In this podcast episode, BFM 89.9 Market Watch speaks with Tony Nash, CEO of Complete Intelligence, to discuss the current state of the economy and the stock market. Nash predicts that GDP growth will be around 1% this year, which is a downgrade from previous estimates. He suggests that, due to inflation, firms have been passing on their costs to customers, but with lower volumes expected, there will be a focus on efficiency in the latter half of 2024 and into 2025. Nash also notes that there is a lot of excitement in the tech industry surrounding generative AI, which could bring about efficiencies and revenue opportunities for companies. This has resulted in a rally in tech stocks, despite the lower GDP growth estimates. However, Nash acknowledges that it’s difficult to predict how long this rally will last and whether companies’ valuations will come back down to earth eventually.
Regarding the bond market, Nash suggests that it has historically been more accurate in predicting interest rates compared to central bank prognostications. Currently, bonds are indicating that a recession is coming, but Nash believes there is only a slowdown expected, not a full-blown recession. Furthermore, he suggests that the Fed may be late to respond to this slowdown, as central banks are typically reactive organizations. Nash also discusses the recent performance of safe-haven assets such as the yen, gold, and the US dollar, and suggests that this is due to concerns over the Omicron variant and rising inflation.
Overall, Nash predicts that there will be a focus on efficiency and cautious optimism in the stock market in the coming years. He also suggests that it’s important to remain cautious and vigilant in the current economic climate, as there are a number of uncertainties and potential risks.
Transcript:
BFM
This is a podcast from BFM 89.9. The business station.
BFM
BFM 89.9. 7:06 A.m. On Thursday the 30 March. Good morning. You’re listening to the Morning Run. I’m Shazana Mokhtar with Wong Shou Ning. In half an hour, we’re going to discuss whether the worst is over for the Sri Lankan economy after it secured a 3 billion U. S. Dollar bailout last week from the IMF th. But as always, we’re going to kick start the morning with a look at how global markets closed overnight.
BFM
It was almost perfect. Almost perfect because almost every market was upset one. So let’s name the guilty one. It was the Shanghai Composite Index, which was down 0.2%, but otherwise us all in the green. The Dow was up 1%, S&P 500 up 1.4%, Nasdaq up 1.8%. In fact, if you look at the Nasdaq, this is the shocking thing, right? I thought tech was dead. Growth is over. Well, it ain’t the case because the Nasdaq is up 14% on a year to date basis, this has been the stellar outperformer. Now, if we look at Asian Nikkei was up 1.3%, Hang Seng up 2.1%. Shanghai, like I said, was the one that was down 0.2%. Singapore Straits Times Index, up 0.2%. And our very own FBMKLCI currently up 0.8% to 1420 points.
BFM
All right, so for some thoughts on what’s moving markets we have on the line with us, Tony Nash, CEO of Complete Intelligence. Good morning, Tony. Thanks, as always, for joining us. Now, given recent performance in US. Equities, investors seem to be looking beyond the challenges in the financial sector and recognizing that US economic growth continues to be resilient. Could investors be headed for a rude shock, though?
Tony
Well, it’s a really interesting question. I think those investors who expect rapid GDP growth, I think will be disappointed. We expect GDP growth to be kind of around 1% this year. That’s downgraded from a couple of months ago. And so it’s not necessarily overall economic growth that will happen. There will be secural growth. And what we’ll see through the rest of, say, this year and into 2025 is a focus on efficiency. What’s been happening is, because of inflation, firms have been passing on their margins or been passing on their costs and more than their costs to their customers. Okay. And so with a lower volume. So we’re going to see a focus on efficiency in the back half of 2024 and into 2025. So you will see equity performance in pockets. But in general, we’ll likely see things sideways unless we see the Fed change footing dramatically, which is still not really expected.
BFM
Okay, so, Tony, is that pocket the Nasdaq? Because help me understand this. Right? Since December, it’s actually up 20%. And I thought growth is great. What’s going on?
Tony
Well, in tech right now, there’s a lot of excitement over generative AI. This is ChatGPT and the other kind of applications of generative artificial intelligence. And so investors are looking at companies everything from semiconductors to say, Meta and saying gosh generative AI, which is kind of the next milestone for AI, could really change these companies and could really bring about efficiencies and could really bring about these revenue opportunities. So there’s a lot happening in tech, of course, but in general, when you look at companies like Microsoft that has made the major investment in OpenAI and you look at Google and their new AI kind of chat item that’s out there and then other companies. It’s similar to I know you guys are too young to know this, but in 2000, whenever a company would release a website, their stock would get a bump. And so what we’re seeing right now is whenever companies release an offering or say they are implementing some sort of generative artificial intelligence or ChatGPT or something like that, they’re getting a bump in their equity price.
BFM
Okay, but how long can this rally kind of last? There seems to be a disconnect because you just told us GDP is 1% and then companies earnings probably aren’t going to be that great for the moment. Yet markets seem to ignore the news. Will they all come back down to earth eventually?
Tony
Well, it depends on how you define down to earth. Right? Is down to earth 2018 valuations and 2018 market levels maybe. Again, it really depends on how the market views, I think generally, how the market views activities by central banks and the Fed. So if the Fed has really isolated the banking crisis, which I believe they have, then the Fed can continue to raise rates and then they can continue to shrink their balance sheet. Now they just grew their balance sheet by a lot by bailing out banks. But they can shrink their balance sheet in certain areas, say mortgages, those sorts of things. So that can help to bring some of these valuations down to earth. But keep in mind, we’re going into a presidential election year in 2024. And so it’s really hard to determine, does the US administration not want a recession or do they want a terrible recession so they can be seen to be passing a fiscal stimulus plan. So I don’t know what their calculus is. They can either keep the economy steaming ahead or they can try to drive the economy into the recession so they can be seen to be passing massive stimulus packages.
BFM
Tony, in one of your panel commentaries, a suggestion was made that bond markets were more accurate in predicting rates compared to central bank prognostications. Why is that so? And what are they currently saying about future Fed hikes?
Tony
Well, the first thing kind of every amateur loves to be a central bank prognosticator, so those are rarely right. But bonds. So if you look at a year ago, bonds were telling the Fed that they needed to raise rates because inflation was coming and they waited until too late. Right now, bonds are saying that a recession is coming and the Fed is continuing to tighten and the Fed is always late. Central banks are typically always late because they are a reactive organization and that’s how they’re designed to be. Are bonds going to be absolutely right about a recession coming later in the year? I’m not really sure. Again, we think there’s a slowdown, but we don’t necessarily think there’s a recession. And when we use the R word, we also have to be careful because it can be defined any way we want. Right. Because we had two consecutive quarters of negative growth last year and nobody says that we had a recession last year. So a recession kind of is whatever we define it as today.
BFM
Okay, well in the last two, three weeks there’s been clear, three clear safe haven assets: yen, gold, and US dollar. Do you think these three asset classes still can be safe haven assets?
Tony
It’s really hard for the dollar and gold to be safe haven assets at the same time. For the yen, I think with the change of the governor, the chairman of the BOJ, and Japan of course is already doing this, but I think they have to be very careful. That happens in, I think late next month. And so if they can handle that transition in an easy, seamless way, I think we can probably continue to do that. Gold? I’m not entirely sure. I know there are a lot of people out there pumping gold right now, and there are a lot of people kind of naysaying the dollar right now. Trying to say that Saudi signed some agreement. Saudi Arabia signed some agreement to deal in US dollars, and Russia signed Chinese Yuan and Russia signed an agreement to deal in Chinese Yuan or whatever. But those are very small, nominally very small. So I do think the dollar will remain a safe haven in times of turbulence. Japanese yen probably because currencies are all on a relative basis. They’re all on a relative basis. Gold, I don’t think gold is going to fluctuate a lot, but I think gold investors can be very fickle. So I’d be really careful of that one.
BFM
Tony, thanks as always for the chat. That was Tony Nash, CEO of Complete Intelligence, giving us his take on some of the trends that he sees moving markets in the days and weeks ahead. Commenting there a little bit about the difference in market exuberance in tech sector compared with, I suppose the sentiment that perhaps the US could be heading towards a recession or at least markedly slower growth than what was anticipated early on.
BFM
But I think it’s interesting that Tony brought up the reason why, which is, it’s generative AI, well ChatGPT, right. So much excitement about it and I think questions about is it a disruption or is it an opportunity? But I think markets thinking, hey, which companies are going to get involved in this.
BFM
If you see a company that’s involved in AI, if they have their own AI bot or whatever, oh, that must.
BFM
Be a good thing.
BFM
It reminds me so much of the hype over the Metaverse not that long ago when Facebook or Meta decided to take that angle. And right now, there’s no no one’s talking about the Metaverse metabolism.
