Can The Fed Keep Raising Rates Amidst A Banking Crisis? | Michael Howell

all right everyone welcome back to another episode of forward marginal guidance which is of course the name of Jack and my um mix up collab show here uh today we are joined uh by uh Michael Howell of cross-border capital Michael welcome back to the show great to be here thanks for the invitation great to be here Mike great to talk to you Michael again good good hi Joe absolutely so maybe we can just dive in you know we're recording this um just a couple of minutes after chair Powell's fomc address has has ended uh there was a lot to unpack there before getting into kind of the Nitty Gritty details um Michael I'd love to kind of just turn it over to you and kind of get your high level take on chairpal's address yeah I'd say after having listened to a lot of these fomc uh press conferences I mean this has actually been one of the most interesting ones that I can remember uh those they actually say there's a lot to unpack I think the chair pal was very transparent he answered all the questions very honestly as honestly as he could have done um so I think that he gave a lot of clues about the the way the the fomc sees the the path forward in a way um so uh could you maybe get into get into some of the details there uh Michael like what stood out to you and maybe just uh to give the audience like the subtext at least for me going into this fomc meeting and why there was so much tension on it is you know the FED had been up until this point very clear about the desire to to hike and to use Powell's exact words to get the job done right but you know just a couple of these These past two weeks have been barked by several high-profile bank failures and actually culminating in a bank failure over in Europe uh with the in the form of Credit Suisse so there was kind of a bit of questioning about how much leeway the the Federal Reserve really had to keep hiking rates so I guess what um you know with that sub context in mind I mean what kind of stood out to you from this fomc well I think one of the things that seems to come out is that we're we're a lot nearer the peaking rates this week than we were last week or 10 days ago I think we're we're coming near to that Summit for sure uh they may all debate about how quickly rates can come down but I think it was uh interesting in the sense that uh let me pick out a couple of points that I noted one was that chair Powell noted they've been a sharp tightening in U.S credit conditions as a result of these uh of these Bank difficulties or failures so I think that's what one point to note that clearly will have to be taken into account in future assessments of monetary policy the second thing is that the fomc's own estimates of the terminal rate which I think one would have inferred may have gone up a tad pre the meeting was actually left unchanged so it's sort of signaling that we are in my view somewhere near the peak in rate uh that's at least as they see it the other thing I think that comes out of this is really about the balance sheet and I was kind of surprised by maybe the transparency maybe the honesty with which chair power dressed a lot of the very pointed questions about uh is this QT uh is the is an expansion on the balance sheet essentially derailing uh the existing policy uh what does it mean Etc and I think there was a lot of insight that came out of that and you know the takeaway that I would say is that he said look um this is not an attempt to alter monetary policy in other words this temporary lending to the banks uh it's very different from the prior policy of long uh of uh large-scale asset purchases which was actually the accumulation of treasuries that got put onto the FED balance sheet during the covid crisis uh he sees this as being different it's not an attempt to ease monetary policy but what I would say is it probably results in an easing of monetary policy and that may be a subtle difference but my reading of this is this is clearly a QT a quantitative easing or as I put it when I was uh you know tweeting the other day it's a quantitative something and we've got to hope it's a quantitative easing and that's what you know I would say now if we cut to the sort of the the chase of this the question that everyone's really got to ask is this is why are the banks the major casualties of increasing interest rates not borrowers because if you look at the what the economists say or what the textbooks tell us it should be the borrowers that are getting squeezed by higher rates not the banks so something odd is going on here and rather like 2008 and run like 2012 in Europe or 2019 or again in 2020 what this tells us is that it's a it's a funding or liquidity crisis and that's really the key point to take away so in other words it's not borrowers that are being squeezed so much or the real evidence of Blood on the streets it's actually the banks and the banks are clearly in a situation now I think if we if we take this narrative when we kind of roll forward what does it mean I think that the state of the banking industry worldwide is sufficiently troubled that what we're moving to quite quickly is a de facto nationalization if you like of the world banking industry now that's a big statement but let me try and unpack them a little bit the first thing is that when svb uh needs to be bailed out if my memory serves me correctly the FDIC initially said that large deposit holders would not be fully bailed out in other words they'd be the 350 000 US dollar limit correct right in 2012 after the European banking debacle then when you saw many banks under great great pressure I believe there was uh an agreement among the G20 governments that no banks would be bailed out or depositors would not be made good apart from these limits okay so the FDIC and the G20 agreed there would be effectively no bailing of depositors and what do you get the treasury or the government essentially derailed that and said svb everybody all depositors whatever they've got are made good so this is a fundamental change and as far as I can see and actually chair pal to his credit sort of hesitated about actually confirming this he you know said he wouldn't comment any more if my memory serves me correctly essentially what this means is de facto in my view that bank deposits have been more or less guaranteed now if the US is doing this including we don't know this is my inference we don't know it's true but I think that's the the extrapolation one's got to make here then all other governments worldwide have got to make the same commitment because otherwise the U.S banking system which is underwritten by uh the treasury is going to look a lot better than the European or the British or the Japanese or whatever it may be so I think that this is essentially saying what you've got is we're moving towards a situation whereby the balance sheet of commercial Banks and the balance sheets of of the central banks are de facto merging together so effectively overnight we've virtually nationalized Global Banks and we're moving very quickly towards Central Bank digital currencies all that effect and that's a big statement so that's my view of what's going on the U.S banking system is is clearly fine under that under that backdrop uh there's no problem okay at all but the issue that you've got to face is that what's going on now and what the problems what where all these problems were exposed is that the funding structure to come back to my point this is not uh you know this is a funding crisis the funding structure of banks worldwide is actually very difficult uh they they you know with a lot of losses on bonds and you know after all we saw that back in 2008 the losses were different kind of losses they're about credit risk these are about duration risk but those losses basically need to make be made good somehow and what you've got is the monetary Authority now standing behind that so I think that's an important point the second thing I would go on to say is that the corollary of all that is that Banks under this particular uh situation are probably going to be much better are regulated in other words you've got to expect some time down the road a Basel four if you like in other words they're going to have to there's got to be more oversight on what banks are doing and that may mean at the end of they hold more government debt now that may be if you like a virtue uh from the government's point of view and what you've got is a situation where this may be deemed uh Financial dominance so in other words the banks have been you know they've been bail out uh and they've had they've got liquidity but at the end of the day they are then being if you like uh subservient to the governments because the governments will use that balance sheet to actually hold more and more government debt and that if you like squares a very important Circle but it tells us one thing if I'm correct that we're looking at a situation moving forward over the next few years we're structurally the level of inflation uh in the world economy or at least in the west is going to be higher than we been thinking and the reason for that is that there's an awful lot of debt to finance out there in other words government debt just look at the CBO figures uh that have recently been released for the next decade about U.S fiscal spending and the size of the deficit they don't even put in uh what is likely to be a significant Step Up in defense spending uh I've said as well in many occasions that the US is actually the cleanest shirt in the laundry here once you start looking at other countries so the US is not that bad relative to what's going on in Europe uh for example and so what you've got is a lot of debt to sell and the banks may be the recipients of that so effectively the growth of debt uh by the US government is going to be reflecting on the growth of bank balance sheets which is going to be reflecting on the growth of money supply which as we know is ultimately determining the long-run inflation in the economy so I think there's a lot of there's a lot to unpack in that but that's my my view of what's going on and what was what we're likely to see uh coming out of this crisis is a significant increase in my view in the size of the Federal Reserve balance sheet we can dance on the head of a pin and say is this queue or your is this not QE my view is it is QE uh the multiplier effect onto the economy may be disrupted in the near term for sure but ultimately this is going to have an impact right and there's so much to get into Michael I so there's the solvency of the banking