ASH BENNINGTON: Yields rising on US Treasurys, the rotation trade in US equities, and of course, the digital asset market, including red hot NFTs. Raoul, welcome back. It's been a few weeks since we've done one of these.
RAOUL PAL: I know. I'm looking forward to it. Lots going on.
ASH BENNINGTON: Yes, lots going on. We're just talking a little bit off camera about all the things that are happening in markets right now. Starting with US Treasurys, Raoul, what are your thoughts?
RAOUL PAL: There is a cyclical inflation pressure. I do not believe it's secular inflation pressure. I think this is passing in transitory. But we're going to get the brunt of the inflation numbers looking strong over the next six months. What that is leading to is obviously the market trying to reprice inflation risks.
Yields, 10-year yields, I don't know where they are today, 160 something, is the high end of the range. We've seen that that has made the equity market wobble somewhat. It's also started to ignite the dollar. These things aren't good for the ongoing growth. The other thing most people don't understand about yields rising, it's not a matter of oh, look, inflation is coming yields it need to go up.
In a heavily indebted world, a rising yield is actually a crimp on future expenditure. Because if your debt service costs go up, what happens is you spend less. We saw that in 2018, when yields were up, growth started slowing pretty quick. Financial conditions tightened faster than people actually imagined because there's very little margin of room. We're talking about yields going up too much and they've gone up from 80 basis points to 160. That shows us how little room we have in this heavily indebted world.
What happens from here? Well, the Fed either let yields continue to rise, and the equity market cracks, and the dollar goes higher, which pushes down emerging markets too, and starts off the dollar wrecking ball, or they have to do something about it. I think there is almost no chance they can allow that the yields to rise much further. So, they have two choices.
One is Operation Twist, which is essentially to move their buying further out of the curve to alleviate pressure and hope it stabilizes rates, possible, or yield curve control. Yield curve control differs from quantitative easing in the fact that quantitative easing is the Fed buying a limited amount of bonds at an unlimited price, i.e. they come into the market, and say we're going to buy $10 billion.
Yield curve control is unlimited buying of bonds at a fixed price, i.e. any bonds that trade through x, we buy them all, which the Bank of Japan did, and the Australian banks are doing, and the ECB is doing. I think that is where we're going because they do not want yields to rise. Because unemployment at structural level, people like David Rosenberg have been on the platform talking about if you take in the labor force participation rate and the unemployment rate, you've got an unemployment rate of about 10%.
There is a structural unemployment, there's a lot of retail workers who had never gone back to a job. There's a lot of people who never going back to a job again, they're not trained for any other job. We don't have those jobs. Those jobs are being taken by the machines. So, we've got a problem.
So overall, I think we're still in a very deflationary world. But if the Fed are forced to buy bonds in unlimited size, that is an unlimited expansion of the balance sheet, that goes hand in hand with the potential fiscal stimulus that may need to be monetized in some way. And maybe this is the mechanism by which the Fed monetizes that fiscal stimulus. If that is the case, and the balance sheet grows, I've shown this at length on Twitter and talked about it, it is the key denominator now of asset prices. The dollar is not the denominator. We should be using the Fed balance sheet.
When you divide the S&P by the Fed's balance sheet since 2008, the S&Ps traded in a range as is gold, as is real estate, which is at the top end of the range. Equities are in the middle range. They basically offset the growth of the balance sheet. The only asset that's obviously done differently is Bitcoin, and the NASDAQ's done slightly better.
So therefore, if we see the Fed go to yield curve control, and this extra stimulus is coming and maybe a stimulus package behind that, the chances are that equities will go higher. We've got the actual stimulus of people trading this as well, it's going to push a lot of assets higher again, which is asset inflation as opposed to CPI inflation, and things like Bitcoin get ignited yet again. So, we're at a very interesting inflection point here. Because if they allow yields to go further, they're going to slow the economy too fast. That they can't raise rates, obviously, because they'll destroy the economy.
They've said it's all about unemployment, so they have stand true to their word. And the market is going to play a game of chicken with them. And they'll either crack the equity market, or the dollar will crack the equity market. You've got these three, this trifecta of things. Now, if the equity market falls, bond yield is going to fall. There's an easing mechanism, but they're all fully stretched right now. So, let's see how this plays out.
ASH BENNINGTON: It's such an important point, Raoul. Many people are just following the US equity markets. But if you don't understand what's happening with the Fed, and with fixed income, especially US Treasurys, it's really hard to get your head around this. To your point earlier, if YCC starts to look a lot like MMT as it gets implemented.
And the important thing for people to realize about the Operation Twist that we've seen was that it was dollar neutral, so that the buying the shorter end of the curve was offset by the twist to the longer end of the curve. If that regime changes, we're in a very different place.
RAOUL PAL: We are. And again, people will scream inflation, because they always do. And the reality is we'll have yet more asset inflation, and yet more wage deflation and the world becomes much more expensive to invest in, which is the ongoing theme I've been talking about is wages are not keeping up with the rise in the price of assets that generate wealth.
