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Over the last two weeks, a few of my little side projects have exploded in workload and the markets have gone completely crazy with a lot more opportunities but also a higher demand for “maintenance", i.e. time to keep up. I realize I won't be able to deliver the podcast write-ups at the level of quality they deserve, so I have to suspend them for the time being. The weekend issue of fx:macro will of course be published as usual.

Here’s the latest issue of my regular weekend FX and Macro deep-dive in case you’ve missed it:

fx:macro

Outlook for Week 39/2022

Welcome to issue #24 of fx:macro! This newsletter is quite long, so there's a Summary section at the top. Everything you find there is derived from data and news I show in detail in the second and third parts of the newsletter (Week in Review and Market Analysis…

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Release date: 08.08.2022, recorded 16.06.2022

Host(s): Corey Hoffstein @choffstein

Guest(s): Hari Krishnan @HariPKrishnan2

There were no charts in the podcast video, so every chart and link was added by me.

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Notes

Hari explains his background a bit: he was brought up to be a quant without realizing it. He was fascinated by James Gleick's book Chaos (link) and its ideas on chaos theory. In finance, no one was interested in that, because no one could make money from it.

Hari's first job was helping an options market maker build floor hedging models. They were getting out of their positions or delta hedging by the end of the day on a position-by-position basis. There was the idea that you could aggregate some of the volatility risk of the books of various market makers. Hari then joined Morgan Stanley where he built asset allocation models before running a CTA himself. He also was involved in a fund-of-fund business for a while. At one point he wanted to trade for himself and not outsource things he didn't understand. Since then he's been trading macro and tail risk, long vol and currencies. He's also run an FX fund and a volatility fund for a while.

Corey asks about Hari working in weather derivatives for a while and what the similarities are between weather derivatives and more traditional instruments.

Hari explains that it's impossible to hedge in weather. You're making directional trades. They're a bit like the VIX or fixed income. There's a bit of mean reversion priced in. Weather is a bit more well-behaved than rates, but it's not tradable the same way: credit can be decomposed into forward rates, spread across countries or credit etc., while weather has a lot less of those ways to hedge or spread out.

Corey asks about Hari's second book Market Tremors (link) which came out in September 2021.

Hari says he was happy with his first book The Second Leg Down (link), but the final chapter was a bit sketchy because he didn't really understand central banks and the various crisis prediction models. He mentions Richard Bookstaber's The End of Theory (link) and that he couldn't really take anything solid from it, so he wanted to write a book that looked a bit like the standard risk model with adjustments for credit and positioning risk.

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Corey asks Hari to explain Mean Field Theory, the main theoretical idea from his book.

Hari explains that there's a branch in physics called Statistical Physics that deals with averages or large numbers because it's easier to look at averages than to do everything on a molecular level. An example would be temperature, and it's even in the Black-Scholes model in a sense. Mean Field Theory also applies to networks and as long as agents behave approximately the same way the average configuration is good enough.

What that means for markets is that when you look at the distribution of returns of an asset and things haven't changed then this is probably a good way to think about risk. It doesn't cover the tails or accounts for changing dynamics, but it's okay overall. But when there are major players (“mega agents”, “whales”) distorting the network, you have to modify the network in some way. So, risk can emerge when players get too large, too levered or too active. In that case, you have to model the interaction between the historical distribution and the mega agents.

If you believe a whale has to sell if the market goes down by 5% and if you can estimate the impact of that selling you can adjust your risk estimate accordingly.

Corey thinks it's like there's a return distribution that becomes conditional on the actions of market participants that have an outsized influence, and when they are forced to act it can lead to cascading effects on the potential return distribution. He wants to know how to implement that in practice.

Hari explains that you need to know who the players are. Dealers and market makers are whales. They take the other side of institutionals that like to buy puts and sell calls on equities. Dealers have to hedge actively, and if they are short options their hedging exaggerates moves, see Squeezemetrics (link) or Cem Karsan (link) for examples: if you know where dealers are short you can make a guess about how much movement to expect in those regions.

In his book, he used various statistical techniques to explain why the market was that volatile in 2020 besides the newsflow. Another topic is the ETF and ETN providers, especially around the Volmageddon event of 2018.

Central banks are also whales given the size of their balance sheet sizes and the impact of market expectations.

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Corey asks: when you have a dominant agent present in markets there will always be a latent risk that isn't captured in the historical risk measurements. How do you identify those dominant players on a go-forward basis? Hari says he just asks around at banks who's buying and what big flows are going through. He's also looking at open interest and distortions of relative options prices. If put skew in the S&P 500 was too steep either the return distribution is different from his estimates or something is bidding it up structurally. An example: the IV dip in December isn't caused by structural distortions like flows as much as it is by how people think about markets.

Corey wants to know how to play defence in the presence of dominant agents. Hari's main points are

• position sizing, and

• avoiding overcrowded strategies like “value” or short-vol trades, especially if they have limited upside and unlimited downside.

He warns about ultra-high sharp ratios or guaranteed monthly returns. Just because something doesn't move doesn't mean it's safe.

Corey thinks the low-volatility environment in 2017 was due to a lot of dominant players were shorting volatility.

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He asks Hari what he thinks about structuring tail hedges in this environment vs. 2022. Hari believes in 2006 banks were the mega players and they were suppressing volatility because it was making them money until things broke. 2017 was similar but less driven by banks. People wanted to substitute carry for alternative forms of return because interest rates weren't going to go up. In December 2021 VIX was pretty high and S&P options were quite expensive, and that was a problem for tail hedging. In the S&P hedging for him is three parts:

1. Gamma hedging in the short end

2. Spread trading for middle maturities (3-6 months)

3. Interest rate/Vega plays at 12+ months

The standard tail hedging idea of buying puts 20 or 25% OTM hasn't worked in 2022, because volatility hasn't gone up enough. If vol goes from 10 to 20 you can make a lot more money than when it goes from 30 to 45, because you can just buy more units of protection. Also, the market has gone down in a trend-like semi-slow way. That's why trend-following and long volatility are working well together.

Corey points out that higher levels of vol of vol have increased the sequence risk of instruments with convex payoffs, i.e. choosing when to roll precisely or when to monetize. He wants to know how to manage during periods of heightened path-dependence.

Hari says that it's very hard to use stops in short-dated options because profit is so volatile. He thinks mixing up different strikes and maturities makes sense, taking some profits along the way. Longer-dated options tend to work better with stops.

Corey asks about constructing tail hedges in rates markets. Hari says that skew in the bond market was a bit of a chameleon: when bonds were crashing higher, a call skew would form and if they were crashing lower, there would be a put skew. From 2010-19 skew was fairly priced and volatility was quite suppressed. That has changed: rates are now seen as a source of real vol.

At the beginning of the year rate hikes were beginning to be priced in in the US while in Europe no rates were being priced in. Historically, the ECB has lagged the Fed, so there was opportunity there.

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Hari takes a bit of a detour and talks about Lucrezia Reichlin (link), who he's friends with, and Domenico Giannone (link… not sure if that's him, though). They developed a statistical model for estimating a GDP nowcast from economic data releases. Over time, people wanted to know why they don't have an inflation model. The model they developed doesn't predict inflation but rather characterizes the Fed's view on inflation (link). It's based on three factors:

1. Inflation trend anchored by inflation expectations.

2. Kind of a Phillips Curve factor: the relationship between the output gap and inflation

3. Oil prices

If the Fed raises rates there's a delay until it affects growth, and there's a longer delay before it affects inflation, especially sticky inflation. That means that the dampening in inflation may never occur. So, now there's a huge amount of inflation being priced in and then sudden and sharp episodes of deflation and vice versa. He thinks that this can be exploited in a hedging program.

Hari believes that the Fed cannot control inflation without creating a severe, unpalatable recession. It's not that the Fed is messing it up or that it's doing a great job. Rather, controlling inflation is a bit out of their control.

When inflation was low it was much easier to kick-start the economy. If the delays are as he believes then it is much easier to stimulate than to withdraw stimulation. They are a source of instability that ultimately affects how impactful policy can be.

Delays in dynamic systems aren't stable and if they change even a little they affect the outcomes in a highly unstable way. Corey asks if Hari sees delays as a source of instability not just at the macroeconomic level but also in financial markets. Hari believes there's a behavioural aspect because it takes a while for people to realize that the regime has changed. He mentions crypto where it took a long while for the belief system to develop and arguments to be formed, and then it took time for people to change their views at least temporarily and question the whole thing.

Corey mentions institutional mandates and that they have long lags. Hari says he believes that too much rigidity in hedging is not ideal.

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Corey asks Hari how he thinks about monitoring the emergence or disappearance of dominant players within the options markets. He mentions the vast number of retail traders on the one side and large institutions on the other side.

Hari says that implied leverage, i.e. options, and the social network phenomenon as reasons why retail became important. Retail is important in individual names. He has a lot of bank contacts to get information about what they are doing. He thinks looking at broker chats and flows is one of the most important sources of ideas for concentration risk.

Corey quotes Hari saying “tail hedging is just a bag of magic tricks”. Hari confirms that and adds: if you have a strong directional view on the market then you don't need to tail hedge but take a directional position instead. The bag of tricks is just: what's the best hedge given today's environment. Every dog has its day: there's some scenario for any options strategy when even the silliest one pays out. Option strategies have to be regime-dependent.

He's asking: given three simple options positions (a put, a put spread, a put butterfly), what are the conditions in which each of those performs best? Asking that question is the bag-of-tricks approach.

Corey asks about machine learning. Hari answers that machine learning gets rid of the tails. There's a tradeoff you have to make: minimize bias and minimize variance, so in the end, the models always end up being long stocks and long bonds.