system and then there's liquidity solvency is or the assets exceed the liabilities you have more than what you owe and the uh liquidity is the ability to finance those assets so the federal reserve's uh discount window as well as the bank term funding program where it's extending credit lending Banks uh cash against collateral which actually can be posted at par value at a premium to what they would trade at the market that's applying an ample amount of liquidity and a lot of that as well as the discount window is responsible for the pickup in the fed's balance sheet uh which is followed by by many um but then there's the level of solvency which is affected by the level of rates because as interest rates go up Banks which you know have a lot of duration risk the the value of those would go down and their funding costs might increase as well is this primarily a liquidity issue in the banking system or do you think it's a solvency issue and depending on what your answer is does that impact uh your review of what the FED ultimately will do yes uh I think we have all the answers yes to most of most of your questions I think the first thing is yes it is a liquidity question liquidity problem that's for sure that's why I've said it's the banks that are really getting hit here uh not really the borrowers and that's telling you it's about funding and liquidity and there's a problem uh there could well be ultimately a solvency problem because at the end of the day if you look at the bank term funding program that the feds put in place it's effectively meaning that banks that take up this facility are borrowing at one year rates and those rates are now a tad higher after the rate increase today but they're basically uh they're they're getting as income they're paying out one year rates plus 10 bips but they're actually getting in as income uh the coupon on the coupon yield on their existing Securities now that is below the level of one year rates uh probably significantly so the Federal Reserve is actually uh embedding now and operating loss uh in these banks on their security portfolios and that comes back to the yield curve being inverted now what you can't have over the long term is an inverted yield curve so effectively you've got to have that changing its gradient and if we're in a situation as I suggested where there is more oversight and more involvement in the banking system uh both in the US and worldwide then I think you're looking at a situation where we move very quickly to what I've called yield curve control now yield curve control as we know has got you know there's there's a yield curve control in Japan right now you could argue that there's a form of yield curve controlling Europe in terms of uh trying to control spreads between European uh different Sovereign European debts uh there was a long history of U.S yield curve control uh during World War II and immediately afterwards all those episodes I would say have actually been pretty successful and I think it's coming back again now if you think about uh to go back to the scenario that I outlined is if we're in a situation where there's an awful lot of government debt to be sold uh in the future and we know the banks are probably going to be on the hook for taking a large part of that uh what's the interest rate that the government can stand uh you know maximum interest rate now I would suggest that that is somewhere like and you know I mean I'm willing to uh debate this maybe five percent you can't have anything more than about five percent otherwise you get a big spiraling out in the interest Bill uh in uh for the for the US or for any other Sovereign government worldwide right Michael just says the Federal Reserve today just raised interest rates from 4.75 to 5 so that's a five percent your threshold and we're there yeah okay that but we're there on the at the short the policy end right so I'm talking here about long-term debt so I think it's very difficult in of over the medium term or long term to get the interest rate on longer term debt up much above five percent because the interest bill would be too high now if you then said that the banks have got to earn a spread and let's say you need a yield curve of say a hundred basis points then you're talking about a ceiling on the policy rate of about four percent four percentage points so in other words we're above that level now now if that's the case that is effectively a yield curve Control process if they want to maintain that and if you run through the maths and it may be sort of difficult right here on air to run through the maps but very generally if you look at the growth rate of federal debt it's got to be mathematically equal to something like the primary budget deficit plus the interest rate uh prevailing interest rate on the debt now let me just try and uh try and go through these numbers just very briefly and simply so if you've got a primary budget deficit of three percent and you assume that uh let's say the debt GDP ratio in the US is 100 which is near as damned it is and you've got an interest rate on your existing debt of five percent that's basically telling you that three plus five equals eight so your debt is growing an eight percent and that's what money supply will grow at if you've got the banks effectively monetizing that and if you said the economy is growing at two you're underlying inflation rate is eight minus two is six percent so that's what we're looking at as a very very different world out here and this is what I'm I'm trying to say if this is all correct this analysis is correct that this is going on and what we're looking at is the early stages of this particular path then assets like crypto currencies and gold need to have a step higher valuation jump um well actually I well so I I agree with you Michael I agree with a lot of what you're saying and I want to get into the the nitty-gritty of sort of what you were talking about in terms of nationalizing the banking sector because that's been sort of suggesting there's a lot of kind of strong pushback that that's not actually what's happening so I want to dig in there but before we go you know super deep in the weeds I do want to get your your thoughts on a couple of things just as it relates to the the fomc I'd love to kind of parse out your reaction to the the market reaction uh to what what chair Powell said and let me caveat this by saying that usually very very often the the initial Market reaction uh to things like the fomc is wrong you know but what you had was a it's a little bit confusing to me you know you had um the NASDAQ and Bitcoin both down you also had the two-year down so the the two questions that I have for you is one it appears there's a discrepancy in between what chair Powell is telling the market uh is what is telling us interest rates going to do versus what the market actually believes and basically starting over the past couple of weeks the two-year has been a one-way track down uh because the you know my my guess is that um the market has anticipated that chair Powell has basically hit the liquidity floor right or he's reached the amount of what he can do in terms of rate hikes he says he keeps telling us that there there could potentially be more so I'd love to get your opinion on that and then if you could talk to us a little bit about their Market reaction to the f1c okay I think the first thing is how much more can rights go up I think that we're as I said right at the beginning um I think we're a lot nearer the peak than we were last week or 10 days ago uh and I think that's the impression that one gets uh out of the statement uh that doesn't say anything about the duration by which rates are going to remain at high levels and it's long been my uh you know my my argument is that the the problem that central banks have given us uh which is uh zero interest rates or very low interest rates for a long time created a problem of a huge debt pile and the world economy is saddled with this big debt pile and that's the problem we've got we've got to get out of we've got to get rid of this debt so if you have too low interest rates that is an incentive for debt okay taking on more debt you can't go back to that world of very low interest rates and I think all these Central Bankers understand that point the problem is though is if you keep interest rates you keep jacking up interest rate you then create funding problems in the system so you know you you're really walking a knife edge and this is the the difficulty they've got so in my view what you've got to go back to is a policy that was originally foreshadowed uh more than a century ago uh century and a half ago in Britain uh by somebody called Walter Badger who was a financial journalist but he's the sort of Diane of central Bankers Jim Grant in the US well-known uh animal banking analyst uh has written a wonderful biography of a water Badger and what will the badgett's point was was that what central banks have got to do and this was in the early days of the bank of England acting as the central bank or lender of The Last Resort is he said what you've got to do is to lend freely lots of liquidity in other words against good collateral at a high interest rate and the central banks for the last decade have been doing the absolute reverse of that now what we're going to get back to is a sensible world and I think what that means is that rates probably have to stay up at high levels for longer but there's got to be more liquidity in the system to try and underpin uh the funding structure and with what we've got is a fragile funding structure and the reason we've got to fragile funding structure is that basically because of all this debt world financial markets have shifted from being new financing Vehicles where you finance New Capital spending to being primarily refinancing roof vehicles or rolling over existing debt now let me just give you some figures to back that up okay if you look at the amount of debt that's out there it's about 350 trillion dollars okay with an average five-year maturity what you're looking at is probably 70 trillion a year that needs to be rolled over if you're going to roll over debt you need balance sheet capacity to do that balance sheet capacity is liquidity so liquidity is absolutely Paramount in this equation think of that 70 trillion against the how much money is raised as new capital every year in World Capital markets which is 10 trillion so you're seven to one in terms of the ratio of refinancing to new financing that's not what the textbooks tell you what that says in that world the flow of liquidity is far