Transcripts
Erik: Joining me now is Charlie McElligott, Nomura's cross asset macro strategist. Charlie, what a perfect week to get you back on the show because your team is really good at looking at market internals and the flows and so forth. Here's my question. If Bear Stearns just happened and I contend it did, it's called SVB. And you're not sure if Lehman is about to happen next. How do you tell because the Fed and other government officials have a strong incentive to lie in order to shore up confidence? What can we look at in the market to tell whether this banking crisis is a flash in the pan that's already over or if it's something that's just getting started?
Charlie: Appreciate being here. Great to speak with you again. Look, this is one of those rare opportunities where I get to kind of step back from very tactical flows, and look at some actually larger structural, strategic stories. And, you know, that is exactly what's happened over these past few weeks with regards to you know, both the the US regional bank dynamic as well as the, you know, the EU bank story, with SIVB, and Signature, and SI, and Credit Suisse. You know, all of those fails are idiosyncratic symptoms of this larger bank profitability crisis becoming a solvency crisis. And, you know, as it relates to your question, these are long term structural dynamics for banks, whose kind of profitability models were built for an era of 0% interest rates and an era of large scale asset purchases, and an era of slowflation. And we're seeing, you know, the emperor has no clothes pretty clearly here. And, you know, as it relates to, you know, too flat yield curves, as it relates to higher cost of capital, wider credit spreads for banks, and all that means negative carry. So, you know, NIM compression, you know, it's a future state of enhanced regulation and forced capital raises.
And all of that is against this, you know, huge headwind. That's really the catalyst here, which is this continued deposit flight story. Too low deposit rates, versus customers who are then being incentivized to continue shifting money out and into money market funds that sit at the RRP or direct into bills that are offering magnitudes higher premium. So it's that two-tiered US banking system. You know, Janet Yellen got absolutely pinched on her testimony two weeks ago, and that clip that went viral. And basically, it's telling you that there's like a structural long term placeholder trade here. It's like long the major banks versus short regional banks, and the implications of it from the big picture is that, you know, this profitability and solvency crisis becomes a massive financial conditions tightener. And ultimately, you know, in a fractional reserve banking system, where, you know, this is the transmission mechanism for US economic growth. The global economy is going to get toasted, because these banks are going to go into zombie mode, at best and at worst, it means that, you know, credit and lending doesn't flow out into the economy. So it's a really big story. It's a really significant story. And it's where this cycle that's kind of been on this, you know, slow autopilot for the last while, as you know, fed hiked rates and without a lot of market impact. Now, it's really taking a turn.
Erik: Joining me now is Luke Gromen, founder of Forest for the Trees. Luke, what a week! The big news, of course, that came out over the weekend was the failure of Silicon Valley Bank. This is a bank which specialized in setting up fundings for venture capital firms for startups in Silicon Valley. Therefore, a lot of big companies with a lot of cash that was not insured, that bank failed. I think, because of the Fed's hiking cycle. Do you think that that was the cause? And if not, what was the cause? How do you interpret this and what does it mean for the Feds hiking cycle?
Luke: Yeah, thanks for me back on, Erik. I agree, I think it was ultimately the Fed's hiking cycle and really inflation driving the Feds hiking cycle that caused it ultimately, you put that bank and a number of other banks in a position where they have to compete with the Treasury market, the short term Treasury market in particular money markets, money market funds, where the yields error, call it at least before today's trading for three quarter percent for 30 day money, give or take. And so that puts the banks in an uncomfortable position of either having to raise deposit rates, which will put pressure on net interest margins and earnings, which is never popular with bank management's and bank investors or they need to sell these bonds to fund the deposit outflows. But the problem is, is there are these were supposed to be high quality liquid assets. And they've been not so liquid, and they are down on price. And so banks, and I'm not an expert on bank accounting. So take this with a grain of salt. But the gist of it is that the banks don't have to take a mark on big chunks of their securities books, unless a couple of things happen. One of those things being if they sell the bonds, so they would have to mark losses, and that would also hurt earnings, or they have to issue a bunch of equity, or raise otherwise raise capital to replace the deposit funding, the cheap funding as as the deposits go elsewhere, looking for yield. And so it's it sets up a choice of a number of choices for banks that all of which either hurt earnings or margins, are hurting margins, or dilute shareholders. None of which they are really big fans of so I agree with your assessment of it.
Erik: Joining me now is GaveKal co-founder Louis Vincent Gave. Louis, I've interviewed you quite a few times over the last several years. And if there's anything I've learned, the best way to approach an interview with you is take whatever the one really big macro theme of the day is and ask you to sort of frame that in terms of what the markets are telling us. Just one problem. I don't know how to decide! There's so many big macro themes, from geopolitics to energy to everything else. What's the biggest theme in your mind and what should we talk about this week?
