Comments
Transcript
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GRTerrible music, do we really have to be assaulted with this negative harmful bad vibrations?
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BDMichael - this was excellent. I was curious through what specific financing mechanism do you view the gap between FF and term premia as effectively tightening financial conditions? As a measure of desire to hold safe assets it certainly makes sense, is the logical connection to financial conditions that people are holding safe assets at the expense of funding more risky endeavors or assets, hence tightening overall conditions?
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MNtop notch content thank you Mr. Howell and real vision. would a steepener example just be a bull steeper playing the NOB spread? thank you
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RMRisk assets should rise but they could also collapse. Brilliant.
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GFExcellent presentation. And a huge THANK YOU for adding a voice-over to the questions, rather than just flashing them up on the screen. For those of us who prefer to listen to these, this is a HUGE improvement. I've been asking for this for a long time. Thanks for listening!
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JCIn regards to Michael's and George F comments. I'm not sure I follow the full implications. Simply stated : Michael does this imply that the current Fed funds rate is too high by circa 500 bps? If not... where do you think the Fed funds rate ought to be based on your analysis? I ask because I've seen a number of economists saying rates are too high, Fed over tightened as well as others saying r* estimates are also too high etc etc.
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FAThe FED can't print money.
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KJI thought this was a great presentation, and liked the fact that it provides an alternative narrative to the one I'm following in my investments, which are heavily in the 'bond trade' at the moment, holding a very large slug of long Treasuries. Along with Raoul, I'm betting on either a Doom Loop or a more intense selloff/recession (which would be one of the 'crevasses' Howell talks about, triggered by the extreme flows into US Treasuries and/or the funkification of US corporate debt that he refers to as counter-narratives). It's always good to hear a good counter to your perspectives and an itemization of what to keep an eye on to gauge whether your narrative or a counter narrative seems to be taking hold going forward. I have to say I remain utterly amazed that so very few talking heads across the financial world seem able to get beyond seeing the exponential growth of negative bonds around the world - now supposedly over $17 trillion worldwide & growing $1 trillion/month and over 40% of all bonds outside the US[!!] - as anything other than a central bank manipulation to create liquidity, boost asset prices and growth, as Howell seems to. If we think of markets as actually ultimately self-organizing instead of controlled by central banks, (the opposite of Howell's narrative) the meaning of the massive growth of negative rate bonds globally is quite clear in simple bond terms: global bond markets are pricing in a global economic contraction that may extend for many years into the future - the destruction of capital, the forcing of money into risk assets, which by definition generate partial loss of capital in a world not creating new capital, (Howell says there's no new capital). That dire outcome certainly may not happen, but I'm struck by the fact that almost all financial market players and analysts are so embedded in views that predict and require economic and asset price growth, they seem constitutionally unable to talk about a durable global depression/contraction and the chaos that would accompany that as a possible scenario. That's why I appreciate Raoul putting his 'Doom Loop' on the table, whether it plays out that way or not. As rates go negative for the first time ever, we just aren't going to be able to kick the can forever, so potential Doom Loops and crevasses should increasingly be a possibility to keep in mind and hedge against until the world starts to reflect the hard limitations of the completely absurd notion that central banks printing money by pressing buttons can fix what's wrong with the world, including the investment world.
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SSWas Bitcoin developed by Goldman Sachs (Highlands Group)? These guys seems to have dug up some interesting stuff -----with patent crumbs and other facts all cited as back up: https://aim4truth.org/2019/08/20/goldman-sachs-is-the-creator-of-bitcoin/ Where's Mark Yusko on this? Lets get RV to shine some light on these shady areas.....either way fellow RV's -if you are building a position you simply must look at all angles of the story. IMO
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WBAnyone know what those three "red lines" were from the Chinese back in May? The trade issues which are no longer negotiable??
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RHI misunderstood one of his points. He said bonds are risky, in part because pension fund managers are going to come under great pressure to buy bonds?? This makes no sense. What did I misunderstand?
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LWOne interesting comment Michael made was the idea that there could be a “scramble for natural resources” (think mission-critical resources such as uranium, rare earth metals, etc.). We can already see some first signs (see uranium’s 85% drop and now the petition 232, etc.)! Interesting stuff!