far more important than the level of interest rates think of it as a homeowner if you want to refinance your home mortgage okay you're slightly less concerned about the interest rate I'm really concerned about whether you're going to get the role or not because if you don't get the role you're homeless and the same with a corporate you can't refinance your debt your default and that's really the issue it it focuses the mind and that's why liquidity is so important now I think that if you go back pre-2008 policy makers didn't get that point I think what they're doing is they're getting that very quickly and if you look at the alacrity with which the federal authorities moved to support svb and you know other you US banks that were in trouble it shows that they're very very conscious about this and chair power I think made it clear that although there were no discussions about the balance sheet runoff of treasuries that's an open question if it needs to be addressed they'll address it so I think the FED is there in a way that we were maybe unsure about whether the Feb was there in uh mid-2008 you know look at the speed with which the FED opened up dollar swap lines uh to Europe uh and in fact the world uh uh last weekend I mean this is this is a bold move Central Bankers are clearly concerned about funding and I think they're much more uh you know up with events now than they were at previous times right and you can see that on the fed's balance sheet uh Michael you track liquidity many aspects to liquidity one of them is Central Bank liquidity and the FED very prominent we can see if people zoom in and they you know put their screen very close to their face at the very right edge of that screen you have a tick up in the Federal Reserves balance sheet it exploded higher during 2020 uh 2020 and 2021 it gradually drifted higher quantitative tightening enacted last year a very gradual slow decline not as big of a decline as people thought because of mortgage-backed Securities they weren't selling they were extending in duration that's a whole other point but that little blip up is is this a injection of liquidity Fed chair J Powell Michael today said people can rely on us to supply ample liquidity is it the discount window is it the bank term funding program is this quantitative easy is that not even a good point how much uh bigger do you think this balance sheet will get and why is it significant well I think if you if you work through the maths it could it could work out to be a sizable jump it could be in theory in extremists 50 higher okay and the reason I get to that figure is that if you look at the division between let's say smaller banks in the US and the bigger Banks start with the smaller Banks they've got effectively about one trillion dollars of eligible Securities that they can post to the FED uh in this uh Bank term funding program okay so if the Federal Reserve supports them through that mechanism even disregarding the discount window borrowing that would actually increase the left-hand side the asset side of the FED balance sheet by close to a trillion dollars okay and that would immediately come through in presumably Bank Reserves now it may well be that that uh that process involves a migration of deposits out of the small Banks towards the big Banks okay but then you've got to ask the question that if you've got such a disparity between the rates the deposit rates that large U.S banks offer compared with what you can get in the money market fund why should you be holding money in a large Bank why shouldn't you migrate to a money market fund and if you migrate to a money market fund then the banks lose Reserves and the big Banks lose Reserve so if they and they lose deposits of course as well now if they had to post this collateral to the FED term lending program funding program they've got probably about four trillion of eligible Securities that they could post so what you could be talking about here is something like somewhere between four and five trillion increase in the asset side of the fair boundary now I won't get to that point uh this I'm talking about an extremist but what I'm trying to show you here is the elasticity of the system now the problem comes is that what we're talking about here is liquidity in the money markets and if you look at the key number to look at on the FED balance sheet is really uh the reserves of the banks the reserves the banks hold of the Federal Reserve and that is an indication of the amount of money in the money markets now the reverse repo which is another element on the balance sheet is actually a withdrawal of liquidity from the markets okay the FED is basically holding that money on its balance sheet now many people say uh and I think it's an ill-informed comment that the rlp the reverse repo program is indicating there's abundant liquidity in the system it's not telling you anything about the abundance of liquidity it's telling you about the generosity of the Federal Reserve in offering such high interest rates uh on its instruments on its uh uh reverse repo instruments that's why it's there it's actually money that's been withdrawn from the system and you could get a situation whereby the smaller Banks lose deposits to the big Banks and the big Banks lose deposits to the money market funds and in that situation what you've got is a tightening of liquidity conditions in the U.S system and the Federal Reserve would probably have to act on that to get Bank Reserves up now one of the things that I think we've learned in the last 10 days is what is the minimum operating level for reserves okay now our view across border was that that level was about 2.7 trillion dollars okay prior to this crisis the Fed was operating Bank Reserves at about 3 trillion okay and in fact since the British guilt crisis in September of last year that Reserve number on the FED balance sheet has flatlined at 3 trillion and I think the Federal Reserve was trying to tell us something then that the British guilt crisis was a warning a little bit like bear Stearns in the spring of 2008. that was the warning that was the warning bill that said we've got funding problem there are funding problems here in the system okay somehow the plumbing isn't working properly and what the Federal Reserve has engineered in my view and I think it's deliberate but who knows that that bank reserve number flatlined at 3 trillion now U.S academics who are experts on looking at bank funding Jonathan Wright at John Hopkins being one in particular have already cited a level of 2.5 trillion for the minimum operating level Reserve operating level for U.S banks so we were getting pretty close to these thresholds okay and I think what we learned with svb and others is that it's not 2.5 or 2.7 it's probably three okay the problem is that once you get a crisis the demand for reserves goes up so in actual fact that's three rising and the level of reserves in the system now is a short 3.5 trillion so I would suspect that's got to go up anyway so I think what you're looking at here is potentially a a significant increase in the size of the FED balance sheet and as I said we can dance on the head of a pin so is this QE or not in my view it's a liquidity easing and that's what the system wants okay whether it has a big multiplier effect on the economy is a complete completely different question but the Federal Reserve has backstop the system which is what it's doing and it's done I think very effectively I've got a I've got a question for you for you Michael so um you know we were taught you were talking about uh the the banking system sort of starting to nationalize uh in a sense I do want to say uh I think Yellen despite some comments from uh yesterday she actually said that they're not considering coming in and guaranteeing all Bank deposits so there is some limit in terms of in terms of what they're willing to do but you know there's a there's a great quote from from Chris Cole from Artemis Capital which has always stuck with me which is you can't destroy risk you can only transform it so you know I think the vast the the majority perception right when the FDIC and the government rides in is they say we are taking care of a whole bunch of risk that's in the market whereas I kind of generally try to ask okay there was a bunch of risk here that existed in the banking system how's it being transformed so if the federal government some mix of like the government and the FDIC are guaranteeing larger and larger parts of the banking system my question to you is what's the transformation of risk that's going on well I think that I think it's a very interesting point that you make Michael I think that you know the first thing to say is that uh there are obviously different types of risk that we've got to try and try and evaluate and if you look at the problems that the banking system essentially has uh we're talking about credit risk and we're talking about maturity risk or duration risk okay now 2008 was very much about credit risk this crisis is a lot more about duration risk now the Federal Reserve kind of effectively resolve both and the more the Federal Reserve balance sheet expands and that encourages if you like an expansion of the general private sector balance sheet what they're doing is they are effectively reducing credit risk and duration risk in the system okay and that's what the Federal Reserve can do but to take up your analogy of the balloon you're squeezing that balloon you're reducing credit risk and duration risk but what you're doing is interesting another risk which may be inflation risk and that's the problem that what we know is that that money can that the money that the Federal Reserve creates can seep out it goes into asset markets pretty quickly okay uh because it's part of the financial sector but that can seep again into the real economy and create High Street inflation um the Federal Reserve creates monetary inflation or monetary deflation those are the only choices that a central bank really has okay but if you look at High Street inflation High Street inflation is a cocktail of monetary inflation and cost inflation so we've had the cost inflation because of you know what was happening with Putin's Russia and the covid crisis and that gave us some cost inflation but we also had a dose of monetary inflation on top because of the growth and the fair balance sheet what I'm saying is if you look forward you know parche what may happen to costs in the future but we may be getting a significant and permanent growth of monetary inflation and that's coming through because of not because of this problem