BFM
What are you talking about, Charles? Everybody’s forgotten about it. Right. So there are always trends that come and go. Let’s see who really can monetize it. That’s the thing at the end of the day.
In the latest episode of The Week Ahead, Tony Nash is joined by Michael Nicoletos, Tracy Shuchart, and Albert Marko. The panel first explores Russia’s recent announcement that it would use CNY for trade settlement outside of the US and Europe. Michael Nicoletos explains that this move could be viable, but it would depend on whether all countries would accept the terms of trade.
Albert Marko believes that the recent rate hike was the right thing to do and predicted that the Fed would raise rates twice more. He also criticizes the lack of depth in the economics department of some central banks, citing examples from the RBNZ and the ECB.
The panel also analyzes the energy market and predicted when we might see an uptrend. Tracy Shuchart updates the chart and pointed out that crude seemed to break the down cycle a bit, leading to a good week for the commodity. The team answers a viewer’s question about the possibility of energy prices remaining low for a long time and offered their perspectives on the matter.
Finally, the panel discusses what they expected for the Week Ahead. Michael Nicoletos predicts that the energy market would remain volatile, and Tracy Shuchart believes that the focus would be on the stock market, particularly the Nasdaq. Albert Marko highlights the importance of watching the inflation data and suggests that investors should keep an eye on the bond market.
Key themes: 1. Russia ❤️ $CNY. Why? 2. Where does the Fed (and other central banks) go from here? 3. When will we see an uptrend in energy?
This is the 58th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, and welcome to The Week Ahead. I’m Tony Nash and today we’re joined by Michael Nicoletos. Michael is the founder and CEO of DeFi Advisors based in Athens. We’re also joined by Tracy Shuchart of Hilltower Resource Advisors and Albert Marko. Guys, thanks so much for joining us. We have a couple of key themes and I was really in questioning mood when I put these together. The first one is around Russia and the CNY. There was an announcement this week. My question really is why? What’s the point of that? Next is where does the Fed go from here? And really where do all central banks go from here, but mainly the Fed, ECB. Albert is going to lead on that and I know Michael has some views on that as well. That’ll be really exciting to talk through. And then we’ll talk to Tracy about energy. For the first part of this week, we saw energy on an uptrend and we’ve seen a little bit of turbulence on Friday. So when do we expect to see an uptrend in energy? So again, guys, thanks for joining us. Michael, I really appreciate you taking the time from Athens to get involved with us today. Thanks so much.
Michael
Thank you. Happy to be here. Great, love to talk to you guys.
Tony
Great. So first, Michael, I know that you know a lot about China and you follow a lot of their economic activity. And I saw you commenting on this Russia announcement about CNY. Of course, they announced that they’ll use CNY for trade settlement outside of the US and Europe, which is Latin America, Africa and Asia is what they said in their announcement. So that’s about 37% of Russia’s exports. So I put a little chart together. I used UN ComTrade data.
This is 2021 data, which is the latest data that UN ComTrade has. So if they’re really doing that, Latin America is 2% of Russia’s trade, Africa is 3% of Russia’s trade. China is 14%. Okay? And so I guess is all of their trade with China settled in CNY? I seriously doubt it. And then Asia is rest of Asia is 18%. And of that about 1%, just under 1% is Taiwan. So I seriously doubt Taiwan would settle in CNY. But what’s obvious from looking at this chart is Europe is more than half of Russia’s trade. So it’s not as if this is necessarily a massive bold announcement that everything is going to be in CNY from here on out.
Tony
It really is just kind of putting a stake in the ground saying I think it’s almost a best efforts thing. So I guess is this viable? That’s really the question. And Michael, you put out this thought-provoking tweet.
You said if that were the case, China would have no issues running out of USDs. Let’s take that on and help me understand why is China trying to do this and what is the US dollar question that you have around this arrangement?
Michael
Well, first of all, again, thank you for having me. It’s great to be here. Now we need to segregate two things: wanting to do something and being able to do something. It’s clear that a lot of countries which are highly dependent on the US dollar for trading would rather be on something else and not be dependent on the dollar. We saw what happened with Russian FX Reserve when the war started. So clearly this was a warning shot or a lot of countries said we could be next if we go into a fight with the US. So clearly there is a tendency and China wants this to happen as soon as possible. Now, for this to happen, there are a lot of things that need to happen first. I’ll give just an anecdotal example because we get all this news flow and all these headlines where one signs an agreement with another and then two people or two prime ministers come up and say we’re going to do it, and everyone takes it for granted, especially on Twitter. It’s either a fanatic from one side or a fanatic from the other side. So again, I agree with everyone who is afraid of this happening in the sense that a lot of people are saying that the end of the dollar is close and that everyone’s going to go to something different.
Michael
I agree there is the willingness. I’m not sure this can happen soon, and I don’t think it can happen without some conflict occurring somewhere. So an example is that in 2018, Iran signed an agreement with China to sell oil in Yuan. Still, after four or five years, the volumes are ridiculously low. So again, there are agreements, but in order to enforce them and in order for them to happen, they take a lot more time than one would want. So Russia had no option. So because of the sanctions, they still sell to Europe, a few things, but they’re trying to outweigh it by selling more to China. And China and Russia are trying to make these agreements where they will be settling in Rubles or in Yuan. And they try to make these agreements. They want to expand them to other countries as well. However, you see, for example, India. India doesn’t want to settle in Yuan or doesn’t want to settle in ruble. They want to settle in Dirhams, which is back to the dollar. So you get all this information and the data, at least until now, does not support that there is a threat to the dollar.
Michael
There is a threat to the dollar in terms of willingness. There is no threat to the dollar in terms of data which says that this is going to happen tomorrow. So I think that this will eventually happen, but I don’t think it will happen soon. I think until it happens, we’re going to see a few episodes. And these episodes are not straightforward, how they will evolve.
Michael
Now, regarding China and its macro, the reason I’m saying what I’m saying and I’m saying that China needs dollars. China has been dependent, first of all, on its real estate, which was like 30% of its GDP. We saw what happened to the real estate. The second leg was it was highly dependent on exports. There’s a global slowdown. So these exports will have some issues. And now, how has China managed to keep this economy running? I’ll give you a few metrics to understand. The US is an economy which is like 26, I think 26 trillion of GDP. And if I’m not mistaken, its M2 is around 21 trillion. In China, the GDP is around 17 trillion, all in dollars. Okay? And M2 is $40 trillion. 40. Four, zero. So what does that mean?
Michael
The China government prints money. Prints money. Prints money. Because there are capital controls, the balloon gets bigger and bigger and bigger, but the money can’t leave, or it can leave for selected few, and I’ll explain how it leaves. And for the rest, because our capital control, the money can’t leave. So it stays in. But this is in one. Some try to buy gold, some try to invoice over invoice to Hong Kong and take it out of Hong Kong. But when the disparity is so big, clearly there is a problem. There’s an NPL problem. Chinese banks are like four times China’s GDP.
Tony
Sorry, NPL is non performing loans.
Michael
Non performing loans. Sorry. Sometimes they’re non performing. You cannot have an M2 of 40 trillion and a GDP of 17 trillion and not have non performing loans. Chinese banking system.
Tony
Sorry, I just want to go back and I don’t mean to interrupt you, but I just want to make sure that people understand. China has currency in circulation of $40 trillion, and they have a GDP of $17 trillion. Whereas the US has a GDP of what you say 24 trillion. I don’t remember what number you’re… 26 trillion. And they have 21 trillion in circulation. Right. So for all of these people who talk about China being this economic model for other people, why does it matter that their M2 is more than double the size of their economy?
Michael
Let me say something. First of all, let’s put something that the US. Is also the global reserve currency. So everyone in the world wants dollars. It’s not like only the US wants dollars. At this stage, less than 10% of the world wants Yuan. So it’s not like everyone wants to get.
Tony
I think it’s 2.1% of transactions or something like that.
Tracy
2.8%?
Tony
2.8, yeah, transactions.
Michael
Okay. I saw a number which was around 6%. Maybe I’m wrong. Okay. But again, it’s a number which is very small.
Michael
All this money that is in the economy, if Chinese people were given the choice, they would be able to take it out. The economy is growing at a faster pace than its potential. I’ll give you a number. Right now, Chinese banks are more than 50% of global GDP in terms of size. The US, I think its peak was 32% in 1985 and Japan’s 27% in 1994. So we’ve passed all metrics in terms of the world dominant power or the dominant economy, if you want to put it this way, being a percentage of GDP in terms of banking assets. So the banking assets clearly have a lot of bad debts in there, which we cannot know what they are because the Chinese economy wants the Chinese government wants to control that. Now, there was a special committee put in place this month, I think, in order to oversee the financial situation in China. So I’m pretty sure they’re a bit worried about it. They want to switch from an export oriented economy to a consumption driven economy. But this is still less than 40% of GDP and this takes a lot of time to go like the US is around 70%, but it takes a lot of time to go for 40%, 70%.