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TSGreat video but this is assuming the Fed begins easing. What happens if they hold onto their EFFR view?
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LMMore of this guy please! Very clearly spoken and well explained! To the point!
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CLMr. Howell, you suggested the US (as other central banks) will have to start QE in order to increase liquidity in the system to stop the USD shortage and to fight this currency war (basically a race to the bottom through currency devaluation). In previous presentations you mentioned you studied USSR economic dynamics too. Would it not be in US's interest, assuming they stand in a stronger (less fragile) economic condition, to NOT apply such stimulus, let the USD rise and break China's economic growth with all its implications in order to avoid further future and more evenly matched conflict? Or is the US not prepared to take such actions? i.e. US psychology would be "fight now and on our terms"
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RMExcellent talk Michael! Would like to ask, when the liquidity starts to flow, which of the global assets has the most upside alpha (gold, EEM, oil, etc).
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DHThank you for reading out the topic "aloud". It helps to listen during driving.
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GFHe said: term premia, the premium that investors prepared to pay for long-term debt, long-term Treasury debt in the US, compare that to the Fed Funds Rate. The collapse in term premier is equivalent to a significant or it implies a significant monetary tightening. And that monetary tightening could be equivalent, on our estimates, to a Fed Funds Rate which looks at around about 5% points. So way, way above reported levels. Where is that 5% from? Fed Term Premis web page: https://www.newyorkfed.org/research/data_indicators/term_premia.html
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KOMichael is one of the best guests RV has. Wonderfully nuanced view. Thanks for bringing him on!
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TCMike always brings it
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BSBring Richard Koo on the show!
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SSBrilliant!!!
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BHTop drawer analysis
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CDFantastic video, two fantastic videos in two days! Bravo :)
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JWThe 5th bullet point is the same as the 3rd when summarising at the end.... or is it twice as important 😎?
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JWWhen ever I see Mr Howells name come up I have to drop what I’m doing and watch what his take on current events are! It’s people like Mr Howell which make me a subscriber!
MICHAEL HOWELL: The world's financial system is no longer a new money raising system. It's effectively a refinancing mechanism. And if it's a refinancing mechanism, what you need is balance sheet, in other words, size. You're not too worried about the level of interest rates.
There'll be a lot of pressure being put on the Federal Reserve now to try and cap any dollar appreciation by printing money.
So effectively, we're in a currency war, but the gold price comes out of this magnificently. And cryptocurrencies, which are pure liquidity play, should do extremely well.
I'm Mike Howell. I'm Managing Director of Crossborder Capital. We're a fund management and research company based in London. My background prior to that was that I was at Salomon Brothers involved in research. And what we focus on almost entirely is global liquidity and capital flows worldwide.
What's your macro thesis?
We think that the world economy is clearly stuttering. It needs a boost. Central banks have been behind the curve. They've basically been tightening too much collectively over the last few months. And what they're going to have to do is to embark on a major easing program. In other words, another QE. That is very bullish for gold. And it's pretty bullish for cryptocurrencies, too.
Can you explain the context of China's slowdown?
Yeah, I think one has to go back actually quite a long time or one's going to look at what happened to China starting in 2001, when China was allowed into the world trade organization. As a result of that China built up a huge trade surplus over time. It developed Chinese economy. China became very, very export-driven. And the US accommodated China, accommodated Germany too. But effectively, China was being accommodated by the US trade deficit.
America is now saying enough is enough. They're no longer prepared to accommodate these big deficit diet China surplus. And this is the background to the tariff dispute. China was reacting to that. America imposed 10% tariffs, I believe, on the 17th of September, within five days, China went and started to tighten monetary policy. Through October, China hit the monetary base very, very hard and curtailed liquidity injections into Chinese money markets. We've seen the biggest slump in liquidity in these Chinese money markets that we've seen for five years probably, and effectively, that is slowing the economy hard.
Now, if you look at the backdrop, not only is Chinese manufacturing slowing down significantly in the Chinese economy, but China dominates global value chains, in other words, supply chains globally. And as China has slowed down, world exports have also shrunk. And that has hit manufacturing companies worldwide, but particularly in those locations that are involved in these supply chains. In other words, Japan, Taiwan, Korea, and Germany. And those markets have been among the hardest hit through the slowdown. America and service industry generally have come out of this relatively unscathed.