Louis: Well, first thanks again for having me Erik. I really enjoy our conversations so thank you so much. To your question, to be honest, I'm as confused as you are. And I want to say this and really no modesty today. It is very hard to parcel things out. As you point out, you want to strip out the signal from the noise and all that stuff. But I think there's so many moving parts right now that I think any investor, the first thing we have to acknowledge is to be very humble, to accept that we're going through things that, probably no investor below 75 has gone through and you know, I've got a whole list, I'm happy to rattle off. But, the first thing and I know, you've done a number of episodes on this, but, we're going through the end of the peace dividend, right? I know, you've called it world war three. Some people call it the start of a new Cold War. Either way, we have the end of the peace dividend in here. I love what our mutual friend Luke Gromen pointed out the other day is if truth is the first casualty of war, then bonds is a close second. War is always and has always been inflationary, whether a Hot War or a Cold War. So that's for me as a first important, obviously, big marker. Wherever you care to look in the world every meaningful economy is increasing its defense spending. Whether in Europe, in China, obviously, in Russia, obviously in the US. And military spending is fundamentally unproductive spending. You’re spending money on a bunch of things, high priced items that you hope you never use. So that's a first dramatic shift. Unless you were investing 30 or 40 years ago, you're not used to rising military budgets, you've always had sort of shrinking military budgets.
Now against this, the second massive shift is, most countries are going through a very important demographic transition. Most countries are aging and aging fast. The big pools of excess labor in the world that used to be China, India, Mexico, places where women would have 2, 3, 4, 5 children per women now have less than two children per women. And so we are going through, you know, an aging in our societies, and just looking globally across the world. We no longer have somebody like China adding an additional 20 million workers to the workforce every year. And for me, that's a paradigm shift. I know a big theme of yours has been the energy transition. And it's been one of mine as well, we've talked about this before, my go to line is that economic activity is energy transformed. And really the story of the past 250 years, the story really of rising wealth levels, rising disposable incomes, is fundamentally a story of humanity, always moving to more efficient methods of producing energy. You know, you start with coal, you move to whale oil, you move to oil, you move to natural gas, you move to nuclear. And for the past 10-15 years, we've decided, let's move away from all this and move towards more inefficient energies. Wind, solar, and we need to do this because otherwise we're going to destroy the planet. But in so doing, there's a tremendous economic economy cost and economic cost is, you know, means lower living standards. Higher energy prices means lower living standards. So we're going through this energy transition. And that's another big uncertainty out there.
But for me, perhaps the biggest, most important structural question is whether the monetary system such as we've known it for the past, really 70 years since World War Two is in the process of changing and you and I have talked about this before, but cutting off the biggest commodity exporter, namely Russia from the US dollar system, I think basically amounted to cutting our nose to spite our face. I know we don't like Russia, I know they're bad people. I know all these things. But the fact that we're now seeing deals for oil, deals for iron ore, deals for coal being done in Renminbi, Rupees, Thai Bahts. I think we've started a structural shift and the global monetary system and these things, of course, don't happen overnight. But that to me adds a lot a lot of uncertainty in the world that we live in. And then against that you have all the cyclical uncertainty. So you got these, for me these big four structural forces that add just enormous uncertainty for lack of a better word.
And then you got the cyclical stuff, you've got a Fed that's tightening, while on the fiscal side in the US, you're still running massive budget deficits, municipalities, state federal level of spending money willy-nilly. You have the second biggest economy in the world that had been locked down for three years that is reopening. And a Chinese government, I know we talked about the Xi pivot. Last time around, most people looked at the Xi pivot thinking, okay that was just the opening. It's not just that. It's getting rid of the red lines on real estate lending. It's recapitalizing the local authorities to get local infrastructure spending again. So you got all these things going on. And what fascinates me is that most people you talk to only want to talk about the Fed all day, every day. Because I think as you know, through the years of QE, through the years of zero interest rates, we raised an entire generation of investors to just worry about what the central bank was doing, and to basically build all their investment decisions on that one factor, on what is the Fed doing. I think, given all these forces that I've just described, what the Fed does actually matters less and less. We’re seeing it now right? The Fed is tightening but, meanwhile, inflation stayed strong. And growth in the US is actually not as bad as people thought it would be and growth around the world, as you know, and inflation around the world are turning out to be still decently high. So I think against all this uncertainty, you have to be very, very modest. You have to look at the markets and say what messages am I getting from the markets today?
And personally, the message I'm getting is, bonds are done for. We’re now entering a second year where US Treasuries are losing money. OECD government bonds serve no purpose in portfolio. We're now entering the second year where emerging market bonds are up, outperforming OECD government bonds. For me, these are important, important messages. Energy stocks are volatile, but they continue to do pretty well in spite of an energy price that has remained stubbornly low. And that, to me is a big mystery. Why isn't energy rallying more but again, we have to be modest. There's dramatic shifts going on in the economy and to think, you know, I love to work with decision trees. It's like, okay, you ask a question, you go, yes-no, etc. But when you have 5, 6, 7, 8 questions and each time you have a yes-no answer, your decision tree gets to be too many branches. It's like being a chess player. I was a very modest chess player in my youth, I could think maybe three, maybe four moves ahead. The great chess players think eight, nine moves ahead, and they've got everything mapped out. Unfortunately, I was never that guy. And so um, in all honesty, I find today very, very tough.