per se but because basically you've got very bad fiscal arithmetic in the west per se and I come back to the fact look America is the cleanest shirt in the laundry here for sure but there's a it's still got problems the rest of the world you know big problems it's all about aging demographics and the fact that you've got mandatory spending which is shooting up where your tax base which is working population is underdown Will pressure is still very overtaxed and they can't get Revenue up and then you've got the added problem of increased defense spending which is coming through so how do you square the circle it's really difficult and you need if you like the banks to play a role in this now for yeah maybe by some accident of History we've just we've just stumbled on the solution uh what what so if for the base balance you to continue going up uh for banks to draw upon the the bank term funding program or the discount window uh that scenario that that you envisioned would be one in which banks have continued uh continue to have a liquid crisis is not just Silicon Valley Bank it's not Signature Bank you know First Republic has to go down and take others others with it and in that environment deposit flight ensues and uh Regional banks have to pledge their agency government securities as collateral to get money from the Federal Reserve what do you think are the odds of that you know the uh lightning doesn't strike twice or three times and people just keep their money in their Regional Banks and everything is fine in that world and I want to know your what do you think the odds of that does the Federal Reserves balance sheet still go up do we still have uh you know is liquidity from the central bank still on the way yeah I think absolutely I think that you know in my view I mean we we track liquidity pretty closely as you know and you know I've gone on record and said many times since that the low in global liquidity was basically October last year that was the floor uh it's picking up bad things happen we know bad things happen at the low point of the liquidity cycle and hey Presto what we've got again is another example of that happening um you know Banks don't go Bust or very rarely at the peak of liquidity Cycles they tend to go bust at the bottom of liquidity cycles and that's if you like the the fact of the instrumental factor that causes the cycle to turn around so I think that now what central banks have got to start to do is to expand their balance sheets and that's what I see happening worldwide so this is what we're doing you know let's you know for a moment step across uh the pond to what's happening in Europe uh you know Europe European the European Central Bank uh plans to um shrink its balance sheet this year on my estimates by between 15 and 20 percent good luck with that I think they're going to be anywhere near doing that uh because you know the the state of the banking system in Europe is uh you know certainly I would suggest more fragile than maybe in the US but you know hey prove me wrong um I that that's that's a risk so I think what you've got to do is you the the important you know the important central banks in the world are really the US fed and the People's Bank of China those are the ones that really matter the ECB the bank of England the bank of Japan will come on and follow what the FED is doing uh as far as I can see but those are the two independent voices and what you're seeing is on my estimates the Federal Reserve is beginning to add liquidity to the system now uh it's actually if you look at the detail it's following almost exactly the same path that it followed through uh 2001-2002 uh in terms of its liquidity injections in the markets we're around the trough and it's beginning to pick up and as I say I think it's going further and then if you look at what's happening in China The People's Bank of China through uh December and January of this year injected about three trillion Yuan so you know a short half of uh half a trillion US Dollars into Chinese financial markets uh that was a huge liquidity impulse it represented three and a half times the total amount they'd put in in the previous um uh two years uh a mythole it came off a little bit in February but what they've been doing laterally through March is injecting a lot more liquidity in the system and the pboc in China is very very important for the health of the Chinese economy or The Temper of the Chinese economy and hence by definition because China's such an elephant in the room economically uh for the world economy overall and China is restarting or attempting to restart on this estimation so you've got that and then the US is really the Paramount Central Bank which influences Financial Market it's worldwide so these two are really beginning as far as I can see to turn the money Taps on now if that's the case what you want is to increasingly think about monetary Hedges um or what I call monetary Hedges which are basically uh Securities or instruments that hedge against monetary inflation the obvious one to that is gold because gold has been long-standing as a monetary inflation hedge and I make this subtle but in very important distinction between a monetary inflation hedge and a High Street inflation hedge uh gold is not always a great High Street inflation hedge but it's a very good monetary inflation hedge and the new monetary inflation hedge are things like Bitcoin now that's not a recommendation to buy Bitcoin or anything like that I'm not a Bitcoin analyst but all I'm saying is these are likely to be uh pretty decent measures of liquidity so if liquidity goes up that's what you've got to expect to see as a barometer of that move gold going up and Bitcoin getting up so so Michael uh I I'm in I'm in agreement with the vast majority of what you what you've just outlined there I suppose uh dad just again to kind of bring it to some of the events that are that have been happening today you know I'm looking at my the price of Bitcoin on my screen here and it's basically been in free fall uh post frmc I mean it's down about you know four and a half four and a half some odd percent uh so my question to you is uh you know do you think the market you know believes the same thing that you believe in terms of we've seen the liquidity Bottom already basically this last October we're already starting to see you know overt injections over with the people pboc in China more covert injection questions here in the United States and that it's going to be liquidity positive from here I don't think the market agrees with that because the Market's the market and the market has many different opinions but uh there may be some people in the market that believe it and there's an awful lot of people that probably don't believe it but you know our remit and what we do is we look closely at liquidity ever since you know the days when I was at Solomon Brothers in the US I mean this was the this is what uh you know I learned at uh you know the feet of people like Henry Kaufman Henry Kaufman you know a gentleman now at age 95 but tremendous wisdom I mean go back and read some of the things that Henry used to write I mean he has nailed this current crisis yet again uh you know even in his writings of 20 years ago he foresaw the future and what um you know these problems in funding markets so I think you've got to understand that you know Salomon was a fantastic brand name and franchise but it really made its name and its reputation and its profitability from understanding money flows in the world and that's exactly what we're trying to do now and so tracking liquidity understanding where the money is is absolutely fundamental to investment and that's what people are going to do more and more uh central banks are increasingly uh playing a big role in that so we need to understand what the central bank's doing but it's not always the central banks that are the key drivers can also be the banking system as we saw prior to 2008. right and I just want to know uh note that Mike you're correct uh Bitcoin gold stocks all falling in the wake of the Federal Reserve meeting today but gold and Bitcoin and even stocks had been rallying over the past few weeks and Bitcoin had gone from about twenty thousand dollars a month ago to twenty eight thousand dollars so uh was that a 40 rally so the if liquidity it that the the price action recently does fit that Narrative of liquidity is supporting liquidity sensitive uh assets Michael I just want to ask you when the central bank is supplying liquidity there's quantitative easing when it expands its balance sheet and that is our balance sheet is going to go up no matter what no matter whatever the banks think whatever people think our balance she's going up we don't care and then there are special facilities such as the discount window now the bank's new uh Bank term funding program btfp where the money's here if you want if you want it but we're only going to you know expand our balance sheet if you want it so if the banks don't need it the balance sheet doesn't go up and the reason we had a makeup in that chart is people uh Banks uh tapped the discount window at btfp for funds so how do you expect the fed's balance sheet to increase uh in absence of the those programs that rely on banks needing capital okay okay let me answer that question in terms of of how we see the world and how we operate liquidity is a driving factor and one of the most important transmissions for liquidity is in the term structure of interest rates if you see liquidity expanding the yield curve in other words the term structure will steepen the yield Curve will begin to be upward sloping and you'll get a steeper and steeper uh yield curve as liquidity goes in as liquidity comes out you start to see a flattening and inverting yield curve and there's about a six month lead time between movements on liquidity and what happens in the yield curve now what we've seen uh in the world is tightening liquidity Bank funding has dried up but fundamentally where you're seeing this is through the negative effects of an inverted yield curve this is what's giving the banks a lot of trouble for the simple reason that as we know um you know to give the example of the bank term funding program if you go to this fed window you are going to have to pay the FED uh one percent rates and you're only going to get a coupon return from your security portfolio of probably uh you know maybe 50 to 100 basis points below that so in other words you're you've you've got an operating loss so this is the situation that you're in you can't correct the banking the funding