Michael
Now, all this money stays in China. They have no option, they can’t do anything. So it’s an issue. And I’ll give you a ratio. If you take their FX reserve, it’s around 3 point something trillion. If you divide FX to M2, it’s around 7%. So if that money were to want if that money wanted to leave, in theory, only 7% can be covered by FX reserves, the fixed reserves of the government. Just to clarify, the Asian tiger crisis in 97, the tigers collapsed when the ratio went below 25%. So they didn’t have that support to keep it up.
Tony
And just be clear for the US that’s 100%, right?
Michael
The US doesn’t have any problems. So this is something that needs to be addressed and I don’t know how they will address it. They try to make all these agreements so that the one becomes a tradable currency and they can invoicing one. So if the Yuan, in theory was to become the global reserve currency tomorrow morning, their debt would become the world’s problem. Now, they haven’t managed to export that, so they need these dollars to keep that balloon, let’s say, from all the area in the balloon to be taken up. They need these FX reserves to keep the money in and they need to build confidence, and they try to build confidence with narratives and not with data. But again, they don’t have a choice right now, in my opinion.
Tony
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https://youtu.be/yYom7Zqezio
Tony
The difference between, say, the onshore and offshore CNY or CNH or whatever, there is a huge difference in perceived value. I would think you can’t change the perceived value of CNY onshore, but offshore, if people are nominating contracts in, say, I’ll say “CNY” in quotes, there is an exchange right there. But again, this M2 issue, which I can’t stress how important that is, I haven’t heard anybody else talking about this. And it’s so critical to understand the fiat value of CNY itself, right, because it’s not limited, and the government because they’re effectively fun tickets with Mao’s face on it.
Tony
Right. And that’s how the PBOC was treating it. And again, when people talk about CNY as a global reserve currency, nobody is looking at the integrity of the PBOC and nobody is looking at how the PBOC manages monetary policy in China.
Michael
I’ll give you anecdotal information. I haven’t checked the number for a few years, but the last time I checked, if you look at the import-export numbers from Hong Kong to China, and you look at the PBOC, and then you go and see the same numbers in the HKMA, you would assume that these four numbers should be the same, not the same. Import should be export and export should be imports. The numbers should be very close. The discrepancy is huge. These numbers do not reconciliate, which means that in some form there is some over invoicing to Hong Kong.
Tony
And you’re not talking about 30%, you’re talking about multiples.
Michael
You’re talking about a lot. It’s ridiculous. So I think if you see the Hong Kong peg has been stable to the upper bound lately because I guess because of the interest rate differential, a lot of money is leaving. So it’s putting pressure on Hong Kong as well. So it remains to be seen what happens there.
Tony
So let me go to Tracy. Tracy, in terms of Russia using CNY, okay? And I know you look at a lot of their energy exports, and of course there’s all this official dumb around sanctions and stuff, but what’s your kind of guess on Russia using either USD or proxy USD, Dirhams or something else as currencies for collecting on energy exports or commodity exports more broadly?
Tracy
Well, first, I think that they prefer dollars no matter what this kind of China saying we want to trade a Yuan. And Russia said, okay, but that was a suggestion. That does not mean that it’s necessarily happening. But what is really interesting is earlier this week, on Monday, Russia laid out conditions for extending the grain, the black seed grain deal, right? Because it was supposed to be for 90 days, but they cut it to 60 days because they’re trying to use that as leverage. And one of the things that they are trying to use as a leverage is they will extend the deal or they’ll give or the other part is they’ll give African countries just free grain instead of selling it. But one of the big conditions for that was for the removal of some Western sanction, specifically to get them back on Swift. And so if that happens, forget it. Everything’s going to be all the trade will be all euros and dollars.
Tony
I thought Swift was terrible and everybody wanted on Swift.
Tracy
I just thought it was important to point out because if they get back on Swift, obviously that’s going to make trading in dollars easy for everything, all commodities across the board.
Tony
Right. And so that goes back to what Michael said initially about kind of these guys really want dollars and all this other stuff. There’s the official dumb of the prime ministers meeting each other, right. And then there’s the factual activities they undertake based on the reality of their position in the world economy. Right. What are your thoughts here?
Albert
I agree with Michael and Tracy to talk about the reserve currency. Switching from the dollar to the Yuan is a joke, to be honest with you. You do have some people in other countries in the Middle East and China and whatnot talking about the death of the dollar and actual serious tone. But anyone with even like a shred of financial backing and insight knows that it’s just an impossible thing. From what it sounds like, it’s more of like a barter system. But that introduces even bigger problems. I mean, you can’t scale it up. There’s no standardization. How do you value things to begin with?
Tony
That’s it.
Albert
Valuing goods and services without using the dollar right now is just an impossibility. And on top of that, you have the political problems that come along with it. I mean, like the Saudis, they want dollars for their oil. They need defense assistance. The Greeks needed US defense assistance. The Turks, as much as they want to make noise again, they’re reliant on the US and NATO for defense and whatnot. These components not just financially, what Michael talked about and decided much more eloquently than I would ever would, but there’s also political components that you just can’t get around in the near term.
Tony
But even if they had a barter system, they would reference the price in dollars, right?
Albert
Well, yeah.
Tony
10 billion.
Tracy
Your chocolate is back to iran did that when they were first sanctioned over a decade ago. They were trading oil for gold, but it was still referencing dollars.
Albert
On top of that, you run the risk of hyperinflation eliminating dollars from your FX reserves and starting to trade away from the dollar. You’re going to end up in a hyperinflation event.
Tony
Right.
Michael
Can I say something? Can I say something? About all these points? I agree with all these points. There’s one more thing. Let’s say you trade in rubles and you trade in Yuan, okay? It means that you’re going to keep FX reserves in rubles or in Yuan. So you feel more comfortable keeping a currency from an authoritarian regime than holding the US. Dollar, which is fully liquid, fully tradable, and anyone in the street will take it at a split of a second. You need many years of track record to build that trust. There are a lot of bad things about the dollar. We agree that I don’t think anyone will say that it’s a perfect mechanism, but right now, it’s very functional, it’s very liquid. And if you want to keep your reserves in US Treasuries, you can sell them at the split of a second. You don’t have any issues with that. If you have Yuan, you’re going to do what? You’re going to buy Chinese government bonds? And how will you sell them if the PBOC calls you and says, it’s not a good idea to sell your Chinese bonds this week? We would prefer you didn’t.
Tony
Bet on the central bank, right? If you’re holding rubles, you’re betting that the Russian central bank is trustworthy. If you’re holding CNY, you’re betting that the Chinese center. So what central banks are out there that you could potentially trust? You have the Fed, you have the ECB, you have BOJ, right? Those are really the only three that are visible enough that have the scale and transparency to manage a currency. And look what the BOJ has done since Abenomics. And on and on and on. Do you trust the ECB? I don’t know. And it becomes, do you trust the ECB or the Fed more? I mean, sorry, but I just don’t trust the ECB.
Michael
I don’t trust ECB. But it’s relative. I mean, you don’t have a problem keeping Euros. Maybe it’s not your preferred choice, but you don’t lose your sleep on holding Euros. Let me put it at this stage.
Tony
That’s exactly right. That’s exactly right. Okay, guys, this is great. Let’s move on to the next thing, because I think we all agreed violently here, but I think we’re going to not agree on the next one, which I’m really excited about. So let’s talk about central banks. And where does the Fed and where do other central banks go from here? So, of course, we saw the Fed raise this week. I think it was the right thing to do. Albert, I know you think it’s the right thing to do. Markets have been up and down since then. And Albert, you’ve said that you expect the Fed to raise two more times, and I want to talk about kind of what’s behind that assertion. And then we get silly statements like this one from the RBNZ in New Zealand, where the chief economist basically says, if inflation expectations don’t fall, we’ll be forced to do more regarding interest rates.
Well, of course. Why wouldn’t you do that. So can you walk us through a little bit, kind of just very quick, because there have been thousands of hours of Fed analysis this week. But why do you think the Fed is going to raise two more times?
Albert
Supercore is trending up and it continues to trend up. Services are on fire. Real estate numbers have been on fire. There’s no slowdown in reality. I mean, even the layoffs have been slow. They’ve come from the tech sector. They haven’t come from construction or any other blue collar jobs at the moment. So until we see that, the economy is going to be red hot and it’s a problem for the Fed, inflation overall.
