ROGER HIRST: Hello, everybody, and welcome to Real Vision Access. And today I'm going to be having a conversation with Christophe Ollari. We're going to be talking about central banks. We're going to be talking about liquidity. And Christophe has given us two of his recent research notes which are attached in PDF form, so you can have a look at those. A lot of the topics we'll be covering are within those themselves. And obviously remember to send your questions in as well because we're going to ask some of those questions to Christophe as we go along.
So it's with great pleasure that we've got Christophe back on, Christopher Ollari from Ollari Consulting. Welcome on board, Christophe.
CHRISTOPHE OLLARI: Thank you very much, and good afternoon to everyone.
ROGER HIRST: Well, today I think we'll go straight into it. I mean, everybody knows and everybody's talked about liquidity, and everybody's talked about central banks. And what I'd love to get from you is what is this narrative? What is this key narrative? Because I think key narrative here, from my perspective, is central-bank liquidity, does it create reflation or does it just create the illusion of inflation and reflation? And central-bank liquidity, can it just keep on going? Can we keep on getting the performance that we've seen over the last three months? So could you just maybe give us the background and your understanding of this narrative that has driven equity markets, particularly in the US, to levels that they are right now.
CHRISTOPHE OLLARI: In fact, I think that the word to describe the central banks are the 800-pound gorilla is very pertinent. And if I have one strong belief it's that [INAUDIBLE], we're not going [INAUDIBLE] anytime soon.
What is being [INAUDIBLE] is very important. In fact, I was reading the comments of Kashkari over the weekend stating that it's some kind of QE conspiracy to say that the resumption of the balance-sheet expansion has driven the risk asset side. First of all, I think that it would match the need for the Fed to massage the markets and to keep on giving that communication that it's not QE. It is just a technical expansion of the balance sheet because, in fact, we're not taking duration out of the market.
The thing is-- and this is why I called the duck equation. If it looks like a duck, if it walks like a duck, and if it quacks like a duck, for market participants, it's a duck. And I think that as soon as the Fed has [INAUDIBLE] that magical world which is expansion of the balance sheet, it will just the green light to leverage and to do what they've done for the last decade, in fact.
What did we see for the decade? Its a massive game what I call the central banks' Nash equilibrium. And Nash equilibrium is a game feeling where, assuming that each player knows the strategy of the other players, there is no gain to change your strategy. In other words, if nobody changed the way he plays, you just keep on doing the same thing.
For the last 10 years, central banks' aggregation has meant buying the dips, has meant selling vol, and has meant risk asset much higher. So why suddenly the market would not take that U-turn of the Fed as a signal that we are back to the pre-2018 paradigm where, in fact, each market participant have a backstop? which I call the invisible end. You know that you can buy because there is put of the central bank which is not too far out of the money.
ROGER HIRST: Yeah.
CHRISTOPHE OLLARI: And I know that some people would say that maybe the liquidity was not there available. The thing is I think that it's a very important secret-- they call a trigger. It's the recreating the muscle memory that has been dormant for one year when basically [INAUDIBLE] the first one, although [MUTED] thing to try to [MUTED] across them.
The central bank has said, we need to know the rates. We need, in fact, to rebuild military policy on munitions to be able to address something that will have been down the line at one stage which is an economic downturn. And that caused a big, big shift.
And it's not surprising that it's coming from Jerome Powell. Do you remember when the reserve [INAUDIBLE] speech in 2011 when he joined the Fed? He talked about the responsibility of the Fed into the 2000 dot com bubble, saying that the Fed has been too slow to mobilize that in fact there was a lack of cash available and the three cuts just were like igniting this amount of liquidity available. Plus, remember, the Fed at the end of 1999 was scared of potential funding [INAUDIBLE] minimum term. Three cuts, a lot of cash, and U-turn of the Fed flooding the market to avoid the funding's crisis.
I don't like to make pre-GFC to GFC comparison. I think he was quite similar to me and we know what happened back then. So in that context, I am not surprised that the markets. I've seen that as the validation that the [INAUDIBLE] and that in fact what is the bottom line. They took it for granted that none of the central banker at the moment would ever break the current Nash equilibrium.
ROGER HIRST: I mean, in some ways the market itself has been policing the Nash equilibrium. I would characterize the Nash equilibrium as being, it's not so much that the central banks have a put on equities or put on bonds, but they have a cap on volatility, which becomes a put on equities, on bonds. And that, in some ways, is the Nash equilibrium. And as you said, when Powell broke the Nash equilibrium, the markets panicked-- or not panicked. The markets chastised him with that 20% drop on the S&P and forced the US back into Nash equilibrium.
And in some ways when the ECB looked like they wanted to break their Nash equilibrium by stepping away from QE, bond yields collapsed, and to the end of 2019 summer, Draghi took the ECB back into the Nash equilibrium. So doesn't that mean that the market's policing it? That the central bankers have painted themselves into a corner they can't get out of?