problems in the banking system until you've got another wood sloping yield curve and that's really a fundamental point now why haven't you had uh you know maybe these problems historically when you go back probably because the banking system wasn't as leveraged uh maybe the funding structure was better than it is now but the inverted yield curve is exposing a lot of these funding problems and we do have a funding problem in the world where you can you can see and I'm gonna get wonkish here but if you look at the term structure there's an element in the term structure that economists or financial analysts will know which is called the term Premier now the term premium you can watch every day because the New York fed publishes estimates of the term Premier on you on the US uh 10-year bond and other uh Tenors but if you look at that data it is near its all-time lows now why is the term Premier so low and in many cases negative at the moment and that's saying there's a shortage of collateral in the system and that is one of the problems which is exposed in this whole funding structure now what we're in is a world where credit is very dependent on collateral in other words pre-2008 uh you know Banks lend to each other on trust now what they need is collateral you need the security of uh of an instrument like a Government Bond or think of a mortgage you need a house to borrow against exactly you need an asset uh to if you like secure that loan and in that in that world of um of collateral what's really important is how much you can margin your collateral because that determines how much credit you can get now one of the key factors to watch and these are the two things that I would watch very closely going forward what you've got to look at is the volatility in the bond market if you get high volatility it's very difficult to get to basically use that collateral efficiently because the haircut you've got on the mark on the on the collateral go up in other words uh the lenders will start to say well okay we're very uncertain about what the value is so we're going to give you a big haircut on that uh on that uh uh on that collateral and whereas you could have borrowed 98 you ain't gonna now borrow 90 or 85 or whatever the the amount is so that has a direct effect on credit now my point here is that it may well be that the Federal Reserve injects liquidity it may improve collateral if there may be more treasure issuance but if you've got a lot of volatility in the bond markets you are not going to get liquidity creation and one of the things that the authorities have got to do is to get Bond volatility down pretty quickly now the move index is one way to watch that the move index is published by Bank of America Merrill Lynch uh it's an indicator they put forward is it is a comparable indicator of the vix uh for equities but it's much more important than the fix don't worry about looking at the vix anymore it's secondary look at them move index because the move index is driving the system and that's what people have got to start to watch now the move index when it was first designed if I remember correctly when it went above it's an index which roughly uh runs between about 50 and maybe 150 people used to say if it goes above 150 it tells you that the authorities the treasury or the FED have lost control of the bond market what did it go to a few days ago 200 uh what is it today I believe it's about 160. so it's coming down but it needs to go well below 150 and probably below 100. so Bond volatility has got to come down so watch the move index and the other thing is watch the reverse repo which is a daily number that you can look at the volume of a reverse repos that uh the Federal Reserve basically has on its balance sheet and if that starts to spike higher that it's probably telling you that liquidity is draining out of the banking system it's going to the money market funds right so uh money market funds used to own a bunch of commercial paper now I think over half of that is directly parked at the Federal Reserve with at the reverse repo facility the point you said earlier Michael was that when people say there's 2.2 trillion dollars in the reverse repo liquidity is ample I see why they say that because it's 2.2 trillion dollars that's a lot of money but it's trapped there and people are putting all the money uh sort of in the in a black box that cannot really interact with the rest of the the financial system also the volatility reference that's how much things moved there's realized volatility how much things actually move in the past and then there's implied volatility what is the market pricing for forward volatility uh vix is implied volatility for equities uh move is is that for bonds when interest rates were at zero last year and you know fed pal raised raised raised raised raised the market was taught totally off guard so the move index spiked higher but uh corresponding with that sort of October pivot uh policy that you've tracked uh the move index went down and that coincided with the pretty significant rally and a lot of risk assets and now the move is back up or it was up because we had this banking crisis so the uh the hikes that were priced at for the rest of the year I've turned into Cuts so you had an immense reversal that was very dramatic but do you see uh now that sort of okay maybe we'll do a 25 base point in May but you know we're not let's be honest we're not getting to seven percent probably not going to six percent maybe 5.25 but I think things are pretty clear now do you think that in that environment where there's a lot more certainty to move action index could actually come down and yeah yes it should come down that's one of the things to watch and I think what the authorities have got to do is to make sure that index does come down because that's the key to feel like Leverage um and if you well put it another way the collateral multiplier in the system um if the move index comes down the collateral multiplier will go up and then therefore you're going to get more liquidity created by the private sector so if you think about it in two moving Parts the uh the government sector in terms of bond issuance and in terms of Federal Reserve balance sheet is determining the amount of collateral in the system but the private sector is determining the size of the collateral multiplier and that is driven to a very large extent by factors like uh the move index how much volatility there is in the system all right that makes sense mom Mike maybe it's time to open up to questions in a little bit but I also just want to ask about the degree to which the terminal in the banking sector will cause Banks to contract credit and curb their lending which would be very disinflationary Perhaps deflationary Perhaps recessionary jpal actually said as much and he referenced that fact he it's the base case of the Federal Reserve that the terminal in the banking sector will cause Banks to curb lending somewhat and he said that they that may be equivalent of tightening uh of a rate hike which is pretty remarkable in fact it could be even more of a rate hike how significant of a factor do you think that is and what are you seeing in the bank lending markets right now with regards to liquidity okay I think the the first thing to say is it was a very significant statement um he actually said that there'll be a sharp tightening or respect to the sharp tightening of chronic conditions as a result he also said that these Financial condition indexes that are very public now there's Bloomberg number there's a Chicago fed number there's a Goldman Sachs number of financial conditions he said we're biased because they were largely Equity uh of volatility measures they didn't include many metrics on lending and it was his fear that lending conditions are tightened now we look at lending conditions pretty closely and what I would say is that maybe this is a takeaway it's very clear that you've had uh a a fall in or a tightening in credit conditions in terms of the appetite of loan officers to make loans and that's very true in the latest surveys however and this is the caveat that lending survey correlates really very closely with business business confidence so if you start to see business confidence in the US bottoming and beginning to pick up and I'm thinking here of something like the ism index what you'll see is is parrot pursue with that you can see uh loan officers getting a lot more optimistic so I'm not going to say it's a given that we've got uh you know we're staring down a black hole we're not in my view I think the economy is actually pretty robust in the US although all the indications that we have would suggest that the economy is probably seeing a bottom I'm getting this information from the fixed income markets looking at the end Trials of the fixed income markers it looks like a body of the economy is coming about mid-year now we may be wrong on that we maybe have to finesse that a tad but I would say that's what it's looking like if that is correct then the stock market is more or less on track because the stock market normally bottoms about six months before they're turning the economy so that looks right let me say one other point about that Stanley druckermiller the renowned U.S investor always used to say that the best uh the best Economist is the inside of the stock market what he meant by that or what he was talking about was the relative performance of cyclical stocks against defensive stocks and if you look if you plot an index and don't take my word for it please do it yourselves look at an index of s p cyclicals less s p defensives Against The Temper of the economy it almost goes one for one but the stock market is a fan the relative is a fantastic indicator of what the economy is doing and what you're still looking at even despite the volatility of the last week is it still looks at cyclicals are outperforming defenses except for banks yeah well maybe except for banks but I wouldn't necessarily say the banks are in that cyclical category but hey you know I've got uh just one more question for Michael before we turn it over to audience questions Jack there was one there was one question uh which was asked of of Jerome Powell he made a comment apparently during the the January fomc I believe about some uh some worries potential worries and the non-bet for non-bank lenders um and my question to you is there's an enormous amount of focus on solvency around Banks probably rightly so right uh but Banks uh there's there's an enormous amount of demand for funding outside of strictly Banks right which this is