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fx:macro Review of Week 37/2022

As announced last weekend, this issue will only include the review part and skip the outlook as I will be on a short break this weekend. The next issue will be out in a week…

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Release date: 14.09.2022

Host(s): Alfonso Peccatiello @MacroAlf

Guest(s): Mr. Blonde @MrBlonde_macro, here's a link to his Substack:

Stuck in the Middle

macro equity market reflections, thoughts, and trades

By Mr. Blonde

Charts were all added by me.

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Notes

Q: Financial conditions are tightening, and they feed into your macro framework. What's going on there? 01:00

Financial conditions have been in a tightening trend since late last year, and that trend has been accelerating. The primary drivers were rising real yields and the dollar.

The tightening is happening at a quicker rate and a higher level, and that has consequences for asset markets and future growth. The last 15-20 days have been the fastest pace of tightening since the start of the cycle late last year.

Q: How does that kind of tightening affect equity valuations? (02:26)

Credit spreads are important: Mr Blonde uses BBB corporate credit as a proxy for the cost of capital for companies since they cannot borrow at the 10-year treasury rate. The dollar is very important as well since a stronger dollar usually leads to weaker sales growth and weaker profit growth.

He uses and has published a model that says: a 10% move in the trade-weighted dollar index that lasts for a bit usually takes 150-200 bps off earnings growth over 6-12 months. Earnings growth is usually about 7-8% on average, so that's a significant impact.

Q: How does a stronger dollar affect sales growth of US companies (04:21)

The main reason is that about 40-50% of the revenue of the S&P 500 comes from overseas. Some companies are better than others at hedging that FX exposure, but it usually flows through to EPS 100%. Most analysts aren't taking that into account in their EPS forecasts. Another reason is that the US dollar is usually strengthening in times of weak global growth.

Q: Real yields reflect the monetary policy stance and long-term real growth. When growth was slowing and monetary policy was accommodative to support growth, real yields would normally have rallied. However, right now, rising real yields are adding to the problem of tighter financial conditions. What are your thoughts on real yields with regard to equities? (06:36)

The Fed made clear that their priority is getting inflation down, especially at Jackson Hole, and that has led to another upswing in real rates. One reason for the strong dollar is that US real rates are outpacing real yields in other parts of the world. You could look at 5s5s for the US and Japanese real rates, and they look like USDJPY:

The FCI has inputs from different markets, and if all of the financial tightening came from real rates then they would have to be a lot higher than they are today.

As for what it means for equities, higher risk-free real rates are much more attractive source of return compared to where BBB rates or equity earnings yields are trading.

Alf adds that one effect of higher real rates is the discounting factor of future cash flows and the other is the way capital is allocated: capital is going to flow to the risk-free assets unless the valuations of riskier assets adjust accordingly.

Q: Before Jackson Hole, Powell had said he wanted real yields positive across the curve but the frond-end was still trading in negative territory. After Jackson Hole, the bond market has now adjusted, and now 5-year real yields are the highest since 2018. What do you expect the Fed to do over the next 3-6 months? (10:16)

Mr. Blonde thinks the Fed will hike as expected over the next few meetings, but beyond that, it will depend on what happens to growth. He says he has a more negative growth outlook and outlook on profit growth than the average investor. Growth is already showing signs of weakness, in other parts of the world more than in the US: Korea and Taiwan are important global manufacturing hubs and data from there is not looking good.

If growth slows down in Q4 that could change what the Fed does. They are anticipating and hoping for growth to slow, so they will be more willing to accept “pain for households” than in the past. That sounded like a codeword for recession and is as close as you can get a central banker saying they need growth to be below trend for an extended period of time. They will probably be at higher rates for longer than anticipated a few months ago.

Alf adds that the bond market is pricing the terminal rate at around 375 bps, so not very different than before, but it has priced out rate cuts in 2023 because the hurdle is now so high.

Q: What are the implications for the equity markets? Can you give us your assessment of US equities going forward and an overview of sectors? (15:58)

There were different phases this year: We started the year at peak liquidity, peak valuations and peak earnings. Regarding peak liquidity and peak valuations, the market has been effective at taking those away. But we're still on peak earnings, which is an important risk. Mr. Blonde expects earnings to come down substantially as we go into 2023, and it's not an environment for valuation expansion, so simple valuation models point to “fair value” at S&P 500 levels of around 3,000 to 3,200. That seems the path of least resistance to Mr. Blonde. He expects periodic rallies because of sentiment and positioning, and he prefers to sell the rallies until either

• The Fed puts in a pivot, which isn't a pause but a change in direction or a change in attitude or

• Various leading indicators show a definitive bottom and turn higher.

Sector-wise, he thinks it's best to stay as defensive as possible.

Q: Please do the math for us on your S&P target of 3,000-3,200! (19:49)

Mr Blonde sees a number of around $200 on the S&P 500 EPS, consensus right now is about $240. $200 is equivalent to about 15% below 2022. The ISM PMI cycle is consistent with EPS running about 25% above trend. The rise in rates and energy costs are preconditions for a more meaningful growth slowdown.

Q: When is the moment to say we're at or near the trough of this bear market? (21:52)

Mr Blonde wants to do more work in that area, but the market tends to bottom 6-9 months before EPS bottoms out. His current timeframe for EPS making their lows is Q3 2023. So, after October or November this year into Q1 next year the window opens for price to bottom.

He doesn't necessarily think that the market has structural issues and that we will have a bear market that lasts 12-18 months. The market went through a significant shock and it's now digesting that. However, a market bottom doesn't mean that it is going to make new highs: it could just be that the trend is flattening out.

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fx:macro Outlook for Week 37/2022

Next weekend there will only be a short review edition but no outlook due to a short holiday break. The next regular issue will be out on 24./25.09. for week 39/22…

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One more thing. You seem to like newsletters, so here's a great way to discover new stuff to read for free: The Sample. They will regularly send you an issue of a different semi-random newsletter you might be interested in. If you sign up using my referral link, I get bonus points and my newsletter will be forwarded to others to check out.

Release date: 09.09.2022

Host(s): @JackFarley96

Guest(s): Dr. Richard Sandor, @DrRichardSandor

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Notes

Richard is known as the “father of financial derivatives”, he created the world's first interest rate futures contract.

Q: Tell us about the circumstances and the reason why you created that futures contract.

Richard responds he was teaching as a professor in the 1960s, and he was trading equities and agricultural commodities. The only debt that was outstanding was in the mortgage market. He wondered if you could turn interest rates into a commodity, and he experimented with a portfolio of an S&L that had about 18.000 loans in it. It was impossible to homogenize that because of redlining and other reasons. He picked up the idea again in the 1970s after Ginni Mae was established.

Here's the description of Ginnie Mae from Wikipedia:

The Government National Mortgage Association (GNMA), or Ginnie Mae, is a government-owned corporation of the United States Federal Government. It was founded in 1968 and works to expand affordable housing by guaranteeing housing loans (mortgages) thereby lowering financing costs such as interest rates for those loans. It does that through guaranteeing to investors the on-time payment of mortgage-backed securities (MBS) even if homeowners default on the underlying mortgages and the homes are foreclosed upon.

At that time, the president of Freddie Mac, Tom Bomar, got in touch with Richard because he was concerned that Freddie Mac owned about $900 million worth of mortgages, which it wasn't supposed to do and which was tiny relative to the size it holds now. Richard was asked to develop a hedging mechanism for a new secondary market. He started a job as chief economist at the CBOT to work on Financial Futures and an insurance derivatives market.

Here's the description of Freddie Mac from Wikipedia:

The Federal Home Loan Mortgage Corporation (FHLMC), commonly known as Freddie Mac, is a publicly traded, government-sponsored enterprise (GSE). It was created in 1970 to expand the secondary market for mortgages in the US. Along with the Federal National Mortgage Association (Fannie Mae), Freddie Mac buys mortgages, pools them, and sells them as a mortgage-backed security (MBS) to private investors on the open market.

Q: What were the challenges in creating a financial future, e.g. with physical delivery? And what was the first contract that you created?

In the 1980s the idea of managing interest rate risk didn't exist: no single bank had a department that did that, for example, you borrowed short and you lent long. Jack sums it up as the 3-6-3 concept: you borrow at 3%, lend at 6% and you're at the golf course by 3 p.m.

In the 1970s there were only agricultural commodities as futures contracts, no energy, no interest rates, and no options mainly for two reasons:

1. Prices were quiescent and there wasn't a lot of volatility

2. The law was ambiguous, so no one had the technical ability to trade financial commodities.

The first thing to do was to find a financial commodity that people needed to hedge. Ginnie Mae loans were the first natural ones: they were originated by mortgage bankers, sold to Wall Street and then sold to investors. These characteristics made them look like wheat. With the Arab oil embargo, droughts in China and Russia, inflation, etc. at the beginning of the 1970s, interest rates became more volatile.

In 1973 the US decided to regulate the futures industry. Since Richard was working at the CBOT he convinced his president to lobby for changes to the definition of a commodity to “anything tangible or intangible” among other things. The bill passed and regulatory impediments were removed, and now there was demand because of volatile interest rates.

The first interest rate future was created in 1975. Around that time, the government started to issue long bonds: the first 30-year bond was issued in 1977 and called the “007” because it matured in 2007. The total outstanding debt was only about 18 billion USD, but Richard believed it would increase by a lot, so he wanted to create a futures contract for treasury bonds and later the 10-year future.

Jack shows a chart of interest rates during the 1970s and 1980s to highlight the volatility:

Q: Was demand for the long bond future very high because many people needed to hedge? And how do you get others to take the other side of that bet?