What are market crevasses?
We've described the market outlook, in other words, the stock market outlook as a market which is generally rising, but there is risk of very sharp selloff, so what we call crevasses. To protect against that, what you need in portfolios is effectively more bond convexity. Now, what's the reason that you're getting these major selloffs? The major reason really goes back to the restructuring of the global financial system, really in the wake of the GFC, the Global Financial Crisis in 2008.
We know there's a big buildup of debt, but debt needs to be refinanced. And the way to think about this is that the world financial system is no longer a new money raising system. It's effectively a refinancing mechanism. And if it's a refinancing mechanism, what you need is balance sheet. In other words, size. You're not too worried about the level of interest rates. So, the focus that the markets have and the media has on interest rate cuts, we think are broadly meaningless. What you need to understand is the volume of liquidity markets. In other words, balance sheet size, and in particular, if the private sector is not coming up with balance sheet with central bank balance sheet.
Now, the key issue with the private sector, which is what makes the whole system a lot more fragile, and contributes to these crevasses is essentially that there was a shortage of safe assets in the system. Now, what do we mean by this? Safe assets are basically high quality bonds, particularly Treasuries, particularly US Treasuries, but to some extent, corporate securities have crept into that collateral mix. And the reason they crept in is there are insufficient Treasuries in the system to provide collateral.
Most lending now is collateral-based. And the reason for that is that what you have is some very, very big new players in the markets, which we call corporate institutional cash pools that basically come out of foreign exchange reserve managers in Asia, or they come out of US corporates that are running major Treasury piles of cash. And what they need are safe short-term assets to invest in in the money markets. And effectively, what's happening is that the bonds are being repoed and sold back to the CICPs, and that is the mechanism of refinancing.
That works very well until you started collateral problems. And collateral problems can occur if you get an economic slowdown, for example, and the value of the corporate slice of that collateral tranche comes under pressure. And then the whole liquidity mechanism collapses. That's what we've seen a number of times. We saw it clearly in 2008 with mortgage backed securities. We saw it again briefly in 2018 in December when markets sold off.
And what's happened every time is the central banks have come in, particularly the Federal Reserve. And that's what happened through December and January. And this is the basis for changing central bank policy now. They're beginning to realize that behind the curve, liquidity has been way, way too tight. And now, what you're seeing is central banks beginning to ease but the leader is the People's Bank of China.
How tight are the central banks?
One of the ways that you can gauge the tightness of the US system is to compare Fed Funds Rate, which everybody knows, with the term premia, which is a slightly wonkish concept, but it's the premium that investors prepared to pay for long-term debt, long-term Treasury debt in the US, compare that to the Fed Funds Rate. Normally, the two move extremely closely together. But effectively in the last two years, term premia have collapsed relative to Fed Funds. The collapse in term premier is equivalent to a significant or it implies a significant monetary tightening. And that monetary tightening could be equivalent, on our estimates, to a Fed Funds Rate which looks at around about 5% points. So way, way above reported levels.
Has China changed its policy to re-ignite stimulus?
We think China has changed policy. And we think that the decisive move was around mid-May. Now, the geopolitical background of that time was right across the Chinese media, there are reports from Xi Jinping of three red lines that the Chinese put down that say they would no longer negotiate on these three aspects of the trade dispute with America. And those red lines meant that America effectively had to now yield, China wouldn't yield. And they're not going to go back on this because it would be a huge loss of face. In other words, this seems to be a very significant watershed in the whole trade tariff dispute.
What China did at the same time was to start to inject liquidity back into their money markets. Effectively, what they're saying is, we are ignoring trade. We are starting to stimulate the domestic economy. And we don't really care if the yuan now devalues. The reality is here with us now because the yuan has broken 7 against the US dollar. The magic 7 number.
China reside to plow money back through the money markets, liquidity injections by the People's Bank that has persisted through May, June, July and into August, and then they're backing that up with other measures of fiscal stimulus infrastructure programs and a lot more is likely in the pipeline.
How targeted is China's stimulus?