like broadly referred to as the shadow banking sector right and a lot of the interest rate risk right that banks have taken I would have to imagine these shadow Banks uh they they basically have a very similar problem the thing is it's a much more opaque sort of Market the forcing function isn't depositors leaving it's Capital call right um and and it's more risky and less regulated so my you know my question to you is and they don't have this access to this btfp facility so my question to you is are we being a little bit too myopic here about focusing on any one particular bank failure and maybe we're missing the forest for the trees when there's a problem in this this kind of Shadow banking less regulated uh you know extended credit I think you'll you've nailed it I think it's spot on and I think that the way that the Federal Reserve addressed initially addressed the svb problem was to say it was an idiosyncratic problem and that's pretty much what chair power was saying this guy this this is an outlier but the solution they put in is actually a general solution uh for lots of things and the shadow Banks clearly don't get addressed in this directly but what the shadow banks will depend upon are things like the stability of collateral in the system and that's part of the reason why I'm saying you've got to get volatility down uh in particularly in the in the treasury market because that's where a lot of the lending will come on the back of security portfolios now we don't know the underlying health of the Shadow banking system there's been phenomenal work done in the US about what the shadow banking industry is uh and you know its needs and its risks and whatever but there are still black holes okay um and that's the problem so if you're shaking the tree shaking the money tree uh you can get accidents and this is the problem that we Face there may be another one around the corner we don't know but this is the parallel that you run at very low levels of liquidity so this is why I come back to the fact that you know it's low liquidity is the problem right now you've got to get more liquidity in the system but if you want to control the system longer term it goes back to the budget rule what you've got to do is to lend at high interest rates against good collateral but you lend freely you create a lot of liquidity and the problem that we've had is in a world where you've got Capital markets which are being used as a refinancing mechanism for debt you can't also use those Capital markets as the acts to try and control inflation it doesn't work because basically your needs for refinancing May coincide um you know with uh periods when uh inflation is is higher and you basically are squeezing just at the wrong time and that's very different from a world of new financing when in actual fact you're squeezing at a time when capital investment is down and probably you want it to go down further so in other words the world is topsy-turvy under this refinancing mechanism and that's why liquidity is absolutely critical to watch excellent that's a that's a very helpful explanation Michael and now I want to take this chance to answer any questions from from the audience and guys if you're listening thanks for all these comments that you're dropping here but uh definitely if you have questions for Michael make sure to drop them and uh we'll get through as many as we can in the time that we have so this first question for you actually comes for um uh this is on the on the topic of banks hedging interest rate risks so svb was criticized pretty heavily for not hedging uh but how could the banks have this the question is basically how could they have hedged uh while being profitable and the the thing that I would append and and add to that is the accounting treatment right of hold to maturity of a lot of these assets basically made it so that these uh these bonds didn't hit the the p l or the capital account so a hedge if they had actually put that on the way it's the accounting treatment works in the US is the Hedge would have actually appeared on the p l and made the bank's profits look all wonky right so you know is this criticism both from a profitability and a p l appearance standpoint is this a fair criticism of SBB and for the banking sector writ large well I think it's it's the result of um with the thing that we go back to which is an inverted yield curve and this is this is the problem they run to because during a period of an inverted yield curve banking becomes less profitable uh and so you know it you you either you know fess up to that and reported but then your shareholders won't like that or you find ways of essentially disguising that and at the end of the day that's really what we're talking about here so the question is is that you know normally in a world in in terms of the how the economy and the financial system works you can't run an inverted yield curve for very long because it creates problems and it almost automatically um you know uh it basically moves to a positive slope and that's that's what we're looking at rates have to come down and this is maybe the the sort of the lesson out of this whole thing is that what we're really saying here is that this is an unsustainable situation uh where short-term rates are above long-term rates you've got to get the yield curve to a more positive slope and that's why I come back to this point that we have to be moving into a world of yield curve control I don't think there's any choice in that and that's the reality not least because the uh the fiscal authorities have got so much debt they've got a they've got a shovel at us in the next few years uh Michael when you say yield curve control when I first heard that term I thought it referred exclusively to pinning rates at let's say two percent and the bond market wants to sell off to three percent so price down yields up but you were keeping it two percent we're gonna buy it if it ever goes to 2.01 but you know I I subsequently learned that Japan uh it was actually to keep rates uh uh below a certain uh level because uh they wanted they wanted an upward uh uh yeah yeah yeah so in this yield curve that you envision is it to let's say keep the 10-year pin debt three percent because the 10 year wants to go to five percent or keeping it three percent because the tenure wants to go to one percent and when I say want to I mean you know Market forces well I think that you know the yield curve control is a is a generic term and it can mean many different things and as I said you know what Japan is doing right now is very different from what the US did uh in the 1940s and early 50s and it's very different from what the Europeans are doing uh but basically they all they're all different flavors of yield curve control and what I'm saying is that yield curve control fundamentally here uh the first thing you must do first condition is you must get an upward sloping yield curve and that's something that needs to be addressed now one of the problems with that statement is that if you've got such a Negative term premium this is a a wonkish bond point but it's very very important to if people think about it if you've got a negative term Premiere it's very difficult to get an upward sloping yield curve okay technically so you need to get that that addressed and I think that's a question of collateral lack of collateral in the system now that may be addressed ultimately because there's a lot more fiscal issuance coming and the Federal Reserve may have to put more liquidity in the system but that's the first point you need an upward sloping yield curve and maybe the banks need 100 basis points of spread between the long end and the short end but you know we can debate what that is the second criteria is that you can't have interest rates at the long end so high that it starts to inflate the budget deficit significantly and create too much debt because basically the interest bill is eating a large part of the deficit right now and every percentage Point uh you know on the interest Bill magnifies that debt burden so you've got to keep in the interest Bill lower so what that says is that if that magic number is five percent uh for bond yields at the long end say the 10-year tenor uh and you want 100 basis points of yield curve slope to benefit the banks then what you've got to have is a four percent policy rate at the front end okay and that's that's how the maths will work there's a variety of ways of getting there but I think what you've got to do is to have the Federal Reserve and the treasury working in tandem together I think they do work together but you know officially they are separate and so do you think that let's say 10-year the 10-year treasury notes will go higher or lower from here given given what you just said well my my view for this year if that's what you're you're asking is that I think this year I would say the 10-year bond is a wash because I think that you know you we may be near the peak in uh in terminal in the implied terminal policy rate that's embedded within the term structure you know arguably it may be there it may come down a touch from where we are but I think the problem you've got is that term premium which is so negative can almost only go up from here now what you've seen um if my memory serving it correctly since the svb crisis you've had terminal policy rates dropping by about 70 basis points and you've had term premium Rising by 35 basis points so you've actually had the 10-year down effectively by about 30 or 40 basis points although there are abouts okay but the problem is that the more that you go the more that you get policy rates down implied policy rates and the term structure down the more you're likely to get term premium going up again so so I don't think you're going to get much gain really from owning longer dated treasuries this year if you want to play the treasury market it makes much more sense to look at the sort of a mid-guration area maybe the five-year or something like that but not to go too far out down the the not to take on too much duration risk right now I don't think it will work traditionally this stage of the uh this stage of the cycle uh gives you moderate Bond returns Not Great Bond returns um if you look at where you get most gain in fixed income at this current state of the cycle it's normally in the credit markets interestingly enough that say we say that last part again sorry well the the way you get most gain at this stage of the cycle go back and look at 2001 where you get most gain or Traction in the fixed income markets is out of credits but wouldn't uh defaults