUS DALE: Yeah, that's very true. But I think that's a-- I've been very vocal on this program and others all year about how that's a