Tony
Okay, so play devil’s advocate here. Banking crisis, Fed had to bail out banks, all this other stuff. So why isn’t the Fed saying, let’s pause on the banking crisis worries?
Albert
Because banks are fully liquid. The big banks have no problem whatsoever. Some of these smaller banks that have no risk protocols are getting exposed. The tech heavy investments are getting exposed. Everyone knows that higher rates hurts the tech sector the most. And those banks were at fault. They didn’t hedge properly.
Tony
Now you have duration risk. I just want to be clear. I just want to make sure that people understand. You’re not saying that they failed necessarily because they’re tech, but they failed because of duration risk and then their tech depositors took their money out. Right?
Albert
Absolutely. But the banking system overall is not really at risk. They’re just shaking out some of the weaker players. But that was inevitable as interest rates have risen. A lot of the problems stem from the Fed and them guaranteeing four, five, 6% deposits, while the banks only do 1%. They can’t compete with that.
Tony
Right. Michael, I know that you think this wasn’t the right action. So what’s your perspective?
Michael
Well, let me say something first. I believe that it was a mistake, and I’ll say why it was a mistake. I think it’s a mistake when you raise interest rates as a central bank and the banks follow by raising rates on the loan side and on the deposit side, what do you do? You make debt more expensive and then you make people because you have, let’s say, a 5% interest rate on your bank, you create an opportunity cost so people want to save. So you reduce liquidity from the deposit side, and also you reduce loan demand because it’s more expensive, and that creates a slowdown. What happened now, because we had ten years of QE, everyone forgot that there was an interest rate on the deposit side. So the Fed, MDCB and all the central banks raised the interest rate. So the loan side adjusted. That became more expensive, but the deposit side stayed zero at 1%. I don’t know where this is in the US. But it’s really low. At some point, people started waking up when it arrived at 4% and they suddenly started saying, okay, I don’t have any interest on my deposit.
Michael
Let me put my money in the money market fund. How much does it give? Three, four, 5%? I don’t know. It’s a much higher rate. So I think I saw somewhere today that around 5 trillion have gone into money market funds. The numbers close to that. So when you take your money out of the deposit and you take it to a money market fund, this is the equivalent of a bank run for the bank that you’re taking the money, it’s a deposit living. It might not feel like a bank run, but on the balance sheet of a bank, it’s a bank run. So this started happening, and again, because of what you mentioned, they had invested in Treasuries and the duration risk was a mismatch. They didn’t do some of them at least hadn’t done appropriate hedging. They started losing money and they started selling this bond at a loss, although they had them at the Healthy Maturity portfolio where you don’t need to take a mark to market loss. And suddenly both sides of the balance sheet were screwed. Let me put it this way. So a few banks started going under. Now, I know that the central bank has come up and I know a lot of people come up.
Michael
And I do agree that there’s no systemic risk. And I mean that I don’t see a cascade of people losing their deposits. But nevertheless, people feel uncomfortable and try to do something about it. Either take them more money market funds or take their money from a regional bank, if they can. To JP morgan or one of the big guys. This creates a big problem for the economy. Yes, there are some signs which show that the economy is still robust. But I think a lot of leading indicators suggest that the economy is slowing down and most of the metrics coming from the inflation side have collapsed. Yes, core CPI is still high and it’s a lagging indicator, so it will take time for it to come down. But I think that given the stress we saw this week and why do I say that? Because we look at the US as a closed system. It’s not. When you raise interest rates as the Fed and you are the global reserve currency, you create a global credit crunch. You saw that last week. The Fed had come out with swap lines for everyone. You saw today that foreign banks borrowed 60 billion in liquidity, the ones that didn’t have a swap line.
Michael
And we see today Deutsche Bank being in the headlines and Commerce Bank being in the gate. So you might think that the US system is okay, but it creates a domino effect, which we’re starting to see. We saw Credit Suisse going under in a deal, which was not, I’d say, what we would think of. I believe that that deal in combination with the high rates is probably the root of the problem in the sense that they destroyed the capital structure, they wiped out all the 80 ones without wiping out the equity holders. Which means now that in Europe everyone’s wondering if my 81 is of any value. And that creates another uncertainty in combination with the higher interest rates and the stress that has started to build up. I think we’ve passed the moment where, okay, it could be debatable if they did right or if they did wrong. The US bond market is saying that it was wrong. It was a mistake. The two years at 370. And so the bond market went from the one side and the Fed went on the other side.
Tony
Why? The two year at 270 is important.
Michael
373, 70. Sorry, yeah. Three seven. Because if in two years you’re getting 3.7% and the Fed fund rate is five someone, it means that someone is buying a two year bond getting much less. Which means what? It means that the market is saying rate cuts are coming soon. So the market is saying there’s no way we can keep it this way. And the Fed is saying the opposite. Historically speaking, the bond market has been right. If you take it into context, it could be this time that they are wrong. It feels to me, at least from the stress I look in global markets and not in US. Only, that things are getting a bit out of hand. And having a bank like Credit Suisse go under, which is a big bank, and having all the central banks come in together on a Sunday night to give up swap lines, it means that the stress in the system, it’s much bigger than with yeah, but Sunday night.
Tony
Is the best time to get swap lines. Okay, so you talk about European banks, but we had Mueller from the ECB out this week saying, I wouldn’t worry about a financial crisis in Europe.
So we have ECB guys out there going, yeah, Credit Suisse happened and we know Deutsche is an issue, but I wouldn’t worry about that in Europe. So I think we’re seeing statements from Yellen, the Fed, the ECB, other guys who are saying, no, there’s nothing to see here, but then we see things kind of blowing up all over the place. Right, and then we have a question especially specifically for you, Michael, from a viewer who said, I’d like Michael’s thoughts on the EU, particularly banks, pensions and future growth prospects. So can you talk us through? How do these banking issues in Europe flow through to European pensions?
Michael
First of all, let’s say something. We’re talking about the US and.
Albert
Duration.
Michael
Risk on the bond losses. Let’s remind everyone that at the peak of QE 18 1818 trillion worth of bonds had negative yield, and these were mostly Europe and Asia. So pension funds and banks in Europe which are forced to buy these bonds were buying bonds. With a negative yield. So they were losing on day one these bonds from -50 basis bonds have gone to two and 3%, the losses on these are much greater and pension funds will have much bigger issues than the ones that have in the US we were talking about a pension crisis in the US. But the European one is pretty bad too. Just look at in France, they raised this week the year that you take your pension from 62 years old to 64 and the country is burning to the ground. Now, you understand that it’s 62 to 64. It’s not like they made 62 to 70 years old. So it’s very delicate. And the situation in Europe, given the negative bonds, given the interest rate hikes and given one more thing in Europe, given that Europe doesn’t have the dollar and it has the Euro was mostly a supply driven issue.
Michael
It means that we were importing oil and energy from Russia and from everywhere and all these commodities were priced in dollars. So as a Europe tell, the price of these commodities were more expensive. So inflation was a supply driven problem. I think there’s a report, I think from the San Francisco Fed two thirds of the inflation was supply driven in Europe. So when inflation is supply driven and you raise rates to stop it, you’re using the wrong medicine to stop the problem. You need to crash the economy in order for this to stop. This is not really efficient. Now, in the meantime, you have yields going higher and now the yields that we see on our screen on Bloomberg or anywhere are not the yield real yields because the ECB is in and tries to contain the spreads. If you left the market low, I’m pretty sure the spreads would be much, much wider. And you have the new thing which came up this week when the Swiss National Bank decided that tier one, additional tier ones would be written off and equity holder, an equity holder would be saved. Now, imagine what happened. You probably saw what happened this week, all the 80 ones in Europe got smashed because everyone says I don’t trust this instrument.
Michael
I don’t know. Yes, central bankers will come out.
Tony
These are the cocoa bonds that came out in I think, 2013, right?
Michael
Yeah, there are a few of them, yeah, but it’s a cocoa, it’s contingent convertible. It means that they’re convertible be converted to equity if something happens. Let me put it as simple as it is, but these are supposed to be wiped out before the equity. So the question is what prevents for something else similar to happen again, the ECB came out, BoE came out, they said this is not accepted. But the fear and the is now everywhere. So you have a combination of factors. You have a factor that this ECB has been raising rates when I don’t think it’s a proper mechanism to address inflation in europe, they’ve created a slowdown. If you see Germany’s numbers and everywhere’s numbers in Europe, the economy is slowing down fast. You have a discussion on the capital structure of lending, which is very critical in the way companies and banks go and borrow themselves and all this at the same time and when the US. Is draining liquidity from the global system. I think the situation in Europe is very tough. Again, after 2008, I don’t think we have a systemic risk on our hands and the risks never materialize in the same place.