Richard responds that the argument that there's only one-sided demand came up on pretty much everything he worked on over the last 50 years and that it's usually a sign that he was on the right track. There are usually two or three arguments:

1. We don't need it.

2. There's no opposite side in the market.

But: you have natural hedgers on the long and the short side. The only thing you need to fill in is the delta between the long and the short hedgers. They educated potential participants and created special exchange memberships among other things to bring people into the market.

Richard remarks that it usually takes two crises to create a market: the first one alerts people to a problem, and the second one makes it clear that it's better to do something before competitors will. The first crisis in interest rate futures was inflation in 1973, and the second was the oil embargo in 1979.

Q: Tell us about the Eurodollar futures market, i.e. the future rate of 3-month LIBOR.

The most important thing is that it is dead because it was manipulated. It also wasn't based on real transactions but purely hypothetical.

It started out well but there were too few underlying transactions for a $200 trillion hedging market: Eurodollar futures are extremely liquid but there's no underlying viable cash market.

To Richard, it was obvious that there was a huge incentive for certain people to misbehave (he's referring to the LIBOR scandal). It also didn't make sense to him that US rates, e.g. a mortgage in Arkansas, were based on an interest rate set by about 30 banks in London.

There's no new debt issued with LIBOR as a benchmark, it only has a use as a legacy measure. By June 2023 even that will be migrated to a new benchmark.

Q: What are the new interest rates to replace LIBOR? Also, tell us about AMERIBOR.

AMERIBOR is the overnight rate among regional mid-sized community and depository institutions: everybody but systemically important financial institutions. That makes it a credit-sensitive interest rate set by real transactions. There are also 30-day and 90-day rates. It's critical to provide a choice of possible interest rate benchmarks, for some institutions SOFR might be more appropriate, for others Ameribor, for example.

Q: Ameribor is credit-sensitive, so what does it do when there's payment stress?

Years ago there was the TED-spread, and it reflected the fact that in a crisis credit-sensitive interest rates will go up more than risk-free rates. There are different buckets of credit sensitivity in rates from junk bonds to treasuries. A regional or a small bank will find it harder to borrow in tough times, and they will charge customers a higher rate because there's a higher probability of default.

Q: Jack mentions he just looked up Ameribor and it also collapsed during February/March of 2020 and asks why that was.

A lot of liquidity was added by the Fed so the difference between risk-free rates and credit-sensitive rates was still there but imperceptibly low on an absolute basis: if the risk-free rate is 10 bps and 12 bps for the credit-sensitive rate it's very small on absolute terms, but it's still 20% on relative terms. When you have zero interest rates and a belief that the Fed will bail out everything and everyone it's not a normal environment.

One notable quote:

In my career I have lived through everything that was a one in a hundred year event, except that it occurs every ten years or so.

He mentions Covid-19, the GFC, 9/11, the tech stock bubble of 2000, Volcker, the market crash of 1987 all as supposed 1-in-100-year events.

Q: The current Fed Funds Rate is at 225-250 bps, and AMERIBOR currently is at 245 bps and SOFR around 218 bps. How can you explain that differential?

SOFR is risk-free, so you would expect AMERIBOR to be higher, and it's behaving that way. Typically it trades in the top quartile or top 1% of the Fed Funds Rate.

Q: When did you get involved in carbon and climate futures?

Richard got into it in about 1990. He was approached by people in the lime industry when acid rain was a big problem, so they asked him if he could commoditize air. He worked on the development of the Clean Air Act in 1990, and the United Nations wanted to know if a carbon futures market would be viable. Similar to interest rate volatility in the 1970s, he expected carbon emissions to become an existential problem. He securitized the Costa Rican rainforest and got very active in funds and exchanges around climate and sustainability.

Q: The implementation of climate measures requires government participation, so are climate futures, greenhouse gas emission credits, etc. only as good as the governments that are implementing them?

Richard doesn't think so. The Chicago Climate Exchange got 108 companies on board completely voluntarily (Ford Motor Company, Intel, IBM and others). Single states and cities joined as well. He believes a voluntary approach can work, and that government backing doesn't necessarily mean the federal government. The open interest for environmental commodities is at least as big as the size of gold without the involvement of the federal government.

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fx:macro

fx:macro Outlook for Week 36/2022

Welcome to edition #21 of FX & Macro Weekly. This newsletter is quite long, so there's a Summary section at the top. Everything you find there is derived from data and news I show in detail in the second and third parts of the newsletter (Week in Review and Market Analysis…

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One more thing. You seem to like newsletters, so here's a great way to discover new stuff to read for free: The Sample. They will regularly send you an issue of a different semi-random newsletter you might be interested in. If you sign up using my referral link, I get bonus points and my newsletter will be forwarded to others to check out.

Release date: 26.08.2022

Host(s): Ed DAgostino (link, @EdDAgostino)

Guest(s): Louis Gave (link, @Gavekal)

All charts have been added by me.

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Notes

Q: Quantitative tightening isn't reported on in the media as much as the discussions around interest rates. What are your thoughts on QT, what kind of impact will it have on the Fed's goals and on the economy?

Louis believes that we haven't been hearing about QT because in reality, it's not happening at the moment. Inflation started to break out in March 2021, and the Fed continued to expand its balance sheet until May 2022 despite sky-high inflation prints. Since May 2022 there has been a marginal shrinkage of the balance sheet, but so far we haven't seen any quantitative tightening despite inflation at 8.5%. He thinks it's because central banks need to help governments to roll over their vast amounts of debt: in the 1970s debt/GDP was around 30-60%, while today it's rarely below 100%. Central banks are stuck: if they stop rolling over government debt they could create a debt crisis.

The Bank of Japan has been a trailblazer:

• they were the first one to go to zero interest rates,

• the first one to do QE,

• the first one to do yield curve control (YCC).

And for each of these steps, people were sceptical. Now they've embraced full yield curve control and buy a limitless amount of JGBs if yields go above 25 bps. Louis wonders how long it will take until the Fed is going to implement YCC. The ECB is already trying to do spread curve control.

Once the Fed starts doing QT it will have a broadly negative impact on global asset prices. But for now, the Fed isn't withdrawing liquidity.

Ed references a paper by the Atlanta Fed where they estimate that letting $2.5 trillion roll off the balance sheet will be equivalent to about a 75 bps rate hike. He thinks that's a huge underestimation. Louis agrees, because that's roughly 10% of US GDP, so it seems not really appropriate.

11 How Many Rate Hikes Does Quantitative Tightening Equal

399KB ∙ PDF file

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Q: How do you see inflation in Japan relative to the US and Europe?

Japan has to import all of its energy, so you would assume inflation would be higher. But it depends on what you think inflation is caused by. Louis believes the reasons for today's inflation rate are:

1. deglobalization,

2. the energy crisis, and

3. “crazy fiscal and monetary policies adopted during the Covid period".

Japan isn't committed to deglobalisation like the West: it's not picking fights with China and Russia. Japanese energy imports from Russia have gone up massively. Fiscal and monetary policy in Japan during Covid was also very different.

If you think inflation is the consequence of supply chain issues: why aren't Japan and China suffering as well? Louis believes inflation is the price we pay for the policy choices made during the Covid period and for us actively embracing deglobalization. That's a political choice and it comes with a cost.

Q: Is deglobalization happening at the corporate level at a relevant scale right now?

Louis believes that there is, and it started in 2018 when Donald Trump decided to weaponize the semiconductor industry and cut off Huawei from chip supply. From China's standpoint, Huawei was their first tech champion with a global brand and market share, and they saw it as the US crushing their success. That spurned them towards independence on the semiconductor front, on the energy front and with their currency.

China pushing hundreds of billions of dollars into semiconductors has led to established manufacturers holding back their CAPEX because of the massive competition they expected from China. For example, 2019 was the first year that TSMC's CAPEX fell since the Asian crisis. That caused the semiconductor shortage of 2020/2021. (Note: in the following chart, TSMC CAPEX fell in 2018 but increased in 2019.)

Political intervention from China and the US created a lot of uncertainty in the semiconductor industry, which caused investments to be held back. Anybody who can move away from China is trying to do it, but they find it challenging. Production is shifted now not because it makes sense economically but because of political reasons. And that comes with a cost: supply chain dislocations and higher costs of production.

Q: Do you think the deglobalization between China and the West is going to continue and will that lead to a higher baseline level of inflation?

It's extremely likely. The US and China are drifting further apart, he mentions Nancy Pelosi's visit to Taiwan. Inflation today is not a bug, it's a feature: 12-18 months ago central banks told us they wanted inflation. Now we're at a phase where inflation has become inflationary because it changes people's expectations. Louis mentions a study by Vincent Deluard (@VincentDeulard) where he looked at inflation across different countries after 1945. Once inflation got above 5% it only goes back to below 2% about 1.6% of the time 12 months later, while 20% of the time it's either above 10% or between 5-10%.

He thinks energy and food prices won't be lower in a year because of underinvestment, problems with fertilizers and other issues.

Historically the Fed had to bring interest rates above the rate of inflation to make it roll over, which isn't going to happen. If they wanted to do it they would have done so when inflation was at 4%.

Q: What's going to happen with Europe during the winter when Russia is going to have a lot of leverage because of Europe's dependency on their energy?

The only good news is that everybody already knows all the bad news. Europe is heading into massive energy and political crises. Louis mentions a quote by Benjamin Franklin: if you give up liberty for security you end up having neither. In Europe, people have been pushed into the bargain of giving up freedom on monetary, fiscal and energy policy in exchange for more prosperity down the road. In reality, they have “ended up at the gates of hell”: we've lost control of monetary policy, the inflation rate is as high as it hasn't been in generations, fiscal policy is increasingly constrained and energy policies have been "so stupidly dumb”. Now there's a risk of significant political crises.

