MAGGIE LAKE: Hello, and welcome to the Real Vision Daily Briefing. It's Friday, February 4th, 2022. I'm Maggie Lake, and here with me today is the one and only Harry Melandri advisor at MI2. Hi, Harry, how are you?
HARRY MELANDRI: I'm good. It's good to see you again, Maggie.
MAGGIE LAKE: Same here. So, great to have you on Friday, jobs Friday, another big, surprising number. We saw a move up in US bond yields, equity markets that actually stabilized after posting some pretty big swings again this week, so let's kick it off with jobs. What did you make of the report? Was there any new information in there for us?
HARRY MELANDRI: There's so much new information, I can't really give you a sensible answer. Because first of all, on its face, those are obviously blowout numbers. But they also included a massive seasonal adjustment, and a massive population control adjustment. So, there's a zero-hedge story about it. I think, it's the kind of thing I don't want to mislead anybody or give you a sphere that's incorrect.
But I think it's one of those where you have to go back and really dig into the data to truly understand what happened. I got one observation for you, which is pretty much every cycle, you reach some point where they do some sort of backward review and reassess what the position is, and then you find out how many jobs were really being created, what the real situation was.
So, it wouldn't be the first time that we all got a shock and look back over the course of 10 months or something and find out, wow, actually, we're completely wrong in this. There's a million extra jobs in this economy than we'd realize. In fact, we're already overheating.
But as I said, it's a little early for me to make a definitive comment on this, because those were huge adjustments. I could not tell you what the net of those adjustments with seasonal population control, which is like a 10-year adjustment. They're controlling for the size of the US population and COVID. So, the net of it, don't know. What I do know is that every Central Bank, as in the West, at least-- China's a little different-- has come to terms with growth, pretty much being at trend.
And maybe in the ECB, that's not true, but for the Fed, it's not so much the inflation now which has been stonkingly high. It's the fact that there's no significant output gap anymore. So, we've got a monetary policy that's set for COVID and the disaster that's associated with COVID. And COVID seems to be roughly, give or take, over. So, every monetary policy seems to be totally inappropriate here. It's totally inappropriate in Japan. It's totally inappropriate in the Eurozone. It's not surprising the bonds don't have many friends.
MAGGIE LAKE: And you can see that in the short pivot they're all making. They might as well hang a banner and say, we are so far off the mark on this, and we are behind and scrambling. You get the sense they want to be aggressive here, Harry, but can they be?
HARRY MELANDRI: They can be aggressive if they choose to. But if they wanted to be aggressive, why will you wait 'til March? So, I can't think of any other sensible reason to wait 'til March other than you don't want to scare the horses, i.e., us, people who are participants in markets. So, to my mind, the very fact the Fed's waiting 'til March to do something tells you that the priority remains growth over inflation.
And I'm a little skeptical about where we get when they start to tighten policy. I'm not sure we'll see very positive real rates when they finish the tightening cycle. And I talked to friends about this, people who are significantly better connected than me, which is not so difficult, I'm sure you can imagine. But they were pointing out that if this goes according to plan, with that, we may talk to their Fed context, this is a multiyear tightening cycle.
We could be tightening for 24 months before we get back to normal. And that's true for their balance sheet as well. There's significant tightening that should come through both of those given where we are. So, I can see why the equity market is not necessarily petrified, while the bond market is readjusting to it. For me, I'm a little concerned about the whole thing because after all, what kind of tightening is it if financial conditions don't tighten? So down the line somewhere, financial conditions are going to tighten one way or the other.
MAGGIE LAKE: It's been so long since we've been in the situation. There seems to be this sense of doom. We see it coming through in the questions we're getting just today, how much further are equities going to fall if they're going to tighten, especially if they do something 50 basis points in March? Sounds like you don't think they'll do that, they're going to just be steady drip for years of trying to gradually get us there.
Is it a foregone conclusion that we will have to see severe fallout if we're entering a new reality where the Fed is going to hike rates 25 basis points every time they meet? Can the economy and asset markets adjust to that if it's gradual?
HARRY MELANDRI: I'm not a Fed analyst, but I'm going to play one right now on TV briefly. And what I'd argue is that the Fed will probably be unhappy or unwilling at this stage to pencil in a hike for both March and May, because doing that would make it look as if it's going to be, and people will extrapolate. And they'll say, oh, my God, every meeting will be 25. And you'll get that extrapolated down to ED curve and in the bond market bond curves.
And so, I would have thought the Fed's objective was to put a placeholder in 25 in March. So, look, the process has started, and then try and hold off in May. And then you get all the data through to June, and you'll have three months of additional data where you can find out exactly how far behind the curve, and as frogs, we'll be gently boiled a little bit more while we sit there wondering what's going on. I just think that that's clearly, if they were that worried, they would already have hiked.