It is more targeted. It's looking much more at infrastructure programs as far as one can tell at the moment. It's been given certainly to the state-owned banks, and they'll be generally at more into state-owned enterprise. Now, I want to stress here that this is not a first best solution. This is the second best solution. China cannot continue to keep getting growth through debt. We know that. But in the short term, this is the reality that is happening.
The Chinese economy needs to get between 6% and 6.5% growth a year. China has estimated that the trade dispute could cost it 1.5% points in GDP every year that this persists. It pushed the growth rate significantly below their targeted rate. And therefore, they need to rebalance to get the growth rate up. And hence the stimulus.
Other central banks will follow the Chinese lead simply because of China's importance in the world economy and the importance of the yuan in terms of a currency within these global value chains. Essentially, what you're seeing at the moment is as China has devalued and started to push in more liquidity, you've seen devaluations generally of companion currencies or peer currencies against the US dollar. Other countries that are experiencing fallout from the slowdown in China will want to try and boost their economies.
And so we're starting to see an increasing debate in Asia and in Europe about easy monetary policy, already a lot of countries, for example, Australia, are already doing that. The Federal Reserve is starting to cut interest rates. But the most important thing that the Federal Reserve can do is to expand liquidity. And that's what it's doing.
Now the $64,000 question, which comes back to the dollar is will America allow the US currency to appreciate? In other words, to put it another way, other units to devalue again the US unit? And that with the answer that we think is no. In other words, there'll be a lot of pressure being put on the Federal Reserve now to try and cap any dollar appreciation by printing money. So effectively, we're in a currency war, and every currency, every economy is trying to leapfrog every other economy in terms of monetary ease.
Who wins out of that? Financial assets should generally do pretty well. But the gold price comes out of this magnificently. And cryptocurrencies, which are pure liquidity play should do extremely well.
Will we see another coordinated currency accord?
We call this Shanghai 2.0, which parallels the Shanghai Accord that occurred in early 2016 following the G20 meetings. After those meetings, the G20 countries agreed to stimulate their economies. And that broadly came through in terms of central bank balance sheet expansion, or what we call QE. That launched an equity rally. Equity markets rallied strongly through the back end of 2016, through 2017 and until they hit the hiatus in 2018.
This is happening again. It is not coordinated this time around, but it's coinciding. It's coinciding, because every country is now trying to react to the slowdown, which we say is China-induced by basically trying to stimulate their economies. And as each one tries to beggar thy neighbor, so to speak, you get a general lift in liquidity worldwide.
What will the Fed have to do?
There'll be a lot of pressure now for the US currency's rise, particularly if other countries are beginning to leapfrog the US in terms of monetary easing. Therefore, the US has to keep up. And we think the pressures will start to build on the Federal Reserve and the Treasury to try and maintain dollar parity at current levels. And that will mean more monetary stimulus coming through. So there'd be a lot of pressure on the Federal Reserve to do even more QE.
The point is against this ground, where generally central banks are easing, this is the environment where equity markets tend to do pretty well. The best time for investors in equities are when central banks are trying to stimulate economies that are very sluggish, such as now. There's a lot of competition now to see who needs the most. And unless the US matches other major economies, you're going to start to see the US dollar rise. And that's something that the administration clearly doesn't want, so they're putting a lot more pressure on the Federal Reserve to expand the QE programs.
In terms of what this will actually mean, we think there'll be a significant easing of policy. To try and put it into perspective, probably you're going to see the equivalent of 100 basis points of US rates that will be bullish certainly for the front end of the yield curve. It will mean that the yield curve likely steepens and there is a chance that long yields could come down as well. But generally in this environment, when central banks are trying to stimulate economies that are very sluggish, equity markets are the big winners.
Will monetary easing increase growth or just asset prices?
Can we grow away out of a slump with credit or debt alone? And the answer is probably not. But it does help to alleviate some of the symptoms. What you're likely to get is much stronger financial asset prices. In other words, if you look at equity markets, we can't expect very much from the E, but the P can expand probably quite significantly. And generally speaking, as far as we can see, well, the equity markets, while not being cheap, are comparatively inexpensive.
What the big danger for markets is, is if you get a major cracking liquidity as we saw previously in 2008. Now, we don't think that's on the cards, because basically central banks are now beginning to act. That's clearly something one has to watch very carefully.
Equity markets generally should do pretty well