The energy crisis in Europe is going to lead to supply chain disruptions and will be inflationary for the rest of the world, too. Just as an example: a lot of auto parts are still produced in Europe. It's also going to be a hit to global growth.

Q: Can the ECB do something to mitigate the inflation situation?

The silver lining for Europe is that oil is still not too expensive. Natural gas in Europe costs about $600 of oil equivalents, electricity about $1,000. Europe can buy oil for energy, which is a bad way to produce electricity, but that's the best they can do. That's very bullish oil and very bearish Euro, because Europe has to pay in dollars.

As for what the ECB can do, Louis doesn't really know either.

Q: What are your recommendations to an investor in a world with higher baseline inflation, higher interest rates, energy constraints, etc.?

(Note: Louis is using some weird American football analogies. I have no idea how football works, so if I got something completely wrong here, please let me know in the comments.)

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Building a good portfolio is like building an American football team: you need different players for different things. The big challenge is now: the defensive part of the portfolio used to be government bonds, and we've seen in the past year that this no longer works. The S&P 500 is down 20% and TLT also went down 20%. Treasuries didn't provide any protection, so bonds don't do the defensive job anymore that we want them to do. Which assets behave with a negative correlation to everything else?

• The first one is energy: this makes sense in an inflationary environment, because if oil goes to $150 then the rest of your portfolio is destroyed. There are a lot of ways to play it: high-beta would be coal mines, conservative would be MLPs, oil refiners or uranium. It should be 25% of a portfolio because it behaves like no other asset.

• The second one is emerging market bonds. Emerging markets usually blow up during a Fed tightening cycle, but this time is totally different: Brazilian bonds are up, Chinese bond yields have gone from 3% to 2.75%, Indonesian bonds are up. EM bonds are behaving completely counterintuitively, and that's a strong signal for Louis. He thinks big parts of the world are secretly de-dollarizing. A few weeks ago, China did a deal with BHP to price iron ore in renminbi. That's a big deal because they can now go to Rio Tinto or Valet and make them do business in renminbi too or cut them out. China has been trying to do this with Russia for years but now with western sanctions, it's going to work out: the biggest commodity exporter (Russia) and the biggest commodity importer (China) are moving their trade away from the dollar, so there's less need for US dollars. That might explain why emerging markets aren't doing badly during the current US dollar liquidity squeeze.

Q: What are the ramifications for the dollar near-term?

The dollar index is really a proxy for EUR. The only positive case for the Euro is that everyone is bearish already: it looks terrible from a technical and fundamental standpoint. So, between the USD and the EUR it's clearly the USD, but it's different versus the Yen. The JPY is undervalued, they've started to do business with Russia again, they're dealing with the energy crisis by restarting nuclear power, so Louis is bullish JPY. He's also bullish all relevant emerging market currencies like INR, ZAR, and CAD versus the dollar.

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If you’ve been here for a while, you might notice that I’ve changed the name and overall look and feel of my newsletter:

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fx:macro

FX & Macro Outlook for Week 35/2022

Welcome to edition #20 of FX & Macro Weekly. This newsletter is quite long, so there's a Summary section at the top. Everything you find there is derived from data and news I show in detail in the second and third parts of the newsletter (Week in Review and Market Analysis…

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4 years ago · 11 likes · FXMacroGuy

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Release date: 24.08.22

Host(s): Michael Ippolito @Mikelppolito_

Guest(s): Luke Gromen @LukeGromen, FFTT

Charts were taken as screenshots from the Youtube version of the podcast.

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Notes

Q: Please walk us through your big geopolitical framework.

Luke starts at Bretton Woods and the two competing proposals at the time from John Maynard Keynes and Harry Dexter White.

Keynes proposed Bancor as a neutral trading/settlement asset with national currencies floating against it. The US has been running deficits for about 50 years, and with a system like the Bancor, this would not have been possible: the US would have had to sell dollars and buy Bancor, which would have weakened the dollar. This would have made the US more competitive and it would have forced greater fiscal discipline.

White proposed the system that was finally implemented: every currency is tied to the dollar and the dollar was tied to gold at 35$/ounce. In the post-war period, other economies started to run large trade surpluses while the US was running greater deficits due to the Vietnam war. Debt outstanding was about four times the size of the amount of gold holdings of the US at the beginning of the 1970s. So, in 1971 Nixon closed the gold window “temporarily”. No one knew what the dollar was worth then, effectively.

The US came to an agreement with the Saudis to price oil in dollars, which was basically the foundation of the petrodollar where dollar surpluses were recycled back into the eurodollar market and into US financial assets. The greatest US exports became dollars and treasury bonds.

From 1973 to about 2003 the dollar was kept as good as gold when it came to gold, i.e. the price of oil priced in gold remained relatively consistent during that time. Part of the reason for that was US monetary policy: if oil became too cheap, the Fed would loosen policy, and if it became too expensive, it would tighten.

In 2005/2006 China grew rapidly and overtook the US as the biggest oil importer. The US economy needed rate cuts, but the high oil prices signalled a need for the Fed to tighten significantly. When the Fed ultimately cut rates because of the housing market and the crash in the banking system, oil went from $70 to $150 in about nine months.

So, the US had a chance to go through a period of austerity, wipe out equity holders and settle the problems with capitalism, but instead, we chose to print money and backstop everything. That showed to the world that the US had given up on managing the value of the dollar relative to energy prices (or commodities in general) in favour of taking care of itself first, i.e. managing the dollar for its domestic economy instead of as a global reserve currency.

Q: Every economy in the world needs energy, and you don't want a mismatch between assets and liabilities with assets being the money supply and liabilities being your energy needs. So after going off the gold standard, there was an implicit promise to keep the dollar as good as gold for oil to balance this out. In 2008, the US broke that promise. We also broke the foreign exchange window when we confiscated Russia's central bank assets. What are the ramifications of us breaking these social contracts?

Luke thinks the consequences are far-reaching. Historically these big systemic changes have led to wars. Keeping the dollar as good as gold with regards to oil means keeping it neutral to positive in real rate terms relative to oil: if oil goes up 5% per year, you need interest rates at 5% per year. That works if the economy is under-levered, but with current debt levels, it's impossible.

The European economy is going to collapse if electricity and natural gas are going to go up. There's the fundamental tension again: the US can't afford to pay positive real rates relative to the price of energy that would be needed to bring in new supply, and the importers of energy can't afford to not get paid a positive real rate on their savings.

Historically, tensions like these have led to wars: World War I was about Germany leaving the English economic system after the panic and crisis of 1873 and the following 20-year-long depression. The British implemented liberal economics and free trade, and they offshored production to their low-wage colonies. This caused wealth inequality to increase because the working and middle class could not compete anymore. Since everyone was on the gold standard, it was impossible to print money, which led to this long depression. Germany started to run a different economic model with more centralization, and investments into their infrastructure and military. Rising competition between Germany's and the UK's economic systems led to World War I.

Luke draws a comparison to China's Belt and Road Initiative and sees parallels to what's happening currently with Russia and Taiwan. He thinks that if World War II was an extension of World War I, this can show where things might possibly be heading right now.

Sky-high inflation will lead to politicians being elected out of office, and economic sectors that have been neglected for the past 45 years will benefit: the middle and working class will have wage growth. Profit margins in real terms will rise and in percentage terms will fall. Inflation will be very high and bonds will suffer.

China, Russia and Europe will say that their economy will collapse if oil continues to be priced in dollars. Luke sees major fourth-turning type issues like major wars or collapses in creditor nations as possible consequences of these fundamental tensions that concern fundamental national security interests and are existential to survival.

Michael mentions a document by the Department of Defense from 2018 and quotes from p. 59:

Assessing And Strengthening The Manufacturing And Defense Industrial Base And Supply Chain Resiliency

5.23MB ∙ PDF file

Download

Download

The loss of more than 60,000 American factories, key companies, and almost 5 million manufacturing jobs since 2000 threatens to undermine the capacity and capabilities of United States manufacturers to meet national defense requirements and raises concerns about the health of the manufacturing and defense industrial base. The loss of additional companies, factories, or elements of supply chains could impair domestic capacity to create, maintain, protect, expand, or restore capabilities essential for national security.

Q: What is the link between monetary policy and the hollowing-out of the domestic industrial base in the United States?

Your competitiveness is a function of the strength of your currency. The US can't put a lot of trade restrictions in place because of the dollar's reserve status. But the bigger issue is the US treasury bond. From 1946-71 the dollar was the reserve currency but gold was the primary reserve asset. After 1971 treasury bonds became the primary reserve asset. Foreigners have to buy treasury bonds to store their dollars, so US deficits are “deficits without tears”: the US buys stuff for dollars from foreigners, and they use these dollars to buy treasury bonds.

Foreign countries keep their currencies weak to underprice what's produced in the US, so our ability to produce stuff gets worse and middle and working-class jobs get offshored. On the other hand, the US economy becomes massively financialized because the dollars we pay other countries get recycled back into our financial markets.

Luke cites 2011 as an example when the US was unable to build the Bay Bridge in San Francisco, so they had China build it. As for the defence manufacturing supply chain, it's similar: as long as there's no conflict with China everything is great, but China obviously hasn't had the US’ interests at heart for a long time. Politicians have so far mostly looked the other way on that issue. Covid has changed everybody's mind. To sum it up: if you're going to war with China, they shouldn't be making a lot of stuff for you, because they aren't going to sell it to you in a war.

Q: How effective have the sanctions on Russia been, especially the closing of the FX reserve window?