So, I think there's a poker tell in what their priority is. And the priority probably remains growth, even though, and I think this is a really important thing to bear in mind, inflation is not a vote winner. This is a Biden Fed now. So, he's appointed a whole bunch of people to it. Jay Powell knows what his instructions are and what they're trying to achieve. Inflation is not a vote winner anymore, and it's actually slightly embarrassing to the administration.
They will be doing something, the only question is a balance between the hawks and the doves. And I'm pretty sure the hawks, for example, would like to see some significant a step towards QT before the September hiatus, because you're going to have midterms. People are not going to be-- Fed policy is not in play during midterms. So, there's going to be an argument from hawks to do something prior to September, probably something like July. And then there'll be an argument from doves that that can maybe wait until after September, push it back.
Me personally, as I said, ultimately, it's about where financial conditions are. And if equities haven't gone down, bonds have tightened up, but equities have not noticed. Well, real rates are still massively negative. People are still buying real estate, there's still shortages of-- more buyers and sellers of residences. The Fed's got a lot of work to do.
MAGGIE LAKE: It does. We have Oliver, if you missed the top, Oliver was asking about the jobs number when not adjusted was not good. Some have said the jobs number when not adjusted was not good at all. Is it true? And how much weight do you put on either number adjusted or not adjusted? I think we've established that hard to get a read on these numbers right now until we can work through some of this.
HARRY MELANDRI: Yeah, there's always a big seasonal adjustment at this time of year, so it'd be unfair to not use some kind of seasonal adjustment. But with a population control adjustment, there's so much noise. I think a sensible guy would not comment without digging deep into this data. Of course, I'm not a sensible guy, so I comment a lot anyway. But I wouldn't place much weight on that. I would definitely look at the data or look at a good analyst after he'd done a very deep dive into this. It would be a mistake to draw too much of inference from the data we're seeing. It's hell a noisy, I think.
MAGGIE LAKE: It is. But anecdotally, we are all experiencing hours being cut back, labor shortages. Just in your general travels, we see this. Anyone who owns a small business, if you know anyone who does, all they're talking about is being difficult to get help and they're having to pay up for it. So, anecdotally, we have a sense of what's going on even if we're not getting clarity from the labor market. Yo-yo is asking from the RV site, where do you see the 10 Year yield going? 2%? 2.25%.
HARRY MELANDRI: Picking tops is an error on yields. I suspect it's going higher. Me personally, I'm starting like-- MI2 was a firm very early on this question of how high-- that inflation was going to be embarrassingly high, high enough to adjust policy in itself. And this was an unconventional view 12 months ago, shockingly enough, believe it or not, people didn't believe that you could have inflation so high that it would embarrass the Fed.
If anything, we would suggest that we've got the top is in for inflation numbers in the short term. So, the embarrassment will start to come down. The curious thing about this is that if you look at the last 40 years, inflation has been in a north to 5% range for pretty long spell of times, most of the 1980s, all of 1990s pretty much, and beyond. We haven't recently had higher inflation than that. Well, we're in a different environment now. We're at 7%.
And usually, when it breaks above, and I hate to be all technical with you, talk technical answer, usually a break above is confirmed in the case of inflation, and higher inflation tends to go along with higher volatility of inflation. So, if you look back at the pandemic about 100 years ago, ironically, almost exactly 100 years ago now, that pandemic's were the highest inflation print we've seen in the series, followed by the lowest deflation, the biggest negative numbers on inflation.
And actually, the vol of inflation stayed pretty high right through 'til the 1980s. So, if I say, where would the 10 Year go? I'd be kind to say I don't believe there's a significant inflation problem. But I don't know if that's true. I think there probably is a significant inflation from because it will come down, because of their base effects, there's no way it's going to stay at 7%. But is it going to come down to 2%, where it was before for large stretches that period? I don't think so.
That's certainly not going to happen in the short term. It seems to make more sense to me that we should see something like 3% to 4% inflation in the shorter term, in the medium term over the next couple of years. Well, why are you buying 10 Year bonds that yield nominal 2.5% when you've got three to 4% inflation? So, where is the top on that?
We'd need quite a nasty recession to come in to cap bonds out at something like 2.25%. And I'm not saying that isn't going to happen, I'm just saying it isn't going to happen in the first half of 2022.
MAGGIE LAKE: We're in the situation where we're talking about the Fed. But we also, as you mentioned before, Bank of England, hiking rates, ECB now sounding much more hawkish than people had anticipated, at least sooner, having to walk back their transitory policy. So, now you've got all of these central banks, certainly in the West, we haven't been here in a long time, too, and they're potentially not going to move all at the same pace. How does that play out in your mind? And if I remember correctly, you spent a little bit of time at the Bank of England back in [?], didn't you, Harry?
HARRY MELANDRI: Yeah, I did. And I think the Bank of England, I would rather I didn't remember that, I suspect they would rather that never happened too. So, the bank at this point-- by the way, one of the guys who was a graduate intake for same year I went in was a guy called Andrew Bailey. I think he did better. I think he did okay there, but anyway.