Michael
But I think things are about to get tough and it’s going to be much worse before it gets any better.
Tony
So what I would offer back, and I think everything you’re saying is valid and Albert Tracy, let me know if you want to think about this, but in the US. We have a presidential election next year. There is almost no way that we will see the US economy crash in the next 24 months because Janet Yellen won’t let that happen. And so we may see issues in Europe and we may see Europe and the rest of the world suffer based on US interest rate and monetary policy. But the US. Will do everything, the current administration will do everything they can to keep the US. From crashing in that time. And I’m not just saying this because they’re Democrats, Republicans would do the same thing to keep the economy afloat in the year before an election.
Albert
Albert, what do you think about that? It depends on what is happening specifically with debt ceiling, right? I mean, Janet Yellen and the Biden administration would gladly let the economy sink, the market sink anyways if they could blame it on escape both the GOP on the debt ceiling not getting hyped. So that’s definitely something you need to watch over the next six months because it is campaign fundraising season and they can’t really agitate their voters all that much, to be honest with you. Certainly the political component is going to be high over the next twelve months.
Tony
Okay, great. Let’s move on. Thank you for that, guys. Let’s move on to energy.
Michael
Can I say something?
Tony
Absolutely. Yes, please.
Michael
What appears to be happening right now, at least in my eyes, is that the Fed is using interest rates to attack inflation and it’s using the balance sheet to give liquidity. So these two do not go in the same direction at this point. The question is if they can do this for a long time. It doesn’t feel to me that they can. But at least right now they’re giving liquidity on the one side and they’re raising rates on the other side. I’m not sure they can do this for us.
Albert
We’ve actually talked about that at length here. But it’s not the Fed. It’s really the treasury. Sterilizing QT They’re coordinating.
Michael
They’re coordinating.
Albert
Of course they coordinate for the most part, but sometimes in the last six months or the last twelve months. Powell and Yellen have been at odds with each other in policy. So this is a lot of the reasons why the markets has just been topsy turbine. Don’t understand which way it’s going because you have conflicting policy and agendas from the treasury and the Fed.
Michael
So you feel it’s conflicting or do you think it’s coordinating? They’re doing it on purpose. That’s what I haven’t figured out yet.
Albert
I think the want to eliminate excess cash in the system is coordinated but I think the policy of how they’re doing that is conflicting and that’s going to be a bigger problem, say second half of this year.
Michael
Okay, sounds logical, but it’s one of these things that pass on me. I don’t know if they’re doing it on purpose or if they do any as you say, because they’re using other tools and they step on each other doing so.
Albert
My rule of thumb is to side with incompetence rather than conspiracy.
Tony
Okay.
Michael
It’s not conspiracy when the Fed chairman talks with the treasury guy?
Albert
No, I am absolutely in your corner on this one. I absolutely believe that they talk and coordinate things for sure. I just think that their agenda at the moment doesn’t line up 100% of the time.
Michael
Okay.
Tony
Very good. Okay, thanks for that guys. Tracy, let’s talk about energy for a while. Up until Friday we had a pretty good week for crude. I thought we were breaking that down cycle a bit, but we’re seeing some chop in energy markets. And so we had a question for you from a viewer saying when do you see oil and natty in a sustainable uptrend?
Tracy
Yeah, nat gas is a whole other issue. I think it’s going to be very difficult really. We’re trading in the range that we’ve been trading in most of the time for the last 20 years or so. That $2, $3 range has been very comfortable for nat gas. We produce a lot of nat gas. Yes, we are building out LNG facilities and yes, we have had problems with freeport and such. I just think that we probably won’t really see a big spike in prices unless we see another energy crisis in Europe, do you know what I’m saying? And then we’re going to have to force to sell even more. So for right now I would kind of get comfortable with nat gas about that range. But if it starts breaking above like 375 or so I would start getting bullish. But for right now, just kind of in that area where it’s been comfortable most of the time. Right. So I think it’s going to be a while for that. So we got to kind of assess the situation in Europe as we get to summer air conditioning use and to next winter if they have a bad winter, I think it’s going to be a few more months at least down the line for natural gas as far as oil is concerned.
Tracy
Brent said about $75 right now, saudi Arabia would like it around 80, 90 range is where they’re really comfortable. I think right now what we’re going to have to get through is we’re going to have to really assess we need more time to assess Russia’s situation. They just extended that 500,000 barrel a day cut out until June. The latest records do show that they actually have cut that much so far in March. So the cut is happening, which also means that they’re experiencing kind of a pullback in demand, even though they have really it’s more on the product end rather than, I should say, rather than the crude oil end, because they have floating storage, they have ships piling up everywhere with product. And so I think that will help clear their excess product a little more. So it’s really on the product end and that we also have to see everybody’s freaking if the Fed again decides to stop raising rates or pause. I think commodities really like that situation just because of the cost of carry and transportation and storage for all these commodities is very expensive. Right.
Tony
Because.
Tracy
You get bank credit lines for that. Right. And so I think that’s putting downward pressure on markets right now. And then obviously fear of recession is kind of kicking in again after the recent bank crisis in the US. And in Europe. And so I really don’t think that we’ll see higher prices. I mean, typically this is the time of year we do start seeing higher prices heading into high summer demand season. But we’ve also been seeing, I think everybody expected China. China demanded to shoot up right away. That’s taking longer than anticipated, which I kind of have been saying that on this show for quite a few months.
Tony
Long time. Exactly.
Tracy
So I think that there’s a lot of factors involved right now. I do think, again, it’s higher for longer. Historically still, prices at $70 is high for oil. The market is crashing by any means, just coming down from geopolitically induced spike last year. I think it’s higher for longer. And definitely I could see prices go into that $110 range, but likely into 2024. Not really this year, obviously, unless something happens. Okay.
Michael
Do you think if the Fed poses or whatever reason, or if they do a rate cut, do you think that commodities will explode or do you think.
Tracy
I think if they cut, commodities would get really excited. I think if they pause, they would get excited. Right. I think we would see a rebound in a lot of these commodities, grains, things of that base metals and industrial metals and oil. But if they start cutting, then I think that they’ll really like that because then they don’t have to throw product at the market because they can’t afford to store it.
Michael
Thank you.
Albert
I’m actually quite bullish for oil in the near term. One of the reasons is I’ve heard through the grapevine that the Chicanery and the futures market and I’m reading that hedge funds and other money managers sold the equivalent of 139,000,000 barrels of oil in futures over seven days a week and a half ago. So, I mean, to me, it’s like they’re almost out of ammo when it comes to suppressing oil at the moment. And any little flare up or anything is probably going to be bullish for oil and probably shoot right back up to 80.
Tony
So what could that be, Albert?
Albert
It could be a natural event. It could be weather, I mean, some kind of economic policy stimulus from Europe coming out there, or even the United States going into, like Tracy was saying, the travel season and whatnot. It could be anything, really. I mean, I think the market is just begging for some kind of bullish signal for them to run it up.
Tony
Okay. And Tracy, if you’re sitting in Europe because energy prices were such a factor in 2022, what are the main things that you’re worried about? Their nat gas storage. Has that been depleted much over the winter?
Tracy
No, it wasn’t depleted. They just had to start injections again because what we are seeing is that this really started in fall of 2021. Everybody kind of forgets that the crisis started before the Ukraine invasion, but what we saw is industry start to shut down, especially industry like smelting and glass blowing and things of that nature that require a lot of energy. Right when nat gas prices started spiking, and that was well before that summer of 2022 spike, they didn’t need to spike much where we saw a lot of those industries shut down. So what we’re seeing now is that since prices have been muted for long enough now, now we are seeing manufacturing and whatnot pick up with the numbers came in overnight for Europe. We’re seeing manufacturing pick up again. We’re starting to see some drawdowns finally in storage. Spain in particular has really ramped up a lot of their industry that had shut down prior. I have to say, natural gas prices are still more expensive than they typically are in Europe. Even at this price, right, they’re still higher than normal. So this is also why we’re not seeing a flurry of activity.
Tracy
As soon as prices came down, you have to realize that relative to where they were, they’re still generally high. But we are seeing, I think people are getting used to kind of this price range for Ttf, which is Dutchnet gas. And so we are seeing in manufacturing and industry pick up again in some of these traditional industries that require a lot of energy. So we’ll have to see, and if that really picks up, companies are going back to where they went to fuel instead of gas. We’re seeing them go back to gas now. And so that’s really what I’m watching on the energy end. Is this just one off, kind of, or does this continue throughout the summer?
Michael
Okay.
Tracy
Sorry.