be increasing because the economy is slowing down correct well that's that that's the supposition but then maybe uh you can pick and choose within the credit structure and you can find Opportunities and you know I'm not uh you know I'm I'm not a credit analyst uh or a bond credit analyst but all I would say is that maybe the markets are telling us something in terms of what you're seeing and if you look at how the fixed income markets are unfolding this is a very normal cycle okay you've got to remember that the yield curve is inverted but it's beginning I think to inch towards the steepening you've got convexity which has collapsed in the curve which is the size of the hump in the curve so that's come right down you're looking at Bond volatility which is peaking and coming down and you're looking at credit spreads which are beginning to come in and all those things are what you would normally see at this stage of the cycle so I just want to uh address the point of interest rate risk so this credit risk there's interest rate risk you lose money as interest rates rise because you are getting paid back but it's just not being paid back enough so a lot of banks they made a mortgage at three percent or more likely maybe they bought a mortgage-backed security where they're being paid three percent and that was all great when interest rates were at zero but now they're at five percent and the equivalent mortgage rate would be you know six percent seven percent so three percent just it really is not cutting it uh but then do you say oh but the banks you know don't worry about it because the banks could hedge out their interest rate risk and yes I I could hedge my interest rate risk but I hedge it with you Michael and then you hedge it with you know Mike and Mike Hedges it with someone else and the interest rate risk is there the Federal Reserve is imposing losses on the financial system so we've got a great question uh we could just put it on screen about from Car Pro I've never understood the idea of hedging uh interest rate risk individually that may work but someone has to be on the other side so the whole banking system cannot hedge their risk with whom what do you say Michael well I think that's that that's probably right I mean the at the end of the day what you're doing when you're hedging is you're effectively selling that risk onto somebody else so uh but there are people that will that will bear that risk and it may be that you've got longer term institutions that basically want to want to take on that risk uh that that's quite that's quite possible um um but you know what we're you know what we're saying here is that the you know the fundamental problem uh that the US I mean that the U.S Bank the banking sector has got it comes back to the fact that the yield curve is it it was inverted right now um you know I mean they they didn't do the interest rate hedging anyway uh but you know the question is right I mean all you're doing is really passing the parcel in many ways uh in terms of somebody that must be taking that risk on the other side but it may all be a long-term institution maybe a sovereign wealth fund who's prepared to bear that we got another question uh from Harold gray who says beware the steepener as they say so last year the yield curve inverted people saying it's it's going to be you know apocalypse so worried but the economy was actually you know pretty fine because it was early on it it's the when the yield curve steepened when short-term rates start falling that is when as Harold rightly says you should be beware because we're entering a recession so you you think the the central bikes are a huge influx of liquidity and you think the economy will reach a Navy or somewhere in the middle of this year but isn't an inverted yield curve that starts re-steepening isn't that kind of ringing the alarm Bells from the market purely talking about the economy not the uh financial markets and so just just one uh observation to add to that as well which I think is in tandem Jack is this uh the two-year and the FED funds rate which typically walk kind of hand in hand the two-year has now dipped well below where fed funds is which is usually the first signal that the FED is starting to think about turning or the market is sniffing out that the FED is going to turn which typically happens right when the recession is uh just become consensus which also sort of supports that idea of steepening that's a great context thanks I think I think that's absolutely right I mean the question is spot on is that what normally happens at this stage is you see the short end of the market Falling Away rates expectations tend to drop uh and the longer end doesn't really move that much um so that's so that gives you the steepening of the curve now the problem that you've got this time on this particular cycle is that term premium are very negative and I keep saying this is a wonkish point but it is true that it's not all about right expectations right now there's a big bias in the curve because of term premium and that that means that I think that the yield curve is not necessarily a pure indicator of recession risk right now I think it's very biased I think it's over egging it to my view now I wrote a paper which is an academic paper but it was uh probably about five or six years ago well there are thereabouts which is in the Journal of fixed income that basically looked at the efficacy of the yield curve as a predictor of a recession in the U.S and actually it's an incredibly flaky predictor um in terms of any particular maturity spread so if you looked at the 210 it works sometimes and doesn't work others if you looked at the one three it works sometimes and the others looked at the 10-5 sometimes it works sometimes it doesn't so you can always find a yield curve that will actually predict a recession but you never know which one it is and the point therefore is that what's really important is looking at the curvature of the term structure convexity and basically if you um if you adjust this is again sort of probably Bond and wonky stuff but if you adjust the yield curve slope for convexity which is what we do internally at cross-border Capital that gives you a much much better predictor of the economy and that indicator is basically saying that it should turn around the middle of this year or thereabouts hmm there we go another person asked about the federal Home Loan Bank and why that has exploded I think banks are just posting their mortgages there for cash and I actually don't think they post mortgage-backed Securities uh as the get the the question implied I think that's more discount window and and uh btfp I know we're getting we're getting we're getting very walkish and I feel like yo Michael you are so in the weeds and Brilliant and uh the uh yeah I feel like maybe I could have done a better job of sort of breaking down things uh for for our audience but yeah I want to ask you just about the mortgage question which is that uh mortgages are not only duration sensitive but they have negative convexity meaning that their interest rate risk Rises as uh as it rates go up so things get to get worse and worse and the rate at which you lose more money itself increases so which can be quite scary but the so so banks have a lot of that on their balance sheets the Federal Reserve also has a lot of that on their balance sheets also the U.S homeowner who borrowed money to refinance that three percent there that uh the loss of the banking system and the Federal Reserve unrealized is the realized gain of the American homeowner I know I threw a lot at you where does that lead us well I mean if you if you're saying that um I I I'm not sure I understand the question but are you saying that has uh the American Homer owner benefited from low interest rates yeah um and I think the answer if that if that's your question the answer is very clearly yes uh the issue that you face in Europe is that you don't have um fixed rate long-term mortgages you basically have a floating rate and so the problem is when interest rates go up in Britain or in Europe you start to get the housing market absolutely tanking so if you look at the US and compare that with Europe and Europe you haven't seen nothing yet I mean this can this can be a real uh a real mess Michael I I want to get back to uh to something there's a question here about cbdc's and I want to tie that to something that you were saying you mentioned cbdc's earlier you also mentioned the nationalization of uh banking systems both uh in the United States and Europe I want to get your I was actually having a conversation with a mutual friend of ours earlier today I actually sent him your tweet that you sent either yesterday uh I believe yesterday or earlier today about the nationalization can you just describe what you mean when you're saying that and then you know the question that we actually have here from bubbly bull is uh Bill Fields feels to me like the central Bankers are in need uh to sacrifice the private bank system in order to roll out their cbdc and get overall power on the economy thoughts so my my two-part question to you is can you describe uh what you're saying before about nationalization of the banking system and then does that factor into your thoughts or what is the through line between that development and the development of a central bank digital currency okay well let me just be absolutely clear here what I said was that de facto a de facto nationalization of the banking system and it's not rationalization of the asset side it's of the liability side so effectively what you've got is that the Central Bank uh and the bank's balance sheets are de facto merged effectively so in other words that if there is a deposit run um the Federal Reserve is stepping in to basically backstop that now we don't know whether that's true but what I've said is that's the implication of what Janet Yellen and possibly chair pal into that today that that that's where we're on the US I mean you know time will tell but I think that they've made certain noises to that effect that uh that deposits or the deposit base of the U.S banking system is sacrosanct now the question is when push comes to shove what does that really mean well it means that the Federal Reserve balance sheet is effectively Bank backing uh the the banking system so the bank the balance sheets are effectively won Now isn't that what a central bank digital currency really is so in other words if you've got a dollar in uh in in a bank in JP Morgan or whatever that's really a dollar a digital Dollar in the Federal Reserve I mean