So, you cannot generate wealth if you're a median person, because you can't own enough to represent wealth. The rich get richer, the poor get relatively poorer, and this whole game continues. But it is a structural shift if we go to yet more of this, but as you said, it's basically MMT through the backdoor. And everybody's going to do it, everybody.
Now, there's another broader thing about this, another theme I've talked about here on the Daily Briefing is the death of macro, of traditional macro. If they're saying rates cannot rise and they don't really want them to fall below zero, or even though I think they will do overtime, rates are basically pinned at a 200-basis point range. There is no trade to be done. There's no money to be made. That actually looked like a cash instrument.
And if I'm right that the central banks are also terrified of letting the dollar fall too far or rise too far, then they're going to basically keep the dollar on the range, it's been in the range for six years. So, without the two biggest macro drivers of all, the dollar and rates, what do you have that drives assets? Those are the denominator of assets, and the price of assets. Interest rates and the dollar, without those two functioning, what do we have? What is the anchor? The anchor is this Fed balance sheet. It's a crazy, crazily different world but it becomes understandable when you change the denominator.
ASH BENNINGTON: By the way, we should say, for people who are watching this, the catalyst for this conversation right now is that the story of March has been the rise of rates from about 1.2% on the 10 to 1.6%. It's up 10 basis points from yesterday, from 152 bps to 163 about right now. We're sitting right here at the intraday high on the 10-year, which has been about 1.626 and that's been going on for some weeks now.
RAOUL PAL: I'm just looking at my Bloomberg screen now. To make it a bit more understandable for people, what it means is, let's have a look. I'm looking at in terms of percentage drops. So, this year, the TLT is down 14%. So okay, that's a big move. It's not that big, but that shows you how levered the system is. That if the TLT drops 15%, we're all freaking out. When equity dropped 15%, it's not abnormal. This is the problem when you have a very levered world, small moves have big effects.
ASH BENNINGTON: Especially at low percentages, because it's a higher percentage change. And when rates are moving as quickly as they are, really potentially significant impacts.
RAOUL PAL: This is an argument I had back when the Fed were raising rates back in 2017, or whatever it was, people are like, but rates are so low. I'm like, you don't understand. They'd gone up like 200% or 300%. It's one of the fastest change rates in history. And people said, that's nonsense. It's the low level of rates. I then get a phone call from a family office friend of mine, he goes, do you understand our financing costs have gone up 150% in the last six months? He said, we have a lot of leverage. He said, and suddenly, we're having to reduce risks because we can't afford that the cost of financing.
My mortgage payments went up last time around. And this a very well documented on Real Vision I talked about a lot. My mortgage payments went up significantly because of that and as did everybody else's. Suddenly, that takes money away from your spending. And so, it's an issue, it's an issue if the Fed want to keep the economy growing, they need to either contain inflation or just stamp out and pretend it doesn't exist.
ASH BENNINGTON: Absolutely, crucial point. Absolutely, crucial point. By the way, Raoul, I should say one of my favorite parts about this show is the only show where I ever see someone go, hold on a second, let me check. Let's think this through. Haven't seen that anywhere else.
RAOUL PAL: Well, that's the joy of being Real Vision.
ASH BENNINGTON: Raoul, let's talk a little bit about US equities and the rotation from growth to value. I saw a really interesting number earlier today, a chart showing the Russell 1000 value against the Russell 1000 growth. Russell 1000 value up 10% year to date, Russell 1000 growth, it was at minus 5% earlier in March, now flat, so obvious rotation here from growth to value.
RAOUL PAL: The last time I saw this rotation and not to set any alarm bells off was 2000, it was a very clear rotation then for the same thing, people juiced the end of the rally, but it feels like I can't get my head around it. The equity markets feel like the end of a bubble phase, yet we're just at the start of an economic cycle. Get your heads around that.
And then this conundrum that I've been fighting with, why do I think it's the end of a speculative blowoff while it's the beginning of a business cycle? Those things do not happen. That's why I started changing and looking at it in terms of the Fed balance sheet, and it suddenly look normal. So, I'm thinking do I have even the metrics right any longer?
What is interesting is the value versus growth. You know the key driver is? I think, the dollar. Because when I look at the NASDAQ against the dollar, they're basically the same chart. So, saying the dollar goes up, these big tech earners are earning less dollars, and so therefore, their earnings go down, some mechanism that the market is discounting this.
So, maybe the value versus growth is just the dollar story. That's the joy about macro, is the complexity of the different factors. But usually in the background somewhere, the dollar is lurking. The dollar is the big daddy, 88% of world trade, the thing that we benchmark and measure everything in. And when the dollar goes up when nobody's expecting it, 100% of forecasts on Bloomberg of every single investment bank in the world had the dollar lower this year. Usually when that happens, they're going to be wrong.