CHRISTOPHE OLLARI: This is my strong belief. I think that when we would talk about it or when we discuss-- do you remember last summer when they told you, I am massively convinced that the central banks will take the bazooka out because there is no other options? And in fact, because we are starting from so low levels of interest rates and from already bloated balance sheets, they can't afford to have a recession. So we are shifting from, "Let's try to reread inflation to be able to address potential recession," to "Let's to do anything to not have a recession," which is "Let's do anything to prolong the current cycle."
So if you think that way, they would try to do anything to make that as smooth as possible. They don't necessarily want to have a boom, but you can't afford a boom when you can't afford the bust. They can't afford the bust. So the point here is it's a shadow-- I this the shadow GDP and the subdued inflation is, to some extent, what the central banks and the market participants want more than anything.
And here the 2018 message was like, Powell tried to push until-- and the markets were extremely resilient until September, until it was not and these-- when he said that we were still miles away from neutral that was the last straw that broke the camel's back. Because suddenly the market realized he's going to do more, even more, and we are not--
ROGER HIRST: And one of things you were talking about, and you've talked about consistently over the last 12 months in some ways is that all these actions from the Nash equilibrium, as it were, as it sort of goes, switches from one extreme to the other where they just nearly break but don't quite, we got the impression from their actions within-- their actions on bond yields created the impression of a potential recession. But it's really a ghost impression of a recession. And you mentioned that last year, how people were potentially interpreting it incorrectly.
Today you may be in quite-- you've got a strong view that this is now creating an impression of reflation, but it's ghost reflation. This is not true economic reflation. How do you-- where do you feel on that? Do you feel that global economies are about to take off with reflation, or is it just, again, another side effect of the way central banks are applying the liquidity?
CHRISTOPHE OLLARI: I think that I am massively convinced that the debt inflection that is expected will be disappointing, and had some like, nascent hopes in December when they saw some big key real reflation indicators starting to [INAUDIBLE] back bigger. What is the reality of 2020 so far it's that the idea of the equity market is driven by growth [INAUDIBLE], by large tech, by momentum stocks.
And you see that the value gold ratio is almost back to the August lows when everybody was pricing in the end of the world scenario. Copper has fell back 50% of its gains since early December. [INAUDIBLE] are stuck in that bearish channel and [INAUDIBLE] hibernation around 170.
Aussie dollar is one of the best examples as well. And I think that I'm always very, very focused on the Aussie dollar, because when you plug the Aussie dollar with the [INAUDIBLE] investment from China. It's exactly the same [INAUDIBLE]. So what is the Aussie dollar [INAUDIBLE] is like there was-- there is a shift in the growth model of China which means that any pickup would be less revisionary, because it is going to be less commodity incentive. Because basically-- so don't expect what we had in the past, like in 2016 or 2009, because the growth model of China has changed. It's less that [INAUDIBLE]. It's basically not the capital accumulation of the past. It's not heavy industrialization. So China, we don't give the free ride to the world economy because China doesn't want to go to the excesses of the past.
So since day one. I thought that-- and we can't talk about 2016 because, as far as I'm concerned, it's not gonna happen. But even when you look at now, it's not an efficient dynamic. The price action of most of the asset classes does send you a strong signal. It's we are back into what we love the most, which is the slowflation dynamic. So just below-par GDP and subdued inflation. Which goes end to end with the national [INAUDIBLE].
ROGER HIRST: Brilliant.
CHRISTOPHE OLLARI: The idea of the equity market is a byproduct of the accommodation of the central banks but it's not a manifestation of the [INAUDIBLE] narrative. Which is still a narrative. It hasn't morphed yet into a reality.
ROGER HIRST: Brilliant. No, I mean it's-- I think that's true. I mean, that's the dynamic which is so fascinating. I'm just going to go to a couple of questions from our viewers. The first one, I'm going to ask one at a time. The first was from Michael Hymen and it's basically, Chris, how does QE elevate $30 trillion market cap equities? As in what is the mechanism? Do central banks buy stocks directly? Do they proxies? Are they selling the VIX, or is it just pushing long rates down that is driving the market? So it kind of-- it's what is driving that? What's driving the $50 trillion bond market? Could you maybe explain the mechanism? Because we all liquidity, but how does liquidity from the Fed become equity markets up 20%?
CHRISTOPHE OLLARI: I think it's-- you know, I told you they're [INAUDIBLE] dynamic, basically. It's-- by injecting liquidity into the market you're pushing your impact compressing the curve or the risk, the [INAUDIBLE]. In fact, you saw the curve flatten. You have lower [INAUDIBLE], and you find investors have nothing else to do than trying to go down the quality ladder in terms of product they're going to buy.