The closing of the FX window is a huge deal because the US basically told the world: your FX reserves in US dollars aren't safe. But it takes time for the effects to play out, and there are things happening if you're paying attention: India and Nigeria opening gold exchanges (Nigeria is the 7th biggest oil exporter), and Turkey buying energy in Rubles. These things might look random, but they are small pieces and when we look back in five years’ time or even sooner, the magnitude of closing the FX window will be increasingly obvious.

As for the sanctions hurting Russia: the sanctions have disrupted their supply chains and they are very problematic in some ways but not in others. What was really surprising to Luke was the fundamental misunderstanding of the elasticity of the energy demand: human demand for energy is infinite. Energy sanctions from the EU have blown up in their faces. China and India represent about 40% of the global population and their usage of energy per capita relative to the West is low. They could take all of Russia's energy production if it weren't for the logistical aspects. The sanctions also leave out the demand elasticity from price: if Russia's export drop by 50% but price triples, then Russia is getting more money than before. It shows up in the data: the current account for Russia is at all-time highs because they're not importing stuff from the West anymore and their revenue from energy exports is up. The West miscalculated and now has to deal with an energy crisis.

Q: What's going to happen next in Europe with energy?

Luke thinks the economy is going to collapse, people are going to freeze and die unless either:

• the US starts selling dollars for euros,

• the US starts selling a lot more natural gas to Europe, or

• Europe starts paying Russia for oil in euros or yen.

The threat of people starving and freezing in Europe and Japan will force a geopolitical realignment that's currently unimaginable for most people.

Q: You described bitcoin as the "last functioning fire alarm”. What do you think about Bitcoin and its role with regard to the tension the Fed is under?

Luke believes Bitcoin is doing to the Fed what gold did to Volcker. He mentions an article from a few months ago by a 40-year veteran of the London Bullion Market that goes into how gold is manipulated by “paper gold”. That doesn't refer to GLD or futures but unallocated gold where people can buy large amounts with a simple phone call. That ends up being just an accounting entry that's going to be cash settled in the end. Bitcoin doesn't have this sort of unallocated market that mutes its warning alarm function. Also, it's a lot easier to buy actual Bitcoin than to buy physical gold.

Bitcoin also has a fixed supply of 21 million and it has a steady flow. It is just doing what gold would do if gold didn't have a huge paper market attached to it. It has been very early in pointing out liquidity turns.

Q: There are basically two options for central banks: 1. hike until unemployment rises and demand gets crushed, or 2. hike rates a little bit, let inflation run above target and eventually adjust the target from 2% to, say, 4-5%. What do you think about that?

It's going to be neither of those two options. The problem is the debt situation: the US had a lot of bubbles in housing and stocks, and they created an unprecedented increase in tax receipts. Even as those tax receipts were at all-time highs, they just barely covered entitlements and treasury spending. The US spends 2.8-2.9 trillion dollars in entitlements per year, treasury spending is at about one trillion. Bringing down demand will bring down inflation, but it doesn't account for secondary effects: GDP comes down, tax receipts come down and will end up below entitlements and treasury spending, which is also going to go up because a third of debt is financed at under one year and that's going to reprice higher.

The US can print money to make up for the difference: the bond market will then dictate the rate the US is going to borrow at, and that will lead to a debt-death spiral because debt is going to reprice higher the more borrowing is going on, which is self-reinforcing.

The other option is to have inflation run at 4-5% and inflate the debt away. If rates remain at 2% and inflation runs at 4-5% nobody is going to want to hold the debt. The Fed would have to buy the entire bond market to peg rates at a negative real level. The Fed's balance sheet would go from 9 trillion to something like 50 trillion in a year, the dollar gets crushed and inflation goes crazy.

Q: What are your thoughts on the relationship between the US and other countries?

The balance of power shifted from about 2015-2018. An example would be Donald Trump telling the Europeans in about 2018 that trade in energy is different from other trade and that he was wondering why the US protected them when they bought all this cheap gas from Russia. Or in 2019 he said that if the Chinese decide to take Taiwan, there's nothing the US can do about it.

If the US is an empire and acts that way, it will have to come up with soldiers to defend it. The last 20 years haven't been good for the US in that regard: taking Afghanistan with a massive financial cost and cost of human lives and then giving it back to the Taliban. Young people don't want to fight for the US and its economic system that's not in their or their families’ interests.

Michael compares the post-war period, where the G.I. bill was basically a huge transfer of wealth from the old generation to young G.I.s returning home after the war, to Covid, where only old generations profited with financial assets and real estate going up in price. He says young people feel disenfranchised, and not well represented by current politicians.

Luke thinks it's not just the youth but also the inequity of how the GFC in 2008 was handled was one of the biggest political mistakes in the history of the US: Wall Street claims to be capitalist, but there was no real capitalist solution with a wipeout of equity holders, which would have prevented all the following bubbles.

He mentions an article in The Atlantic from 2009: The Quiet Coup by Simon Johnson, a former IMF chief economist. In it, he argues that the US goes into emerging market countries, breaks up the banks and applies capitalism, wipes out the oligarchs and installs a new leadership. The US had the exact same problem as an emerging market but they decided to do the opposite.

The disenfranchisement runs deeper because capitalism is only applied to, for example, homeowners and pensioners, while the elites and policymakers get the communist treatment: privatizing gains and socializing losses.

Q: What do you expect policymakers will do over the next year to confront the domestic challenges like inflation and the geopolitical problems? And what would you be doing if you were in charge?

Luke thinks they are going to do the right thing by accident after doing the wrong things first. They are going to overtighten, create a brief crash and get inflation down to 4-5%. Something will break in the financing mechanism of the US government, and that will not be allowed to occur, so the Fed will have to turn around and expand its balance sheet again with CPI still at 4-6%. So, within the next 12 months, inflation will be in excess of 10%, which will force the Fed into yield curve control with the Fed buying a large chunk of the bond market. Inflation is going to run hot and it will be like a giant debt jubilee for holders of fixed-rate debt because wage growth will be so high. He believes there will be a period of something like three years with CPI at 12-20% that will lower debt/GDP enough for the Fed to be able to normalize policy without breaking something.

If he was in charge, he would be bold: print something like 2 trillion dollars for the next five years, invest that in semiconductor manufacturing, infrastructure, education, while the Fed keeps 10-year rates at 3% regardless of CPI or money supply. At the end of that time, debt/GDP will have collapsed, wages will have gone up massively, but the US would have strengthened its infrastructure and defence supply chains, and educated and reinvigorated its young generation. At one point the Fed can normalize policy again.

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FX & Macro Weekly

FX & Macro Outlook for Week 34/2022

Welcome to edition #19 of FX & Macro Weekly. This newsletter is quite long, so there's a Summary section at the top. Everything you find there is derived from data and news I show in detail in the second and third parts of the newsletter (Week in Review and Market Analysis…

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4 years ago · 4 likes · FXMacroGuy

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One more thing. You seem to like newsletters, so here's a great way to discover new stuff to read for free: The Sample. They will regularly send you an issue of a different semi-random newsletter you might be interested in. If you sign up using my referral link, I get bonus points and my newsletter will be forwarded to others to check out.

Release date: 15.08.2022

Host(s): Meb Faber

Guest(s): Kevin van Trump (@KevinVanTrump, https://www.vantrumpreport.com/)

Charts were all added by me.

Abonnieren jetzt

Notes

Q: Tell us a bit about your story!

Kevin started working for the NFL after college and got into trading through friends in Chicago. He was hired immediately because of his size (about 1.93 m, 158 kg), which would make it easy to buy and sell on the floor. He started trading FX futures on the Merc, then livestock, later treasuries and corn, beans, and wheat for different firms.

Q: How long have you been writing the Van Trump Report?

For about 12-13 years. Kevin started journaling and writing down his own thoughts on trading and investing at a time when a lot of things were going on in his life (two young kids, fallout from the housing market, some business of his going broke), and it was unintentionally very successful, so he started charging for it.

Q: What's your framework when you think about commodities, what's your investment process?

Kevin mostly trades corn, beans and wheat. Also energies (ethanol, plants, CNG fuelling facilities) and feedlot. He starts every day with a macro perspective. Markets have changed: they have more fund interest and there's more cross hedging from bigger players.

He remembers one year when corn and wheat were just running up and nobody could figure out why. There were headlines about a polar vortex hitting in the winter. Equity traders wanted to hedge an expected drop in Q1 earnings because they thought the polar vortex would have everybody staying at home. They figured that wheat would be very sensitve to a polar vortex because it would kill off the crop, and they tried to cross-hedge their equity portfolios.

So, Kevin thinks there's a lot more cross-hedging now, more interesting spreads, traditional spreads aren't traditional any more, there's more high-frequency trading, more algos. This makes it challenging to look at historic data in certain ways.

Q: How would you characterize your approach… technical, fundamental or discretionary?

Kevin started trading fundamentally but gravitated towards technical trading. He didn't have much success with that, so his approach now is fundamentally driven with technical analysis for entries and exits.

Meb mentions a book called “Oceans of Grain" (link).

Q: Wheat hasn't done much over the past decade, but post-Covid it started to inch up and went bananas last year. Give us a little perspective!

Kevin mentions that the Russian invasion of Ukraine added fuel to the fire. There were big fund movements, but in the last few months that has been dialled back. The appetite for commodities has come down because of fears of a global recession. That hit grains and especially wheat.

The US has become what is called the ancillary supplier of wheat. People go to Russia, the Black Sea and parts of Europe for cheap grain. If they can't get it there and need it delivered anyway, they come to the US as an ancillary supplier.

The strong dollar is another headwind. There are a lot of unknowns about whether exports will improve. The humanitarian grain corridor out of Ukraine made a lot of headlines, but Kevin doesn't believe it will make much of an impact.

Funds use wheat as a cross-hedge, so they're short wheat betting on a global recession.