Tony
And then everybody’s favorite energy secretary, Jennifer Grandholm, had some comments about refilling the Spr this week. Can you fill us in on that? And what does that mean for markets?
Tracy
Basically, she said we’re not filling in the Spr, refilling the Spr anytime soon.
Michael
Sorry.
Tracy
She said a few years, which means a lot more years unless there’s a change of administration and a policy change. But I would say from until the election not going to see an Sbr, which makes sense because they know that if they fill the Spr, what’s going to happen? Oil prices are likely going to go higher, and they can’t afford that going heading into an election year. And so I think that’s really why they kind of pushed that off. That’s kind of what’s going on with that.
Michael
Can they be saying something and doing something else?
Tracy
Yeah, but we would know if they’re actually filling the Spr or not because it’s a public auction.
Tony
Okay, why don’t we just stop calling it the Strategic Petroleum Reserve and just call it the Petroleum Reserve? Nothing strategic about the way they’re using the Tactical Petroleum Reserve.
Tracy
They’re using it as a piggy bank. Right.
Albert
Instead of strategic, you use slush fund, petroleum reserve.
Tony
Right, exactly. Okay, guys, one last question, I guess. What are you looking for in the week ahead? We’ve had a lot of volatility over the past couple of weeks. Michael, what are you looking for in the week ahead?
Michael
I’m focusing on central banks and interest rates. I think the issue will be banks. Again, I think the big stress in the economy is private markets and not public markets. BCS, private equity, all these investments need to do write downs. It will take a bit more time for them to do that. It doesn’t happen that fast. They don’t adjust as fast as public market. I believe that bank we will see that stress mostly on banking stocks. A because the cost of funding goes up, b because the capital structure is put into a discussion. C because they continue to raise interest rates. And there is a stress within, I think, focusing on what happens to the banks and to the two central banks. Again, we’re looking at the same thing, unfortunately, but the problem is not in the same place. But these are the indicators you need to look. I believe that you’re going to see inflation coming down fast. That’s my expectation. Maybe I’m wrong, but if you see inflation coming down, it’ll make the life much easier for central bank. Yeah.
Tony
And for all of us. Do you expect to see, like VCs, for example, some VCs close up because of the cost of funds and a lot of these banking issues, or do you think it really doesn’t impact them much?
Michael
I don’t know if they’re going to close down because it’s a 510 year investment. It depends if they can reinvest or if they have to liquidate. But I think funds that are coming up to their maturity, they need to liquidate or they need to roll over. It’s going to happen at a much lower price than they thought, or they’ll have to wait one or two years more. So I think that stress is going to show up somewhere.
Tony
Tracy, what do you see over the next week?
Tracy
I think it’s type based markets. There’s not really a lot coming up as far as oil is concerned. OPEC meeting is the following week, which we already know they’re going to do nothing. So really, next week, end of month stuff, there’s not a whole lot going on in the commodities world, really newswise next week. So I think probably see the same sideways action.
Tony
Okay, great. Robert, what are you looking for? Let me ask a little bit of a kind of loaded question with that. As springtime is coming in in Ukraine, do we expect that to heat up at all as things warm a bit there?
Albert
Well, yeah, I would say yes. Geopolitically? I think it would be advantageous for Russia to do something to stay face. Absolutely. But for the week ahead, I think the narrative shift I’m watching for the narrative shift of interest rates to banking, like Michael was talking about, I think Yellen is most likely going to come out and try to guarantee 500,000 in deposits and even talk about 750 and get it up there and just get the crisis over and done with. So that’s what I’m looking for.
Michael
Okay.
Tony
Wow. Would that require congressional no, they can use emergency powers. Everything’s. Emergency power is great. Perfect. Okay, thanks, guys. Thank you very much. Really appreciate your time and all your insight, and have a great week ahead.
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This Week Ahead features a discussion on banking systemic risk versus inflation with Hugh Hendry, Tracy Shuchart, and Albert Marko. The group covers recent events in the banking sector, including Credit Suisse and the potential risks posed to the global economy, the impact of higher interest rates on crude prices, and China’s growing diplomatic role.
To start, Hugh expresses concern over the lack of GDP per capita growth since the Great Financial Crisis and the failure of the remedial work undertaken since then, labeling the current environment as “The Great, Great Depression”. He warns that raising interest rates in this environment could be disastrous and discusses the creation of credit and the muted credit cap, as well as the contraction of the M2 series.
Hugh questions the need for central bankers and believes that the totality of credit creation should be examined. He suggests that the bond market has been more accurate in predicting rates than central banks and he notes that there are persistent trade surplus nations that create surplus capital, which is being invested in the United States, resulting in asset price inflation. He argues that the problem lies in the flow of capital rather than the currency (the US Dollar) itself.
Next, Tracy highlights how rising rates are affecting the prices of commodity cargoes. The discussion digs into the possible impact of falling cargo rates on the supply and pricing of commodities. Meanwhile, the discussion anticipates that the upcoming CPI report could inform the Fed’s expected raise of another 25bps at this month’s meeting. They also discuss the ECB’s recent 50bps raise to offset European inflation.
Finally, Albert leads a discussion about China’s shift from an aggressive “wolf warrior” foreign policy to one of a peace negotiator. The discussion explores the motivations behind China’s recent diplomatic efforts to negotiate a Saudi-Iran agreement and facilitate a Russia-Ukraine peace agreement. They also explore the position and potential level of involvement in these discussions by the United States.
Key themes: 1. Banking systemic risk vs inflation 2. Higher rates & commodity cargoes 3. China: From wolf warrior to peace negotiator?
This is the 57th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, everyone, and welcome to the Week Ahead. My name is Tony Nash. Today we’re joined by Hugh Hendry. I don’t think he needs an introduction, but Hugh is a founder of Eclectical and Macro, as well as being a hotelier in St. Bart’s and a lot of other things. We’ve also got Tracy Shuchart with Hilltower Resource Advisors. And we’ve got Albert Marko. Guys, thank you so much for joining us. So much has happened over the last two weeks in the banking sector and especially over the weekend with Credit Suisse. So looking forward to a lot of this discussion.
We’ve got some key themes today. The first is banking systemic risk versus inflation. As the Fed meets, and as we sort out a lot of these banking backstops, I think there’s a lot of discussion about which is more important right now. I think a lot of it is focusing on banking systemic risk panic, but we’ll talk through that with Hugh. We also want to talk about higher rates and commodity cargo prices. Tracy brought some thoughts about that earlier, I guess, over the weekend. So we want to talk through that today. And then we’ve seen China kind of come forward as kind of a negotiator for the Middle East and Russia, Ukraine and other things. And I want to talk to Albert about kind of how real is that, how much of a good faith negotiator is China in those areas?
So, Hugh, first of all, thank you so much for joining us. Hasn’t been easy to get you, and we’re really glad to have you. So we really appreciate having you here. Great. So first off, banking systemic risk versus inflation. Everybody knows the Silicon Valley Bank and First Republic and the BTFP stuff here in the US. All the Credit Suisse and UBS stuff happened over the weekend. What are you watching there? Like, what’s your biggest worry? Is it these 81 bonds? What are you focused on there?
Hugh
Well, I have been focused for some time. My focus has been this impending car crash, which is now becoming more apparent perhaps to the many. And my concern had been Fed by my observation, my belief that we’ve been operating in a silent form of depression ever since the remedial work undertaken since the great financial crisis. Let’s date that to March 2009. It has been a spectacular failure. I will share with you a chart. Maybe we’ll be looking at it now. And it comes from who does it come from? I want to say I always get these names mixed up. Michael Klein. I think the wonderful economist academic works of Michael Barr, doesn’t work with Michael Pettis, but collaborated on trade wars, of political class wars. And he shows the indexing of US GDP per capita from the starting point of the Great Depression. And likewise, he superimposes a similar series for now, if you will, from that March 2009 and over the period spanning to almost 15 years us. Per capita GDP in the Great Depression went from 100 to almost 190. And this time around we’ve gone from 100 to 115. So I said silent.
We should call it the Great Great Depression that no one is allowed to speak of. We went through the pandemic environment to realize that there are some terms where there’s almost a censorship and it would seem that in US financial literature the word depression has been assigned to the past and not to the present. So raising interest rates in a Great Depression has filled me with dread and I think that is what has come to light in the last ten days or so.
Tony
So when we look at the amount of credit that’s been created since the financial crisis and kind of the payoff in terms of GDP per capita, is that one of the variables that concerns you most? I know it’s everything and I think we’re all looking at everything, but it seems to me that the payoff for every dollar of debt incurred by the government and by individuals is rapidly kind of falling down.