So, the Bank of England's interesting, because they seem to have jumped the gun on everybody else. And there's probably a reason for that. They probably, I would guess that the UK is actually more vulnerable to capital flight than other major blocs. But we've got a curious situation where everyone in the West has rates that are too low, and inflation is too high. And clearly, policy will be tightened in those places, that's never going to be good for asset prices.
We can quibble about which asset prices go down. It might be only bonds, it might be equities managed to outperform all the time. But overall, the pressure on capital in the West will be free to leave not for it to attract, whereas in China, they're cutting rates. So, the heat gradient if you will, and forgive my mediocre physics and trying to use it, but there's a significant difference, which you'd have thought would normally be attracting capital into China and Asia, while it's repelled away from the United States or Europe.
Now, we'll see. We'll see. But yeah, the Bank of England will give us a pretty good idea. Because it's a little earlier, it will give us an idea of how much they have to do to head off these inflation pressures, to head off this capital flight problem that you might get if you're raising rates and your exchange rates are a little vulnerable.
MAGGIE LAKE: Yeah, I was going to say things might get interesting in the currency markets, maybe an opportunity.
HARRY MELANDRI: About time. It's been dead for God knows how long. Yeah, we really liked the idea that the Euro could go on a little trip higher here. And after things like the Euro-- the Euro has been-- people have assumed they were never going to raise rates. I vaguely recall last time I was on chatting to you that we talked about EDs we had sold EDs and tell people for short EDs. But I'd suggested that we should switch because there was quite a lot in the price for EDs, and there was very little in the price for Euribor and European rates.
Well, I got that half right. Actually, you should have kept your EDs short and added a Euribor short. And the things really broke yesterday, Lagarde's shocked people. I don't know why they were so shocked because you've got massive inflation in the Eurozone and negative rates. So, how long does that going to persist for? But people were surprised. This is a big change.
MAGGIE LAKE: Yeah. And when you're saying ED, Harry, for folks, Eurodollar, is that you're talking about?
HARRY MELANDRI: Eurodollar contracts, forgive me. Absolutely. So, short rates in the US and short rates in Europe were too low. And [?] as well, the short rates in the UK, everything has broken down. Now, all that said, it's not as obvious that you should be putting on those short rate bets anymore. I like it when I've got an asymmetric risk reward, and I think most people do. So, there was nothing in those prices. Now, there's quite a lot of rate hikes priced in this [?] already.
MAGGIE LAKE: Yes, a lot. And that's interesting that so much has been priced in. And I think the question we keep getting is, is it too maybe too much priced into the bond market? Maybe not it sounds like, and then not enough in the US equity market. But I want to switch gears there for one second, because while we've seen this, and you're talking about things breaking down at the front end, and we know what's been happening certainly for US equities, in some of those high-flying tech names, an area that people have been running to, some people got it early to in the fall, we saw this coming, is energy commodities.
You've seen big moves in those markets, and uranium is something we get a question about a lot, especially if you look at the intersection of what's happening with ESG. And I want to play a clip for everyone have a conversation that Tony Greer, who we know is on all the time and very focused on commodities, Tony had a conversation with Doomberg a couple of days ago where they talked about uranium. Let's have a listen.
DOOMBERG: Yeah, last time I was on, I specifically said my biggest concern with the trade is everybody understands the thesis. If everybody understands the thesis, then the price is probably pretty efficient. And these gains are gone. And then it goes from a trade to an investment. And there's a distinction, of course, and as you know, you're a trader much more so than we are, we're classical investors, I'm prepared to hold uranium for five years.
And I'm happy with the allocation of my personal portfolio. I don't manage other people's money, I'm not accountable to quarterly benchmarks, etc., etc., etc. So, it's important for people who are listening who might be accountable to quarterly benchmarks, or who might be managing other people's money to understand the prism through which our analysis of the situation is coming from, and it's probably different than yours. And that's okay as long as everybody understands it.
TONY GREER: No, that's extremely important. And I like to highlight that, because we have a lot of risk takers that watch Real Vision. And I find that a lot of them will come back to me and say, hey, what do you think about this? Do you still like this, and things like that. So, it's very important for us to frame this in a phase whereby if various portions of this trade pull back 20% or 40% or 30%, that that's not necessarily a deal breaker for your thesis, is that fair to say?
DOOMBERG: Yeah. And again, there's a difference between investing and trading. And we would not claim to be experts in either, but we just observe the markets, highlight things. Our objective at Doomberg, and I'm sure it's some of yours, is we provide information analysis and context for people to insert into their own investment process.
MAGGIE LAKE: The Green Chicken makes me smile every time when I see that, I love what he did there. And that interview, by the way, is available on Essential Plus and Pro tiers. So, Harry, what are you thinking about-- and I love that, by the way, he was talking about timeframe, because sometimes we don't. If you've got a quarterly