Q: Are you trading through futures, options, underlying equities?

Kevin uses futures 80-90% of the time, but there are opportunities for options players.

Q: What does the rest of the ag space look like?

There's a bit more demand for beans because there's no replacement for the high protein beans. Soybean meal has been the leader of the bull run because that's used to feed livestock. Soybean oil has been more of a byproduct.

When prices get high, corn will be used as a substitute for soybeans, but there's really no substitute for soybean meal, and the world needs more of it as a feed for livestock. Now there's also a big push for oil from demand for cooking and biofuels. Money is being invested in more processing facilities.

He also expects more acres of soybeans to be planted over the next five years, but supply is always tricky to get right in these markets. The demand story in beans is good.

Corn is a bit more of a weather market. Wheat is the easiest crop to grow, next is rice and beans, and corn is a bit more difficult and sensitive. The timing of the weather is pretty important. Chinese demand remains a big question mark, and the war in Ukraine is also a big unknown. These two are the driving factors.

Q: China has had a big impact on commodities over the past decade. What's going on with China?

During the early days of the Trump administration, there was some intel on how China started to pivot away from a western diet. There had been a big push for a long time to become more westernized, but now the Chinese government wanted to shift away from a Western-type society and diet. That's a bit concerning: have we peaked at the demand side for cattle, beef, livestock and things of that nature? Kevin is sceptical, because they may already be walking that back a bit. He thinks Chinese demand is worrisome, and that they are trying to do more of their deals with South America. Also, they are trying to push the dollar off its position as a leading currency.

Meb mentions he's been doing a lot of polls on Twitter, and one of them was asking people whether they invest in real assets (commodities, real estate, TIPS). Most people that responded had very little in commodities. Canadians and Australians are an exception because they tend to be more natural resource focussed.

Q: What role does the big-picture monetary policy play?

It's very important to Kevin, he's starting off every day trying to get a better understanding of the macro perspective: what's going on with the dollar, with rates, long-term debt, and where money is going to flow.

Q: What has been the sentiment in the responses and feedback you've been getting this year vs. the past year?

Kevin thinks the “doom and gloom” vibe sells: people want to hear conspiracy theories, the dollar is doomed, buy shotguns and gold. So, a lot of his readers ask him why he's so optimistic. The vibe is people notoriously want to be bearish, but he doesn't believe that the US is just going to fall over in one shot and be dead.

Q: What changes have you seen in the ag markets, especially regarding the role technology has been playing?

Kevin responds that he and his family are kind of angel investors in ag startups. He mentions iSelect who do a lot of investing in ag startups as well. Change in the ag business tends to be more incremental than happening in big leaps. He starts his investing thesis with demographics: spending habits for millennials are very different from spending habits of boomers. Millennials will pay $8 for a coffee at Starbucks or $10 for a burrito. That's a big shift in agriculture.

Farmers used to grow whatever they wanted to grow and the consumer picked from that. That's changing dramatically with the consumer dictating that to a much larger degree: what is grown, how it is grown, and what chemicals they want and don't want on it. Blockchain will be used in agriculture to allow customers to see where crops come from. He mentions a few examples:

• An E. coli outbreak at Chipotle as an example where they wanted to know exactly which farm and which field their produce came from.

• A lot of rice is getting blockchained for Chipotle.

• Cotton is being tagged and put on the blockchain so customers can get a story of where their t-shirts come from.

• Benson Hill has contracts with Impossible Foods to create specific seeds with the right characteristics for their food. Benson uses CRISPR to create the right bean.

Q: How should the typical investor approach the ecosystem of farming, ag-tech, and commodities?

Kevin says he opened Van Trump Farm & Land because there's so much interest around these things. They also partnered with AcreTrader. There are three groups:

• “Legacy land” where people buy land and keep it in the family

• Working farms growing crops or leasing land to solar or wind energy

• Ag business, e.g. turning a farm into a whiskey farm that also has merchandise or does tours

Other ways would be through ETFs, futures or options.

Kevin advises a lot of funds on buying farmland with the expectation it's going to be worth more in 30 years.

Meb warns investors of the risks that come with having no experience in the farming business.

Q: How does it work for institutions on an international level?

Kevin says he owns farms in Argentina and Brazil with partners. There was a massive learning curve where things looked great in theory but were a lot less great in practice. It's a lot more art than science. He bought land in Brazil with a group of farmers near Teresina. There's about 70 inches (178.000 mm) of rainfall per year, so they planted eucalyptus and other crops like rice, wheat and beans. In theory, it was great, but they had to build roads with local engineers, and they didn't build ditches so the water just pooled in the road. Other things like building fences also took a lot longer than it does here.

He says he's never been on the winning side with farms in foreign countries and most of his friends haven't been either.

There's a lot of fragmentation in the ag world right now, that's going to bring in institutional money and will lead to more consolidation.

Q: What are easily avoided mistakes for new entrants?

It depends on how fast you're looking for returns. If you're managing money for your family long-term, it's different than going for consistent annualized returns on a quicker timescale. That's a lot more difficult in the ag space because there are so many unknowns each year, e.g. fires or droughts.

There's a substantial learning curve, so getting in the business and hoping to make money the next year or two is probably a fallacy.

Q: What's been your most memorable investment, good or bad?

Kevin thinks it's best not to think about the last trade similar to a poker player or a golfer not thinking about their last hand or last hole.

He says he was early in TSLA and fairly early in Bitcoin.

Meb mentions a quote: “Every trade makes you richer or wiser, but never both.”

Q: What's FARMCON?

It's an annual event, started about 15 years ago with friends and turned bigger over the years with over 1.200 people, discussions and guest speakers. It's going to be on January 4th and 5th.

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In case you've missed it, here's a link to my usual weekend piece with a recap of the relevant macro events and a comprehensive look at markets from every different angle:

FX & Macro Weekly

FX & Macro Outlook for Week 33/2022

Welcome to issue #18 of FX & Macro Weekly. This newsletter is quite long, so there's a Summary section at the top. Everything you find there is derived from data and news I show in detail in the second and third parts of the newsletter (Week in Review and Market Analysis…

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4 years ago · 6 likes · 5 comments · FXMacroGuy

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Release date: 14.08.2022

Host(s): Alfonso Peccatiello, Andreas Steno

Guest(s): Nick Stadtmiller (@NickStadtmiller)

Charts in the Intro section have been taken from the podcast video. Charts in the other sections have been added by me.

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Notes

Intro

Alf mentions the CPI prints from last week that was a lot lower than expectations. Andreas thinks this could be a short-term turning point in the market cycle: if the market senses a change of trend it starts to price it in.

Andreas looks at NFIB Price Plans from this week that has turned lower as well. He feels confident that the peak in inflation is in now.

Alf mentions that the composition of inflation is also a lot more friendly to policymakers, and if you combine it with the labour market report the week before, the market might price in a goldilocks scenario. Markets are probabilistic, so they don't price final outcomes, and now a soft landing seems a lot more achievable. He wants to know if Andreas would go for a goldilocks asset allocation now.

Andreas thinks it's too early: once the inflation peak is in, it's a decent time to buy risk assets, but this time it's different because the growth cycle is falling apart. Commodities are still driving inflation, and the commodity market is telling us growth is slowing. So, it's not a very good time to load up on risk now. He wants the Fed to at least admit that growth is slowing down hard.

Alf points out that bond markets and OIS are still pricing that the tightening cycle will stop early next year, and that pricing has been historically been right:

The Fed pivot this time is a lot more complicated because of high inflation, though.

Inflation in Europe is different than in the US because the electricity situation is a lot worse in Europe with forward electricity prices being significantly higher than spot. Andreas thinks the ECB might have to hike for longer than the Fed for that reason. The divergence between the US and the European yield curve could be “almost a bargain trade”. Alf translates it as: Eurodollar SOFR Z22/Z23 boxed against Euribor Z22/Z23.

Alf thinks everybody has forgotten about QT. The asset side of the balance sheet is easy to understand: the Fed stops reinvesting in treasuries. But the liability side of the balance sheet has to shrink as well: the most aggressive way to do that is to reduce bank reserves. The liability side is made up of a lot of reverse repos and TGA (Treasury General Account). Alf expects bank reserves to tumble as a result of QT.

Andreas thinks crypto is the perfect hedge against the balance sheet size of the Fed, but not a good hedge against inflation as in CPI. He thinks right now is a window of opportunity for crypto, but the true opportunity for crypto and long-duration tech stocks will be when the liquidity cycle turns around again.

Andreas segues over to Emerging Markets: the BRL has rebounded and MXN is moving as well.

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Feature Interview

Nick Stadtmiller is the Director of Emerging Markets Strategy at Medley Global Advisors.

Andreas: What do you think about current sentiment and a potential soft landing?

Nick thinks there's a lot of uncertainty and there are a lot of diverging opinions out there. He thinks that there's going to be a severe recession in Europe, but the uncertainty for the US economy is very high. That and the strong dollar hurt sentiment around emerging markets.

Alf: Inflation in the US has slowed down this week. How does it influence your thought process?

Nick responds that the sell-off in the dollar and the yield curve steepening were a goldilocks moment for emerging markets. The market expects the Fed to hike less while at the same time the 10-year yield isn't coming down as it would in a global growth slowdown. It also takes pressure off EM central banks if the Fed stops hiking: widening yield differentials would force them to hike even if they see a recession in the future. Still, he doesn't believe we're there yet, because we don't know how sticky inflation will be, and he thinks the market might be a little too optimistic on that front.

Andreas: Is it possible to kill the current inflation momentum without causing a recession in the US?