Hugh
Yeah, I would say that the credit cap has been muted. And again, I make a distinction between sovereign dollar creation and by that I mean the dollar creation from onshore domestic US banks entering into new loan agreements and if you will, printing dollars versus the dollar creation. I would call it non sovereign, which is the Euro dollar which is taking place offshore and where with the ability to provide collateral, new dollars will be created. Now, the Fed I believe, is less interested in the latter and I believe over the last 40 years the latter, these non sovereign dollar creation have come to be really much greater than the sovereign onshore and the credit provision there has been really to fund assets and it’s funded asset price inflation. And I think market participants have been very aware that that credit spigot got turned off, let’s say 18 months ago very dramatically. So I would say it’s been contracting. And now we’re seeing I don’t like discussing the M two series because I think it takes away from this non sovereign creation, but we’re seeing that the onshore M Two series is now contracting as well. We don’t have much per capita GDP augmentation to show for for that.
Tony
Right. So so wouldn’t, after all of the creation of money in and I would say through, largely through government spending and obviously Fed balance sheet in 2000 and 22,021, isn’t this kind of a normal reaction, kind of a normal medium term reaction to that much creation and distribution of money into economies?
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Hugh
Well, again, it’s kind of crossing my arms. It’s a funny money conversation.
I keep saying, I go to Starbucks and ask for a caffeine latte, and I promise to pay it in bank reserves, and they kick me out. The Silicon Valley Bank was acutely sensitive because their corporate customers are startup businesses, which are very much at the riskier end of the spectrum. And typically that bank would be funding between the last six to three months. Your cash is disappointing. You need another fundraise.
But the bank steps in and it holds you over. There was no prospect of more fundraising, so it was kind of exaggerated. But I think with the other banks, what you’re seeing is that and with Silicon, you were seeing that their assumptions with regard to operating cash flow from their client, from their clients, just was not being met. That actually the economy is weaker. That we’ve we’ve, again, within this kind of silent depression, we’ve imposed I mean, I don’t dispute we’ve imposed structurally higher prices, but without again, without the legacy of a dynamic of credit creation, which left, like, a really strong economy, which was to be tamed and to be tempered by the Federal Reserve’s oversight. To my mind, it’s been a muted economy for the real folk. If we move a kilometer or so outside the financial centers of the world, the real world just seems rather grim. And that real world is being hammered by higher rates. And again, with the prevalence of debt, I keep saying, if debt was one X GDP in the so we’re taking out decimal points, then I’d say we’re four X today. And so the Fed at 5% rates is really the Fed at 20% rates in the 70s.
If I can get away with that kind of leap and you break things and we’re breaking things, that’s been my concern. My concern is, I believe, that the depression has been fueled by Bernanke. Back in was it 2013 when we had the taper tantrum, where he encouraged the private sector to raise rates on his behalf? We had seven and a half percent adult unemployment. He was saying, Heavens, I’m beginning to worry that the economy is getting overcooked. The market doubled ten year rates. You know what? The economy hit a wall. Then we had John Yellen, tentatively, in 2015, trying to raise rates again. Why? There was never this economy which was running away. And then you had Jay, and Jay is just being determined from his first day in office to kind of be some kind of volcker guy, what was it called? The Duke of York. He marched them up to the top in 2018 and promptly had to take them down and then he came back again and finally I think I feel like particularly the American economy has been crucified on the cross of Jay’s miscommunication. During the pandemic, he explicitly said on daytime television that they were printing money.
I get why he said it. He was saying it to alleviate the real fear of that time. But it was I mean, I’m going to say it, it was a lie. And so he now owns the price, I would say. Is it causality? Is it something I don’t think the inflation that we saw is monetary. I say it was a supply side thing. I think it will abate because the monetary power will not be there to perpetuate it. But Jay couldn’t escape that. He was the guy who said I’m printing money and then you had an explosion in prices. And so they’re fighting desperately to kind of preserve or reign back their reputation. But it’s the economy and these banks and other actors which are feeling that.
Tony
Yeah, I guess so if the Fed is kind of trying to bring back in their reputation I know this seems a little bit random, but who has a better reputation? Like all central banks have terrible reputations right now. No. So are they in fact the best of the major central banks or are there other people that are more credible? ECB raised 50 basis points last meeting. So is that a credible trajectory?
Hugh
There’s only one thing we know for certain that the ECB will raise rates at the wrong time.
And again, it’s like the pushback I also have is just tell me the last time any central bank made a glorious decision, you thought, gee, these guys, they got it, they got it. Maybe it was 1994 and there was a kind of preemptive hike by Greenspan maybe, but 1994 is a long time ago. So in terms of do we need central bankers? Given I mean the American central bank is the regulator of the onshore banking sector and I maintain that we should be investigating and spending a close amount of money to examine the totality of dollar creation, credit creation because I believe it’s tremendously larger outside the review of the central bank. And then finally, who does it better? Well, the inversion of the treasury curves, not just the US treasury, but it’s a global phenomenon. If you’ve seen what the German curve has been doing, especially the last really if following that huge eruption in the UK pension market when we had the fake budget or whatever, when you have an inversion, it is not the bond market telling you it’s best guess of where rates will be. They create the inversion via a desire to hedge against the expectation of negative consequences like unforeseen consequences of Federal Reserve tightening in a world of tepid demand.
And in a world of great leverage, the bond market has been spot on. Those inversions are at record levels. And again, we are seeing a record form of banks going wrong and needing record forms of financial intermediation from the central bank to fix it.
Tony
Right. So it’s interesting when you say do we need central banks? I know that’s a hypothetical question, but especially over the past week and a half, as we’ve seen the Fed come in to backstop bank runs, that’s precisely the reason why central banks were created. Is that right?
So they kind of are with this BTFD, they’re kind of doing what they were created to do. And I guess with the Swiss central bank, what they did over the weekend, they’re kind of doing what they were created to do. Although nobody loves the fact the kind of bank bailout discussion nobody loves that, but they’re kind of doing in the purest form what central banks were created to do. Is that a fair categorization.
Hugh
At the tail end of the process? Yes. I don’t dispute what they’re doing. I wouldn’t ask them not to do it. Right. But I feel that especially this time around, they are the malignant force that is causing the failure in the host banks. I mean, Credit Suisse credit Suisse has been a problem that should have been addressed at least a year ago. Oh, yeah.
Tony
It surprises nobody. I mean, the fact that anybody’s surprised is surprising.
Hugh
And there’s no bailout. Even if you bought the equity on Friday, I think you lost 60%. The equity lost just about everything. And of course, that spread into one of the tiers of the kind of quasi debt debt structure. So again, we accept that. The wider question is just why is it happening and why is it caught out the central banks? There’s no dispute that the central banks are responding. And I don’t take huge exception to how they’re responding. I take exception to the fact that they’ve been the custodians of a if you were to accumulate the myths in potential GDP you know this, Tony, that in the 30 years up to 2007, most kind of g seven. Economies outside the phenomenon of China were kind of compounding like 2.7%. And it’s been more like one and a half in those years since then. So the miss is now the equivalent of the entirety of the Chinese economy. It’s a big mess. I think it stems from a change in the risk seeking behavior of the horse bank supporting the euro dollar system. They had a near death experience and they’ve been regulated to bring it down.
Okay. And secondly, it’s been periodic preemptive hiking by the central bank, maybe with a noble cause, but actually ending up doing wrong. Those those two functions. I actually believe at the end of this, I think we’re I think the generational time clock where you get profound, you know, like ray Dalio talks about these things, you know, 75 years. He has different clocks, and they all have like, a variation of 25 years, give or take. But we’re in one of those variations in terms of where we look at the underlying monetary system. We had a gold standard. It failed. Great Depression. People talk about bread and woods. I think bread and woods was a kind of in between. It didn’t really work. Private banks went, this doesn’t work. Let’s work it to our ends. And I think that Eurodollar system from was it NatWest Bank in London in 1956 or something, I think that system is near its death as well. I think we’re getting to the point where we’ll have to invent a better way now that’s not to kind of come back and see the dollar is doomed. It’s actually that the system that America accepts is really no longer doing it.
It’s not an unfair advantage. It’s the opposite. You have to really question why they support it. What do I mean by that? Why they support being the recipient of the world’s surplus capital inflows? Why are the world’s capital inflows going into the US. Where they have absolutely no desire for investment beyond the domestic pool of savings? Okay? And so the result of that is we get profound asset price inflation. We turn an economy famed for its entrepreneurial ship, and we turn it into an economy of speculation. That speculation is being unwound with the advent of GDP. When debt accumulates or debt to GDP rises, then you end up there’s a danger that you’re overstating the current GDP at the expense of future GDP. And as you overstate growth, you kind of create a fictional wealth in terms of the price of property, the price of price of stock market, the price of private equity. And it’s not done through kind of sinister means. It’s a miscalculation. And the US. Now, for the last heavens, the last 25 years, we’ve had, what, three or four events within 25 years that in a normal distribution, if there is such a thing, you’d expect these things to be spread out over 70.