that it's it's all intents and purposes the same thing and that's really what Central Bank digital currencies were doing so essentially you've got a digital dollar it may be administered by a U.S Bank but in other words the funding structure is much more robust under this situation that it has been before and you won't get a deposit run because there's really nowhere else for the money to go the central bank is the central bank and I think that that's the way to kind of think about it there's nothing sort of sinister in that per se um you know a dollar is still as good as a dollar but the fact is that it does give um the policy makers greater say if you like in the structure of Assets Now the central bank is never going to be a lender in the way of lending to different businesses you can't get into that game this political game so I have to get the private sector to actually organize credit distribution that that will continue in that form so what you may have is some hybrid whereby um the the banks act maybe as sort of I don't know what you would call or what we call in Europe Gyro Banks so they're basically depositories of money and they may be administer accounts and then if you want to create credit then they will invest in dedicated credit managers who may be specialists in different Industries and they will provide the lending I'm just hypothesizing as to how that may occur but essentially that that would be the if you like the model of the future now the banks May well have to have as an asset a much larger component of sovereign debt in them that's quite possible and as I said earlier on maybe flippantly that may be the solution to the to the Future fiscal problem so at the moment we've got fiscal sorry Financial dominance coming through because essentially everybody has responded to the problems in the financial sector but in the future these Banks may be subservient to fiscal dominance because the needs of the government in selling debt are so great now I'm not reading too anything sinistering to that I'm just saying it's a kind of convenient solution that we may have stumbled upon uh Michael as we reach a close I just want to say on Twitter people can find your work uh at cross-border cap and your book uh Capital Wars is excellent and I actually got the name of my podcast for guidance from from the indexed hunting around for for terms Michael if gold and Bitcoin go up in the short term medium term three six months and it goes up for the reasons that you are saying now because liquidity is going up what do you think happens to the stock market and particularly uh unprofitable technology stocks the Teslas of the world which they did quite well in 2020 and 2021 uh just like Bitcoin and just like gold did for the few months of 2020. I think if you want a road map my my view would be to look pretty closely at what happened in 2001 2002 because I think if you look at the uh movement of the Federal Reserve balance sheet or their liquidity injections it's following a very similar path now in my view that's the Benchmark now clearly we you know in that Pro in that period we got the terrible events of 9 11. so we've got a you know we've gotta we've got to strip that out but you'll look at the sequencing with which asset markets moved so it was initially um what moved first were government debt markets then it was corporate credit markets and commodity markets at that stage then the economy started to get a little bit more traction so we're talking here second half 2001 second half 2023 and then you start to see the equity markets picking up now I would uh suggest that maybe 9 11 was a big hiccup for the equity markets and it delayed their recovery and it may be that the tech bubbled burst uh was sufficient catastrophe that also took time to repair but the equity Market should respond now if you believe as you know it take our view that what you may be looking at here is a similar road map then if there is this monetary inflation created you would expect to see gold uh moving upwards and cryptocurrencies moving up and I think that is a an interesting necessary condition for the Outlook that we've got so you know look at you always look at a range of indicators don't just look at one or two look at the at the at the big of the bigger picture here and I think what you've got to look at is the sequencing of liquidity Rising monetary inflation Hedges going up um things like uh Commodities moving higher credit markets performing well uh and then Equity is starting to get traction and if this is correct it's going to be the cyclicals that perform first so I'd look at cyclical areas of the US Stock Market I'd look at cyclical indicators worldwide look at something like the Dax index in Germany which is a very cyclical index or you look at things like the Korean market or maybe Japanese cyclicals because of their proximity to China or you look at Emerging Markets generally and one of the things that was intrigued me in looking at the data that we that we collect instead for the first two months of this year you've seen huge inflows cross-border Capital inflows into Emerging Markets they've spiked higher and that's normally historically a very good heads up to a turn on the global liquidity cycle it may be different this time who knows but you've got all those factors so it looks as if you know the facts are the facts are telling us that we're moving in a cyclical upswing thank you Michael we just recorded after the FED met today on Wednesday March 22nd tomorrow on March 23rd the the gray lady the bank of England will be meeting announcing their rate decisions uh you know as people might might tell uh you're British where uh so I think interest rates there are at four percent how much do you think their hike and do you think that they also are are close toward the uh the peak of their hiking cycle yes I believe I believe that's right I mean I think the you know there was a nasty surprise in the UK inflation date of the day and I think that's a heads up for all of us to say look I mean inflation is not conquered yet but it's probably trending lower but you will get blips I mean inevitably that that's true uh I think the bank of England is is near as well uh a rate Peak but I go back to what I was saying earlier on look there are only really two big central banks in the world uh the Federal Reserve and the People's Bank of China and the Europeans and including the Brits are going to pretty much follow what the fed's doing anyway and China is maybe a more independent entity there we go well you nicely put me in in touch uh with Paul Tucker who used to be the Deputy Governor of the bank of England so I'll be speaking with him later this week in that interview should air on Monday thank you again for that Michael uh um Michael Polito what what uh you gotta you got a final question yeah I actually just have one question because you know everything that would just if we if I had to sum up uh Michael what you're saying basically hey we have reached the ceiling in terms of interest rates that we can do the uh you know part of the stress especially you're seeing manifested in the yield curve is a lack of liquidity in the system so I hear those two things and I kind of couple that with what the two-year is doing and to me this seems like it should be bullish for risk assets but again I'm just looking at the original at the initial Market uh reaction here so why aren't markets saying what the three of us are kind of saying on this particular chat here and then my other question for you is how does this all shake out because I'm I'm with you that we do need to inject some amount of liquidity here we don't want the banking system to fall apart but Michael we still got a six handle on inflation uh Jack was just mentioning over in the UK it's no better so if the Federal Reserve and and you know Global central banks have their hands forced I mean how does this how does this all end up playing out well let let me uh let me suggest this uh I mean I'm I'm not recommending it but you can do it it's there in the uh in the records go back and look at the fomc testimony um in 1984 in July by chair Volker okay that came just after the bankruptcy of Continental Illinois okay we know the reputation of Volker he was an inflation Hawk but what did he say in that meeting he said we have gone as far as we can go it will be mistaken to tighten further or indicate that we're tightening further right now okay and that was in the wake of Continental Illinois so I think that the parallel is not that different and if you looked at that what was happening in in 84 was that the Federal Reserve didn't Target rates then it was targeting money supply growth but within a few days or weeks of that statement U.S rates were down 50 basis points fed funds was down so that was there a very clear pointer to what happens in the rate cycle as regards should you buy risk assets my view has been you know I've been saying this for months now that this year we'll see the major indexes both stock and bonds range Bound in my view but this is not like 2022 you can make money this year because there'll be certain errors that will move up significantly in 2022 everything went down okay this year it's going to be very different we're essentially at an inflection point and we're moving up doesn't mean to say that you can't lose money you can lose money things may go down but what I would do is to gain look at the sequencing if liquidity is turning which we think it is and the heads up for that would be looking at the move index looking at the yield curve looking at what the reverse repo is doing the tranche of in the Fred balancing all those are key indicators look at um uh some things like the the bond markets credit markets look for that sequencing look at Bitcoin gold if these are all moving in the right direction you've got a fantastic heads up that risk assets are going to be performing because that's your base if you like of which risk asset markets build on all right Michael that's a great way to end it um uh again just uh just uh again guys uh hopefully you enjoyed this I Know Jack and I definitely learned a lot and uh just you want to give the big plus one to check out Michael and all the good work that he does at uh cross-border Capital um so Michael thank you so much again for for coming on the show this has been a ton of fun for for Jack and I and I'm sure our audience as well great thanks guys I appreciate it thank you thanks so much

Channel: Blockworks Macro

Views: 418,504

Keywords:

Id: gj-bzj8izoA

Length: 83min 50sec (5030 seconds)

Published: Wed Mar 22 2023