A soft landing is very hard to achieve because so many things have to go perfectly. It would be too difficult for the Fed to let inflation remain above target in sacrifice of the employment mandate. Nick expects that the Fed will have to accept higher unemployment and lower growth to achieve its inflation goal.

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Alf: What's your view on the dollar and how does it tie into the emerging market economies?

Usually, people use the Dollar Index (DXY) as a proxy, which is about 60% EURUSD. But even EURUSD is very highly correlated to EM currencies. Currently, the market isn't pricing an aggressive and sustained interest rate path that the Fed has set out. So, Nick believes there could be an upside to the dollar that puts pressure on EM central banks to be more hawkish than they planned because they face persistent currency weakness over the next several months.

Andreas: Which countries will be the relative winners and losers in a scenario like this?

Nick points out there's a lot of uncertainty about his hypothesis of a stronger dollar. He can see the dollar pulling back and yields coming down significantly, so he believes it's very hard to make directional bets on single EM currencies. Rather, he favours looking for relative winners. He looks for countries with stronger domestic fundamentals: Mexico can outperform in Latin America, particularly over Brazil, since it's closely tied to the US economy.

Alf: What's your take on Europe?

Russia and Ukraine are obviously knocked out. Turkiye is a complete mess, but Nick expects them to “muddle through without a serious crisis over the next year”. The CE3 countries (Poland, Czech, Hungary) have interesting monetary policy stories.

Those countries hadn't moved rates for years and had very dovish forward guidance in effect:

• The Czech central bank went from being the most hawkish one to being pretty much the most dovish bank

• Hungary has the lowest inflation but by far the highest policy rate and they give hawkish guidance

Hungary has the weakest fiscal position, and there's a lot of hope for EU funds while PM Orban cosying up to Russia and spitting in the EU's face is a risk. So, the market may be too optimistic about the recovery fund money. Also, Hungary is much more dependent on gas than Poland and Czechia, especially since they depend heavily on Russian gas, which can only get into Hungary through either the EU or Ukraine. That makes them potentially much more vulnerable. Nick thinks there's no way the rest of the EU will watch Hungary get away with sourcing cheap gas from Russia while Germany and other EU countries get cut off. So, it's a no-win situation for Orban, and Nick expects the Hungarian Forint to underperform among the CE3.

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Andreas: It looks like Italians are exporting stuff to Turkiye, and from there to Russia. Are certain EU countries using this loophole to circumvent sanctions on Russia?

Nick has looked at the data in more detail, and he doesn't think it's a big issue but more of a catch-up from a dip around Covid. Italian exports to Turkiye are picking up, but global imports in Turkiye are picking up because of their reckless monetary policy. And Russian imports from Turkiye are probably substitution for goods they can't get elsewhere.

Alf: What's your take on China?

Zero-Covid has been the biggest headwind sentiment-wise, and there hasn't been a lot of willingness to provide a lot of monetary stimulus. The Chinese don't want total credit growth to run away again and have people accumulate bad assets, especially when you look at their problems with the real estate market. They are doing some infrastructure spending, and they've upped the percentage of stimulus that has to be spent on wages from 30% to 50%. It's more geared towards stimulating domestic demand vs. stimulating demand for importing commodities.

There's not going to be runaway growth with this kind of stimulus but more of a slow recovery back to a 5-5.5% growth range. Even if it's slow for China, compared to the rest of the world in a slowdown it's still pretty good.

A lot of Emerging Market policymakers are probably using models with data like Chinese GDP, industrial production and demand for commodities, so there's room for disappointment there. So, the current recovery in China probably doesn't have as much impact on other EMs as it did in the past.

Andreas: Do you fear China will become as uninvestable as Russia as tensions around Taiwan increase?

Nick says he's not an expert on that, but he's talked to a lot of them, and his opinion is basically a summary of what he's heard so far. He does not think it's a 6-month to 2-year risk, but on a longer timeframe it's on the horizon. A lot of investors worry about the risk since the Russian invasion of Ukraine, so it's going to keep a lot of capital from flowing into China.

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Alf: Let's talk about India.

Southeast Asia is probably going to be a bright spot going into next year. Growth forecasts show accelerating growth, so the macro backdrop is more supportive than in EMEA or Latin America.

Andreas: Why do you like the outlook for Mexico more than for Brazil, as you mentioned earlier?

The tight labour market in the US leads to higher remittances for Mexico, which is a big source of foreign income. Import demand from the US is strong, too. There has also been quite a lot of fiscal responsibility, which is a surprise given the long-standing fears with AMLO as their left-wing president. The one risk factor is trade disputes with the US.

As for Brazil, lots of things have been going wrong for them lately: commodities are down, which is dragging their terms of trade lower and that's weighing on the Real. Also, Bolsonaro has engaged in a lot of fiscal spending to secure his reelection. Now it looks like his opponent, Lula, is going to win the election in October. He could well be more irresponsible than everyone expects already. But even if he's not, just normalizing fiscal policy and debt sustainability are going to be hard.

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Alf: What is your actionable macro trade?

Number one is going long the PLN vs. the HUF as a geopolitical play:

• Hungary's relationship with the EU isn't going to become any better, they're not going to get the EU recovery funds

• Fiscal challenges in Hungary

• Poland has a higher reliance on domestic demand (among others from the inflow of Ukrainian refugees)

Andreas: What do you think about the carry in that trade and in BRL vs. MXN?

Both of them are negative carry, PLNHUF is about -3% and MXNBRL is about -4.5%. Nick has a relatively short horizon on his trades, both trades could play out in the next few months.

Brazil is probably done hiking, whereas Mexico could even do 200 bps more, so the carry is likely to shrink. Poland doesn't have much room for disappointment, because its central bank is hawkish and they've said that they're going to hike more if inflation is sticky.

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Post-interview discussion

Alf recaps that the two trades are:

1. long PLN vs. short HUF

2. long MXN vs. short BRL

Both of them have negative carry, and Andreas thinks that in the current environment he likes negative carry trades. The main reason for the PLNHUF trade is Victor Orban and his clash with the EU, especially when energy shortages increase. It's a geopolitical trade with a bit of mispriced interest rate differentials. As for MXNBRL, positioning in the Brazilian Real has been extremely positive and it's still positive despite the slide in commodity prices.

Andreas like both trades, but has concerns about timing and the fact that the global slowdown is currently not hard enough and more like a soft landing.

Alf says that the asset classes that are rallying now are associated with strong economic growth. Real interest rates are going up and equities keep on going. That means that either risk premia are compressed to pretty low levels because the Fed is managing the soft landing perfectly or economic growth will meaningfully surprise to the upside. So, you really need to get the story about the soft landing right.

Andreas says that it's usually a bad idea to bet against an inverted yield curve. And in about ten out of 13 attempts when the Fed tried to run a hiking cycle, it managed to hike the economy into a recession. He personally wouldn't bet on a soft landing.

Alf comes back to negative carry trades: they're not going to work when there are higher odds of a soft landing and implied volatility comes down across asset classes.

As for growth, Andreas says that we've had a technical recession in the US in H1. Nominal growth has been pretty strong, but it has been outrun by the high inflation numbers. For Q3 we could get a decent real growth print, because of inflation slowing while nominal growth remains relatively strong. He expects a drop in nominal growth significantly in Q4 regardless of inflation. He's therefore not believing in a soft landing, but for Q3 the market could rally because of growth outperforming inflation.

EPOL is an iShares ETF for Poland. Andreas thinks Poland is a high-beta play on the German economy as both countries are closely linked. If there's a small bullish surprise to the German outlook, it should perform well. He also doesn't think anyone is left to sell Europe, because everyone is bearish already, so he's slowly starting to become a bit more positive on Europe.

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• The Extras section is going to feature about one email/post per week, usually around Wednesday.

• The main idea is to always provide something that has value.

• For now it's mostly going to be write-ups of finance and macro podcasts, but I might mix it up a bit later.

Why podcast write-ups? I listen to a ton of macro and finance podcasts. Some of them are pretty good, and I often take away a few things I hadn't thought about or considered before, especially when I disagree with what's being said. If the discussions or interviews get a bit more complex it's often hard to follow without pausing, rewinding and re-listening, though. And after the episode… most of what I just listened to is just gone, unfortunately. I tried taking notes a while ago and recently came across the idea of doing write-ups.

I think these write-ups are really valuable, because you can go through that in minutes instead of listening to a podcast episode in an hour, and some people like myself are just much better at taking up information via text than via a podcast.

Leave a comment to let me know what you think.

So, here's the first one…

If you like this newsletter, please consider subscribing and sharing it or forwarding it to others who might be interested. I'm also on Twitter @fxmacroguy if you want to reach out.

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Release date: 05.08.2022

Host(s): Imran Lakha

Guest(s): Andreas Steno, Brent Kochuba, Darius Dale, Tony Greer

No charts were included in the video, all charts were added by me.

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Notes

Imran does a quick walk-through of what happened since the Q2 roundtable:

• S&P dropped from 4.600 to 3.650 before the recent bounce

• Bonds have been a bit more receptive to recession concerns, further inversion of the 2s10s curve

• Commodities have seen wipeouts in ags and metals. Energy has been a bit more resilient

• Dollar wrecking ball has been in play

• Energy has thrown Europe into stagflation, the ECB is cornered

• Crypto has been dragged down by macro weakness and financial conditions tightening

The guys’ macro views

Darius’ view: The inflation cycle upturn has been more aggressive and more protracted than expected. As a consequence we're now in a liquidity, growth and earnings estimates downturn that's likely to be deeper and more protracted than what is expected. The outlook for risk assets is therefore unfavourable, and he does not believe the lows are in.

Andreas’ view: This is currently the biggest interest rate shock in modern history, and interest-rate sensitivity-based models imply PMIs heading as low as 35-40. He thinks it's a no-brainer to play risk assets from the short-side because he expects growth to slow down more than currently priced in.