The average for the dollar range over the last six years is, it's just a clear average line that oscillates is 96. And the DXY is wherever it is now, 90 or something. So, there's room for it to move, maybe it doesn't go a long way. But it just moving enough stops equity market dead in its tracks. And maybe that's driven by yields. Again, there's this trifecta approach, but it's usually yields and the dollar that are the most important things of all.
ASH BENNINGTON: Of course, those are related. The conventional wisdom is probably the discounted cash flows on high growth stocks become less favorable as rates rise. But the dollar obviously also very much a factor and correlated to some extent in different ways to rates.
RAOUL PAL: That's right. And the dollar is what's known as Bayesian and its distribution approach, which means that generates a multi-factor variant that applied at any one stage because sometimes it's rates that make a difference, other times it's flows, other times it's M&A, other times it's inflation, and it moves around. It's not a simple thing like bonds, which is basically economic growth, which drives expectations of inflation or not and a bit of speculative activity. That's basically it in Treasurys.
They're really pure, you really understand what they're representing. So, they're now saying the economy is going to go and run hotter, so rates go up, simple. The dollar is not simple. The simple thing of all is we were so used to it, the dollar bill, and it's a simple thing for us. That's how we make payments. But to actually forecast it is incredibly complex. Which is why most people end up using technical analysis as the only way of actually figuring it out, because it's too complex.
ASH BENNINGTON: Speaking of which, we have all these new variables in the equation, another $1.9 trillion in stimulus. This is significant in terms of the percentage of overall GDP.
RAOUL PAL: Yeah, it's huge. What's interesting, again, is coming in checks. And those checks we've seen either get saved or punted in the markets. And that's interesting to see whether that goes. There's a suspicion of many and I hold that suspicion, considering, as I've said, the supermassive black hole of crypto is basically destroying returns of everything else. Bitcoin's up almost 100% this year, nothing comes close. So, I think the probability of crypto getting a large part of the speculative is activity of those checks is high.
ASH BENNINGTON: I've been trying so hard, Raoul, not to talk about crypto, not in the first 15 minutes because it always sucks the air out of the room. You and I both love having that conversation.
RAOUL PAL: Yes. Again, the point being is it is outperforming every asset class on earth. It's not because I'd love it because it's new and shiny, it's because it makes everything else look pointless. I simply don't care about value versus growth. Oh, look, there's a 10% return that could have been had I timed that right. I can buy and hold Bitcoin and make 100% and it's barely the middle of March.
This is what I've been trying to pound the table about, that at this phase in the crypto cycle, nothing else matters. And that does not change. It doesn't change on a dime. We've got a wall of money that's coming in. And so, everybody needs to be focused. And I'm sorry, there's a bunch of you who are like, I don't like this new digital stuff. It's bullshit. Why doesn't Raoul talk about interest rates? Because frankly, I don't care because they don't generate any money for me.
Shorting the bond market was still not the same return as just holding Bitcoin. Buying the dollar, not the same return. Buying copper, not the same return. Buying oil, not the same return. Buying the NASDAQ, not the same return. Nothing has had the same return so why even I do it? Because I think the risk-adjusted returns are good. Now, again, I always say the same caveat. By the time you get this, crypto's probably selling off again, and it probably sells off another 20%. And then it goes up another 50%. That is the nature of the beast, but mind what a beast is.
ASH BENNINGTON: Raoul, $64,000 question or maybe $1.1 trillion question, how do you sort out the price action in terms of sentiment momentum versus a true macro play, where people are viewing this as an inflation hedge?
RAOUL PAL: I don't, it's everything. It's everything. It's adoption, it's institutions. It's a parallel financial system, where people are slowly migrating from old to new, which is probably the best way of thinking of it. It is a sentiment play because it's part of a behavioral cycle, of reflexive loop. It is some beautiful maths driven by things like stock to flow models. There is a seasonality of mysterious origin that seems to play out too. There is the technical analysis that gives the behavior of crowds.
All these things are all in this. And they actually have some purity to it that is understandable to me. It seems to work, and it seems to be a great instrument to trade and invest in. I've talked about this before, hedge funds that are making 300% returns trading this long and short, the source of alpha is gigantic.
Again, I know I keep bringing this stuff up and up and up. Because I feel like it's my duty to tell people that there is a real-life raft to this broken financial system that you and I spent the first part of this show talking about. It's a parallel universe, and you can step out of one into the other. One is a world of pessimism. Where is this going to go wrong? What are the Fed going to screw up? How's the banking system going to break? How are taxes going to go up? How bad can this get? Is the equity market a bubble?
You go to the other world and its optimism. It's macro optimism in this parallel world, where you can opt out of the other one. And here, it's about what can I build on this? What developments are going on? How amazing is that? Is that project going to succeed or fail? I don't know, but it looks interesting. Let's watch it. Where is this all going to lead to? How are they going to figure out a yield curve? What is Bitcoin going to do? What is the size of the adoption? Are they going to sort out the transfer payments from third world countries, remittances?
How is it going to work when you