Erik: Joining me next on the program is MI2 Partners (Macro Intelligence 2 Partners) founder, Julian Brigden. As always, Julian has prepared an outstanding slide deck for us. You’ll find the download link in your Research Roundup email. If you’re not yet registered, just go to macrovoices.com and look for the download and registration instructions next to Julian’s picture on our home page.
Julian, I know last time we spoke it was a very similar market environment. You had made some money for your clients on a short Treasury trade. You had then told them to cover, and were waiting for a bounce to put that back on. I think that, since then, you have put that back on. You’ve made some more money for them. And I think, at least partially, you’ve started to take it off.
So, how do things look as we start to look into your slide deck here, in terms of what we’re seeing in today’s market?
Julian: Thanks very much for having me back on the show, Erik. It’s been way, way, way too long.
Talking about the Treasury market, big picture, we firmly believe that we saw the lows in Treasury yields in 2016. And that we’re structurally in a bear market. But we did recently – having been pretty aggressive shorts into Q4 – recommend that clients back off on those a little bit. Not fully, but to some extent. And it’s just because we’ve come up to some very big levels.
If you look at the chart pack that we’ve attached to this, you can see in 10-year yields, this 3.00/3.05 level is a very big level in the Treasury market. And we’re sort of sandwiched between the low 2.60s and that 3.00 level. I think we sort of continue to mess around in that level.
And 30s is actually even bigger. We’ve put in here a chart that takes you right back into the early ‘80s. You can see that we’ve got this inverse head and shoulders pattern, which has built over the last four to five years. That neckline comes in at around this 3.15/3.25 level.
We’ve also got a very long-term trend line. And a number of people have used this one 30-year trend line. I’m not really a big fan of taking something over that long a period. But the one that I really love, which is one that one of my partners uses, is this simple moving averages – 100-month simple moving average.
This has held the bond market all the way since 1985. And it comes in at around 3.25/3.26. We’ve actually never, ever closed above it since 1985. We opened above it once, in ‘94, but we closed below it. And, to me, this is a big level.
Erik: Joining me next on the program is Alhambra Investments CIO Jeffrey Snider. The subject today is, of course, going to be yield curves.
Jeff, I think most people know that there is this statistic that every major post-war recession has been predicted by an inverted yield curve. The thing that strikes me is, first of all, I think there’s probably more information to gain from just whether or not the curve is inverted.
But, particularly, the statistic about all these post-war recessions – all of those recessions happened before the current era of central bank intervention in the Treasury market. And it was also before the breakdown in the Eurodollar system, which you described in Eurodollar University as not really occurring until 2007.
So why don’t we start with the big picture? What should we be thinking about when we think “yield curve?” What does it tell us? Is it just the inverted or not? Or is there more to it? And how has the picture changed since 2007–2008, when so many things about the structure of the market are different now?
Jeff: Well, first, Erik, you’re exactly right. The yield curve tells us a lot more than just when it’s inverted and when we should expect recession. There’s a whole lot of dynamic information embedded within the curves – and various parts of the curves – that we can look at that tell us a lot about where we are and where we’re going.
And it’s more than just recession or not. We can look at an even bigger picture than that. What is the baseline economic growth? What is the bond market telling us about not just the baseline economic condition, but how that relates to monetary policy.
And, in some ways, the yield curve is almost like a check on monetary policy. Because the short end relates to what the Fed is doing and monetary alternatives that the Fed can create through its various programs. While the long end says: Well, are those programs effective?
So the combination of the short end and the long end in real time gives us a lot of dynamic and very useful information. Far more than when it inverts in the recession. There’s a lot there that we need to pay attention to. And a lot there that people should have been paying attention to for a very long time.
Erik: Joining me next on the program is John Mauldin, founder and Chairman of Mauldin Economics. John, thanks so much for joining me on the program.
The question that seems to be on everybody’s mind right now is: Are we looking at the end of a relatively small market dislocation with this VIX complex blowup and so forth? Or is this actually just the beginning of something much bigger?
John: I don’t think you could characterize anything as the end. There’s always things that move forward. But let’s remember that there’s always another recession. I don’t think Trump has repealed the business cycle. He’s trying to repeal the wisdom of tariffs, but he hasn’t repealed the business cycle yet.
And when we have a recession we will have a 40%–50% or more drawdown. So whatever bumps that we get between now and then will just be that – bumps.
Now let’s remember something: The last drawdowns that we had – the corrections if you will – were not the unusual part. They weren’t the odd part. The odd part was 15 months in a row without a 2% correction. Never happened, ever, ever. So that was the odd part. That should have been what we were all looking at and going “this is scary.”
It wasn’t a 5% or 6% correction. The type of correction we just went through was something that we normally get at least once every 12 to 18 months. You get a 5% correction every 90 days, every quarter. So that was the normal, if you will. The not normal was no corrections and just almost straight up.
And we’re going to see probably more corrections. We’re going to see more volatility. But I would argue that any correction we see now, absent indications for a potential recession, are buying opportunities. If you’re a trader you, you know, see things – when they get to the top you raise a little cash, and when they go down some it gets into your buying session. You buy some, you go back in.