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Has inflation peaked enough to go long bonds?

Darius and Andreas have advocated for a long bond position. Imran asks whether inflation has peaked enough to go long bonds.

Andreas answers that there's party in the front and business in the back of the yield curve with the short end is very inflation-focussed while the long end is starting to trade the slowdown in growth narrative. He believes the yield curve will invert further and likes to be long the long end. Darius adds that his long bias is because of the Fed's resolve to get inflation back to 2% target and less with inflation peaking. He thinks the recent FOMC meeting supports that view, because:

1. The vote for 75 bps was unanimous despite two new FOMC members and Esther George having dissented at the meeting before,

2. Powell was very dismissive of recession fears, and

3. The Fed wants growth to slow.

Tony says he agrees with what Andreas and Darius have said about the economy. From a trading standpoint he sees equities going higher before going lower:

• S&P futures positioning is as short as during Covid lockdowns and during the 2015 selloff

• Sentiment indicators are still very much on the fear side, also sentiment on Twitter is similar.

He believes it's a short-covering rally that has room to at least 4.300 in the S&P before it's over. His trade is commodities outperforming technology, so recent market action has been a huge retracement.

Brent says that positioning has been in place for the rally to occur. The market is now in a neutral zone as far as options positioning is concerned. Bottoms tend to come with fear and loathing, but so far it has been: when can I buy the dip? He also thinks that there's a risk-on bias right now just based on how stuff has been trading.

Imran says that in the 1970s the 2s10s spread went to -200 bps. Having a flattener on is safer than being long bonds. He expects higher volatility especially in the rates market because the Fed isn't giving forward guidance anymore.

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Are metals going to be leading the way lower like in 2008?

Imran: Let's focus on commodities. There's been a bit of a flush-out in ags and metals. Are metals going to be leading the way lower like in 2008?

Tony says there's a battle around how slow the economy is going to be for how long. Energy has pulled back but it doesn't want to break below support:

• There's no spare capacity to control upside in price: OPEC spare capacity is limited, Saudi rig count is down to 31 from normal around 75

• Gasoline open interest has fallen to lowest levels in 10 years, no speculator positioning on the long side

• Gas demand is strong, currently record demand in the US

He says his gut feel is that the market is going to break down, but it's really a battle between the physical markets and the perception of where markets are going. But: inventories are low, spreads are in backwardation and energy policy heading to net zero will cause energy markets to remain super tight. Plus, there's going to be a “Battle Royale” between Russia and Europe in the winter, so he maintains his long bias on energy.

Imran asks why agricultural commodities have been destroyed when natural gas feeds into fertilizer prices and the food supply. Tony says that ammonia prices have barely budged and are still up 8-10 times, so it's very difficult to reconcile the currently low grain prices. Andreas adds that there's a time lag between the price of natural gas, fertilizers and food prices. Gas prices in Europe are up by a factor of about 10 since December and energy demand is extremely inelastic. Electricity is up by 1,000% while usage is down 2.5%. So even if price explodes people will still consume energy.

Darius believes that inflation is going to be much lower a year from now, but it's unclear if it's going to be 2%, 4% or 6%. The Fed's guidance says 2.7% Core PCE by the end of next year, so about 210 bps lower than in June. That has never happened in the past without going through a recession, especially since structural changes are shifting inflation higher:

• Deglobalization,

• Under-supply of labour particularly in the US, and

• Structural under-supply of commodities.

These things aren't going to go away until the end of next year, so it's likely the Fed has to tighten for longer.

He adds that we've seen crude oil prices rise through three of the past seven recessions: 1973-75 with the OPEC oil embargo, 1980 and 1990-91, and it rose for the first eight months during the GFC.

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What's the outlook on the dollar?

Imran asks whether the pullback in the dollar is just a pullback and what the outlook is on the dollar.

Andreas answers that he's very positive on the dollar. There are two dollar liquidity sources: the Fed and global trade (US exporting dollars via negative trade balance). If global trades shrinks over the next couple of quarters and the Fed is tightening it's going to be bullish for the dollar vs. most other currencies.

Darius says he likes short EURUSD for a couple of reasons: Europe is heading into a recession and there are secular shifts in terms of trade in favour of the USD vs. the EUR.

Imran has been a seller of EUR for months, but he's surprised the BTC-Bund spread has stopped breaking higher.

Andreas thinks the ECB won't use the TPI but the old tools instead where they shift reinvestments from PEPP towards Italy, and they are not going to tell us. The question is to what extent Germany is willing to accept it. He thinks they accept it for now because of the geopolitical and energy situation in Europe at the moment. Tony is very bearish EUR especially when Europe is at the mercy at Vladimir Putin this winter. He envisages a scenario with massive unrest and even higher pressure on the EUR than right now, and he wouldn't be surprised by a complete breakup of the EU. Imran thinks it's possible for EURUSD to be at 0.80 at the end of the year.

Imran says that the other thing driving the dollar is the yen and he's asking for thoughts on it. Andreas believes it's still a good trade to be long the JPY, especially vs. the Euro. The BOJ will receive a tailwind if he's right on his growth outlook.

Darius looks at his model and estimates that USDJPY is either 5 big figures too overpriced or the US treasury yield that is about 50 bps underpriced.

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Could crypto be a leading indicator out of the current bear market?

Imran asks what the guys think of crypto after the flush-out.

Darius agrees with the view that Bitcoin has been a leading indicator historically, because it's completely free-trading. Its leading properties are mostly at the highs, though, and he doesn't think it's going to be a particularly good leading indicator at the bottom. He believes that there's more downside in crypto because of the liquidity cycle.

Andreas bought crypto when he left investment banking, and he bought it at the peak. He thinks crypto has the highest beta with regards to the liquidity cycle. Tony sees it as a levered bet on risk assets, believes it's going to go lower to around 10k. Brent thinks that there isn't a case for large crypto adoption. Imran doesn't see Bitcoin as an inflation hedge but a hedge against monetary debasement: it's going up when asset prices are rising, but when you have actual inflation it's not performing. He agrees that we haven't seen a bottom in crypto, yet. The Ethereum merge could be a short-term catalyst for more upside. Darius points out that there's still a lot of regulatory risk.

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Can the market rally if everyone expects a Fed pivot?

Imran: And when the Fed is done, what are you guys buying?

Andreas believes financial conditions need to be tighter to have a recession, so the Fed will need to do more in the short-term and they will need to do more than is priced in. Fed speakers have been trying to communicate that, because they want demand destruction. After the Fed pivot he thinks ARKK will be performing again.

Darius thinks equity markets aren't pricing in a recession at current valuations. He believes that the market isn't able to discount far enough into the future.

Tony believes the Fed pivot is going to be kept in check by commodities. He can easily see oil being back above $100, energy remaining super tight and headline inflation not dipping much below 8%. It's hard for him to even get to a Fed pivot. A possible easing cycle is too far ahead for him to consider it.

In Brent's opinion the beaten-down tech stocks could rebound because of short-covering. Imran adds that in the latest bounce you would have thought ARKK would outperform: crypto ripping up hard, bonds ripping up hard, but ARKK isn't going up. People want high-quality tech because people don't think the bottom in the market is in.

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Is equity vol just a useless hedge or do you expect a better performance from equity vol in the second half of the year?

Brent thinks that unless there are major credit issues and defaults there won't be a 60-handle VIX. The market feels that vol is grinding lower when there's a selloff. Imran believes that people were well hedged, possibly with put spreads, so dealer's weren't caught with short vol on the way down, so they didn't have to bid up volatility. He thinks there needs to be more complacency in the markets for vol to spike. In the first 10% down from here he doesn't think vol is going to go crazy, but more on the next 10% after that. Tony is buying the dip in the S&P, because he thinks we can rip higher, but he wants to be long vol from a tactical point. Brent points out that there are individual stocks that can fall precipitously, he mentions the ARKK basket with stocks that have seen a lot of short-covering but don't really have a business case. Imran: S&P vol is a broad basket. When MOVE was at its highs the S&P vol wasn't doing much, because the volatility was going on in the form of sector rotation. Rates vol and FX vol are probably going to be moving more than the VIX.

Brent asks Darius about the MOVE and whether we can see equities higher as long as the MOVE isn't going lower. Darius responds that the Fed speakers pushed back against market interpretations of a Fed pivot and that led to a full 25 bps move higher in the terminal rate expectations in a single day. There was barely an impact in risk assets. That means that there's investors pushing back into equities. He's tracking the VVIX/VIX ratio.

Normally, in a bear market that's going lower because VIX is spiking faster than VVIX. This year it has been kind of the opposite: the VVIX is going down faster than the VIX. He thinks it's an indication that market participants have taken down a lot of risk. Imran thinks that the general consensus is that the VIX isn't going below 20, so put flow in the VIX has changed because no one wants to buy VIX puts any more. That keeps VVIX suppressed.

Darius has looked at the 17 bear markets since the Great Depression, and the market usually doesn't bottom before the inflection point of the liquidity cycle: typically it bottoms one month after and in an inflationary bear market three months after the low of the liquidity cycle.

What are you buying when things turn around?

Tony is already long because he's trading short-term: natural resources, fertilizer stocks, covered retail shorts and Q's short. Preparing to re-enter shorts around 200-day moving average, thinks towards the autumn markets are going to fall again.

Darius thinks you want to buy defensive assets if you think the June low is holding. If you think this is just a bear market rally then he favours a short-dollar trade three to six months from now.

Is the bottom in yet?

Darius: no.

Tony: no, “but it's in for now for me” because he's on an hourly timeframe.

Brent: no.

Imran: also no.

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