Erik: Joining me now is Dr. Anas Alhajji, founder of Energy Outlook Advisors and noted keynote speaker and general expert on energy markets. Anas prepared a slide deck to accompany this week's interview. Listeners, you'll find the download link in your research roundup email. If you don't have a research roundup email, just go to our homepage macrovoices.com. Click the red button above Anas's picture that says looking for the downloads. Anas, it's great to have you back. I wanted to ask you back because we've just passed the one year anniversary of the beginning of the Ukraine war with Russia. Let's start with the lessons learned to date from this experience in with respect to energy markets. What were the surprises? What have we taken away? What have we learned?
Anas: Thank you very much for having me, Erik and it's always a pleasure to come back to MacroVoices. We learned several lessons in oil and gas and other lessons in even macro economy and related issues like in international trade. But when it comes to oil, one of the main results of what we've seen in a year of conflict is the change in the direction of international trade in energy sources. And specifically, we are talking here about oil, gas, and coal. Just to give you an example of this change. India's oil imports from Russia in December 2021, were only 1% of the total imports, the total oil imports of India. So it was 1% in December 2021. In December 2022, it jumped to 21%. And right now, it is about 24%. Simply because we have this diversion where oil start going to Asia instead of Europe. For China and by the way, and this is a good lesson for listeners right now, because this is one of the most important outcomes of this war is we have to be very careful with the data. And I will emphasize this point one more time. And the reason why because whenever we get data from India, or China, or Saudi Arabia, or any other country, these are the official data. But the market is somewhere else because we have a massive black market on one side. And some countries like China are importing the Russian oil through a third party. So they show that they are importing oil, let's say from Malaysia or Indonesia or other country. But really that is Russian oil.
So if you look at the official Chinese data, we see a jump in oil imports, until almost June or July. And then it dropped and people think well, China is not importing that much from Russia, while China basically is importing massive amount from the black market, and another amount coming from third countries. So we've seen this change in direction, while we've seen African and Middle Eastern countries, exporting to Europe to replace the Russian crude. So the first result is the change in direction of international trade and energy resources that applies to natural gas and it applies to coal to. The second result is the filling of the Chinese strategic reserves. China used most of its strategic reserves in 2021 to prevent prices from reaching $100. And they were hoping that because of the seasonality that global oil demand will decline in the first quarter of 2022 and with that prices will decline and with that they can refill and Putin goes to Ukraine, prices go through the roof and the Chinese got stuck. But they got lucky. Lucky on two fronts. First, they were able to get the Russian crude. And the second, they had the lockdowns. So from one side the demand declined substantially. On the other they were able to get the cheap crude they were dreaming off. And they were able to refill their commercial inventories and their strategic petroleum reserves. Until the end of the year of last year 2022, they had 1.1 billion barrels of reserves, that's commercial and SPR, underground and above ground. And although the commercial inventories declined in recent months, the level of inventories of total inventories in China today is higher than that of the United States, despite the fact that the US consumption is higher than that of China by five to 6 million barrels a day. So the first result is change in direction of trade. The second result is the filling of the Chinese strategic reserves. And as you recall from our previous Interview, the implications of the Chinese filling up and reusing that are huge.
Erik: Joining me now is MI2 founder, Julian Brigden. Julian, it's great to have you back on the show. I want to start with inflation. A lot of people are saying that it's topped. Okay, my question is, well, we all know that inflation was driven, at least partly by pandemic effects. That's probably why we got so high. But even if it's topped, does that mean we're going back to 2% or does that mean that we're really in a new regime that is going to be more inflationary?
Julian: So I mean structurally, we don't know that for definite, right. But if you ask me the likely path of the dots over the next decade, and are they structurally inflationary? My answer would be probably yes. Now, I mean, my analogy has always been the sort of late 60s into the 1970s, to some degree. And even then, in that period we saw four big waves of inflation. The point is, if you never rang, we never were truly successful in ringing out the inflation. And so each sort of low was slightly higher after that initial burst. And that's kind of the world I think we're living in. Right here, right now that would almost certainly suggest that we are and this has certainly been our view. And since late summer, last year that inflation has topped, at least for now. And it is coming down. I think there is a couple of things that the bulls don't quite understand about the relationship between inflation and nominal GDP. And how just even if we were to wake up tomorrow morning, and inflation would be zero, the Fed would still be raising rates. Because I think, the equity boys myopically focus on that inflation component of nominal GDP and don't look at nominal GDP in aggregate, that's very important. So bottom line, I think it is coming down. Certainly headline, I can see quite a lot of stickiness in core and services. And that means the labor market has to be addressed and that's a different question Erik.
MACRO VOICES is presented for informational and entertainment purposes only. The information presented in MACRO VOICES should NOT be construed as investment advice. Always consult a licensed investment professional before making important investment decisions. The opinions expressed on MACRO VOICES are those of the participants. MACRO VOICES, its producers, and hosts Erik Townsend and Patrick Ceresna shall NOT be liable for losses resulting from investment decisions based on information or viewpoints presented on MACRO VOICES.