But market drops, absent a recession, are V-shaped. When you get a recession, that’s going to be ugly. And you want to be sitting somewhere on the sidelines and not involved. Because the buying opportunity will come.
Jim, I have so much been looking forward – ever since we launched this podcast two years ago with Jim Rogers, actually, as our first guest – I’ve been looking forward to getting you on the program. And, frankly, I’m glad it took this long because I don’t think there’s ever been a more important time in the last ten years to be very closely observing interest rates.
Before we get to interest rates, though, I want to start with a higher-level question. A new Fed Chair, Jay Powell, is running the show.
What is your expectation? Is Jay Powell a good pick to replace Janet Yellen? Do you think that we’re going to see a change in policy from the Powell Fed as opposed to the Yellen Fed? And what’s your overall reaction to the state of the Fed, so to speak?
Jim: Well, Jay Powell has one commanding credential. And that credential is the absence of a PhD in economics on his resume. I say this because we have been under the thumb of the Doctors of Economics who have been conducting a policy of academic improv. They have set rates according to models which have been all too fallible. They lack of historical knowledge and, indeed, they lack the humility that comes from having been in markets and having been knocked around by Mr. Market (who you know is a very tough hombre).
Jay Powell at least has worked in private equity. He knows a little bit about the business of buying low and selling high. Also he’s a native English speaker. If you listen to him, he speaks in everyday colloquial American English, unlike some of his predecessors. So I’m hopeful. But not so hopeful as to expect a radical departure from the policies we have seen.
Erik: Joining me next on the program is Alhambra Investments Chief Investment Officer, Jeffrey Snider. Our regular listeners, I’m sure, recognize Jeff’s name. Because of course he’s been the star of Eurodollar University, which is still available at macrovoices.com/edu (edu is for Eurodollar University). That is a very in-depth examination of the Eurodollar system.
We’re going to take a look today, though, at gold – coming from a different perspective. Jeff’s experience and knowledge of the Eurodollar system uniquely qualify him to understand a bit deeper picture than you hear and read about on the internet when it comes to gold.
Jeff has provided an outstanding slide deck to accompany this interview. You’re definitely going to want to download it. You can find the download link in your Research Roundup email. If you’re not yet registered just go to macrovoices.com and look for the download instructions next to Jeff’s picture on our home page.
Jeff, why don’t we go ahead and dive right into your slide deck here? As you talk about the history of paper gold, starting on Slide 4 you talk about the “gold swap.” And I think that’s a really important concept. A lot of people know that central banks engage in these gold swaps, but, frankly, a lot of us don’t understand the backstory of why they do this, how it affects the system, and what the mechanics are.
So, what are gold swaps? Why do central banks engage in them? And how did this all come about?
Jeff: Thank you, Erik. I think the first gold swap, or at least the first recorded instance of a gold swap, is a good place to start. There were some gold swaps that happened earlier in the 19th century. But at least the for one in 1925 there is some recorded history with it and some information about it.
I think that your listeners, at least those who are interested in gold, are going to recognize the year 1925 for its significance. Which was that the United Kingdom in that year went back to the gold standard after being off of it since the beginning of World War I. Winston Churchill had insisted that, if the UK were to go back on the gold standard, that it do so at the pre-war parity. Which meant that there was significant strain in the financial markets and in the economy for doing so.
The US central bank, the Federal Reserve, stood ready to aid the Bank of England in trying to defend the pre-war parity, despite all of those of difficulties. And one of the ways in which it did was this first gold swap in 1925.
Essentially, what happened was the Federal Reserve Bank of New York on behalf of the Federal Reserve system made $200 million of gold bullion available to the Bank of England for its disposal in whatever transactions it might take in defending sterling at that pre-war parity price.
What’s important about that is that it aids both sides of the equation. Because the way a gold swap works is that, essentially, the central bank agent that is providing the gold exchanges it for what’s called a gold receivable.
If you look at Slide 5, for example, I’ve sketched out roughly what this gold swap meant. $200 million in gold was made available to the Bank of England, which it would then sell in the market for sterling at the price that it wished to defend. They put the sterling currency into an account in London on behalf of the Federal Reserve Bank of New York.
So what really happened was gold disappeared from New York and ended up as cash in the UK denomination in London. But, for accounting purposes, the Federal Reserve Bank of New York showed a gold receivable where gold used to be.
You’ve heard the expression “as good as gold.” In this case it’s literally taken to be that. A collateralized account on behalf of a counterparty central bank was, in the thinking of people in New York and London, as good as having gold.
Because if (for whatever reason) the Federal Reserve Bank of New York needed its gold back, there was sterling in an account where it could theoretically buy it back. So the gold receivable was taken as equivalent to actually having bullion on hand in a vault in New York City.
So both parties were satisfied. The Federal Reserve Bank of New York got to continue reporting the same amount in its possession, while the Bank of England was supplied additional metal in order to help defend the sterling at pre-war parity.