It's a frantic quest for yield at any price, and anything with [INAUDIBLE] is just a bargain. So, basically, it's all that liquidity which is, in fact, pushing investors to buy anything which is available. And this is-- I think that this is, to some extent, one of the [INAUDIBLE] of the equity markets, because, you know, if we tried to imagine the rotation out of equity to something else, that was happening when you had 10 years at 5%. There was something attractive to buy.
The problem is if you get out of the equity market, where do you buy? Are you tempted to increase your cash balance? I mean, if you're a European investor, keeping cash would be, in fact, taxed by [INAUDIBLE]. So it's not an opportunity. It's not an alternative. Are you keen to buy your [INAUDIBLE] in negative yield?
That's just a number. It's-- I mean, NASDAQ is trading at 23 times the [INAUDIBLE]. OK, that seems expensive, but buying [INAUDIBLE] European at negative yield, that doesn't make too much sense in terms of-- I mean, in terms of macro fundamentals.
And, in fact, you know, you can summarize QE with something very easy-- [INAUDIBLE] said it, and I think it was so spot on that it's QE comes from cash into liability. You can be long on cash anymore. In fact, it's-- you are rewarded because you have a weak balance sheet, and you have to-- to raise cash, and you are taxed when you are cash rich, and you have a strong balance sheet.
And I think that, for me, it explains why everything is too exuberant because there is no fundamentals behind the rally. It's just, I think, by cheap cash everywhere.
ROGER HIRST: And then I think what [INAUDIBLE]--
CHRISTOPHE OLLARI: [INAUDIBLE] accountable John as well that by purchasing assets, the central banks reduce the pool of available assets for investors.
ROGER HIRST: Absolutely. And I guess, then, my question from Marcus Backman, which is can the longer term one-- but the other side of this is that there's loads and loads of debt out there. How do you see the probability of a debt jubilee, and how could it evolve? Do you think that's something that's going to come because the world is awash with debt. Is a debt jubilee coming? If so, how?
CHRISTOPHE OLLARI: I was looking at the gross supply from the five biggest economies for 2020. It's obviously higher than last year. The net supply is down 40%.
So, again, we see all the impact of central banks just mediating the impact of higher dept burden because I strongly believe that-- and this is one of the reasons why I don't think that the central banks will be able to leave [INAUDIBLE]. It's [INAUDIBLE] is a non-starter because [INAUDIBLE] means sticking to the curve, means a spike of the interest [INAUDIBLE], which will basically as [INAUDIBLE] toward the asset class.
And that has been one of the takeaway of 2018 when the market is getting worried about the path of the central banks, the repricing of the fixing curve is led by the real yields and not by the [INAUDIBLE], and that's when the whole fragile sandcastle is wobbly.
So don't make me wrong, we must be convinced that the whole set up is the biggest bubble we have ever seen before, but, again, it's-- the central banks are trying to deal with the consequence of the bubble burst by creating a bigger bubble, and that has started in 2000.
Then you had 2007, where we end up-- ended up with 2007 because the Fed was too scared to [INAUDIBLE] too quickly. They took their time, and then the cash was still available in the system. And for the last 11 years, we've done what? Nothing. You'll remember when truly the biggest concern for the markets was QE will generate inflation.
ROGER HIRST: Yeah
Yeah that all worked, didn't it?
CHRISTOPHE OLLARI: Yes, it was the biggest joke-- not a joke, but--
ROGER HIRST: The velocity of money was the opposite and equal to the growth in the balance sheet. So they were just canceling each other out.
CHRISTOPHE OLLARI: And you know what I found extremely interesting? It's when you look at the negative yielding monetary policies, it's deflationary in itself because by enabling a weak balance sheet to still survive, you fuel over-capacity, which, in fact, you're fueling deflationary process.
And so this is a side effect of negative yield policy, which, at the beginning, was aimed at generating real deflation. So I think that we know, and then I'm [INAUDIBLE] becoming this is that the central bank cares-- know that as well that more unorthodox monetary policies will not create either inflation or subpar growth.
ROGER HIRST: No, fair enough. No, I agree. I've got a question which I'm going to bring on later from Ernesto on gold. So you-- obviously, we've covered gold before. I think we need to come to that, and it'll now come nicely towards the end.
But before then, I think what I'd love to just shift towards is, in some ways, the second parts of your notes, which is that we're here. We're near the all-time highs on the S&P. What sort of price action should we be thinking about here? Should we be thinking about a correction, which is, in my view, 5% to 10%, or a very bad correction could be 20%, or should we think about catastrophe, which is 20% plus 2008 style?
Where do you-- where do you think that this market dynamic will go because, right now, it feels bulletproof, but at the same time, this is a market begging for at least a 5% pullback. How do you think that could transpire? And what do you think are the likelihood of something deeper given the strength of the central banks behind this market?