We got four events that you would expect to kind of come to bear over maybe 100 and 5200 years. And yet we’ve seen it within 25. It’s no longer doing the US. Any favors. And so I think ultimately the US. Will have to look to perhaps mimic China and say and put up barriers whereby you cannot be the recipient of all these surplus capital flows. I think there would be a better place for that, but that’s perhaps for another time.
Tony
That’s really interesting.
Albert
I’d like Tony. I don’t want to be the one to defend central bankers, by all means, but how much of it is political influence for central bankers to combat supply side inflation? I mean, voters in each of these countries are facing 2020 5% inflation on goods and services and the way I look at it is those politicians need to get reelected. And for them to push back on the central banks to try to do something to combat inflation is the way that I would work it.
Hugh
I agree. It’s an agency to my mind, this is an agency problem and not an economics problem. I mean, it’s creating an economics problem, but it’s the agency of government. It’s the government being the principal and turning to its agent, the Federal Reserve, and saying, you guys messed up and messing up. You affect me, okay? And if you affect me, I’m really going to affect you. So do something about it. It’s mafioza. But my point is this is not an economics problem. Inflation I was saying she was going to have all my tombstone. Inflation is a monetary phenomenon, okay?
Tony
Many tombstones, not just yours. Yeah. So, Albert, what you brought up about the euro dollar kind of out kind of outlasting its use. What are your thoughts on that? I know you know the euro dollar inside and out. Can you talk us through your view on that?
Albert
The problem that I have with that argument is there’s just no alternative at the moment. And I understand what she was talking about is, yeah, maybe we should look at a different alternative. And I think I was on this podcast maybe two weeks ago where saying that theoretically the Anglo sphere could come up with a digital currency founded by the dollar and whatnot to come up with a new system. But these are all theoretical policies that I don’t know how would they work. I don’t know what it would do to the economies, how things would even transpire at that point. There’s a lot of unknowns, in my opinion. But I don’t think that the euro dollar I don’t think even Hugh believes that the euro dollar is in any danger of going away in the foreseeable future.
Tony
Right now, the Euro, if we go back 20 some years, the Euro was supposed to kind of be that offshore mechanism, but it never really worked that way. Partly because the Dutch and the German.
Albert
Different national interests tony the different national interests, different financial policies, different political interests. It just doesn’t work right.
Hugh
But it’s also tony but it’s this point that Europe is founded still upon the rock of Germany, Holland, et cetera. And these are persistent trade surplus nations that create surplus capital, and that surplus capital is invested in the United States. The housing crash of 2007, 2008, the majority of mortgage credit was provided by European banks, not American banks. So again, Europe and China, Asia are less open to the flow of capital than principally the US. And the United Kingdom. I don’t believe to Alba’s point, that we have to invent a new currency. I don’t believe it has to be digital or physical or, God forbid, commodity. There just has to be a greater regulation in the conduct and behavior of trading blocks with regard to each other.
Albert
I agree. There’s a problem where Yellen is the one she’s done this before in 2013, where she drives up US. Dollar policy and hoping that capital comes back into the United States to keep asset prices elevated just purely for her own labor ideas and political leanings. So that’s something like for me, if you don’t put any controls to stop yelling and others from doing this, they’re going to just keep doing it over and over again. We’re going to be stuck in a doom loop of capital flows coming into the United States.
Tony
Okay, but that’s interesting. What you said, Albert and Hewitt, you said about almost trade flow. So it’s the flow that is the problem. It’s not necessarily the currency is that my point.
Hugh
And again, there are achievable. Here we are, and we want to talk about Greta’s recent Silicon Valley, but it’s buried so deeply the underlying problem, which has been with us for at least 25 years. I want to say that the last time the kind of Charles Kindleberger handbook to a currency crisis actually worked out with the great logic of his orthodoxy, where you could monetize it was the Thai bat. And since then and what was the change, because it was the specter of China et al. Seeing the vulnerability to those Asian currencies from being so open and so those bolt fast to being effectively closed or very much controlling the money coming in. So in return, the US. Has had profound asset price inflation. Now, if you wanted to discourage that, you could put a withholding tax on treasury holdings by central banks, by foreign central bank. They already have it at custody with the New York Fed. And and I don’t believe that these institutions are like hedge funds, that they are profit seeking. They are working to a political goal and they will pay it. And if you squeeze it enough, you may actually discourage them, but at least you could impose a rent on their behavior and the disturbances that that behavior is, as we see the disturbances today, play out again.
Tony
Okay, very interesting. Okay, so we’ve gone into kind of the core of the problem. But if we go very short term because we have a Fed meeting coming up, everyone’s nervous about the systemic banking crisis or inflation, what do you think takes the priority in the next Fed meeting? Do you think the Fed stays on its trajectory? And all you guys, Tracy, Albert, Hugh, what are you guys views on this? Do you think the Fed says, hey, this banking thing scared us. We’re going to stamp pad on zero for a meeting and then we’re going to see what happens? Or do you think they proceed with 25s as they’ve been talking about and saying, hey, we put the backstop up. The Swiss central bank came in and put their backstop up. All is good with the banking crisis. Nothing to see here. We’re going to keep fighting inflation. What scenarios do you see them coming through again with a very short term mindset.
Hugh
Or Tracy, forgive me, Tracy, we haven’t heard from you. Why don’t you contribute?
Tracy
That’s fine. I hate having an opinion. Because everybody has an opinion.
Tony
Yes, that’s why you’re here.
Tracy
Everybody’s talking. I would think they stay at 25. That said, I think that if they decided to hold, that would be great news for commodities, and the commodity markets would react very positively towards that. But I think that they’re going to stay with the 25 because they’re going to say everything’s contained, just like we’ve heard a million times before. But we’ll see.
Tony
I remember in 2007, at the beginning of the financial crisis, the early indication said, it’s a 200 billion dollar loss. We’ve got it contained. Nobody talks about this today, but it’s $200 billion. Don’t worry about it. It’s all fine. We’ve got it contained. Is it possible that we’re in one of those scenarios now where 2007, $200 billion, it’s all fine, and we just kind of keep kind of raising into this when there’s a bigger specter living out there, or do you think it’s done? Tracy?
Tracy
I feel like this is not a repeat of 2008. I think it’s completely different. So I don’t want to equate it with 2008 exactly, but I feel like the rhetoric is kind of the same where everything’s contained. It’s okay. We took care of it.
Tony
Yes. Okay. Very good. Albert, what’s your view on the next Fed meeting?
Albert
You think they’re going to do 25? I don’t know what they’re going to do, but I think they should do 25. Going to zero. Pausing is, I think, a bad sign for the market. I mean, it might be bullish for a few days, but realistically, it’s not going to help solve anything to do with inflation, specifically supercore, which is what I think the Fed is. Powell has said himself is what he’s been watching, and its trajectory is going up. So I think they have to stay the course and do 25. That said, they could do zero just because this banking issue has gotten, at least in the press, out of hand, with a lot of bazookas being sent out by central banks to squash it. So we’ll see. But I hope they do 25.
Tony
So if they do zero, do you think it indirectly confirms everyone to worst fear? It’s like, oh, my gosh, they did zero.
Tracy
It must be worth really bad.
Albert
Yeah. Narrative wise, that’s exactly what I would be thinking. It’s like, what’s going on? Why are they overreacting like this? So that’s exactly what I think the sentiment would be. Definitely negative over the long run.
Tony
Right, Hugh?
Hugh
You’re all blinking crazy. May I remind you, for the last 15 years, the growth in per capita GDP for the average American has been catastrophic. It’s been one 6th that experienced during the Great Depression. And we’re talking about the Fed hiking rates further. I recall my trading experience, Tony, you mentioned 2007, and I always sat on big dumb leverage positions and we had northern rock go under. We had some French banks kind of have closures, but it was still modest. It wasn’t really what we’ve seen of late. And the Fed cut rate and the S and P was like pretty much at his all time high. And they won’t do anything. They’ll talk about it. They’ll express concern, boom, cut interest rates. The question is, is that an old Fed? And that may be relevant in the sense that I think the Fed should have been cutting rates six months ago. I think that the sovereign curves have been telling you that. But they’re kind of trapped again to the agency point and to the assumption, as Tracy said, hey, if they hold, can you imagine they cut, your commodities would be off to the stars and risk assets would explode.
And I think the Fed is very conscious of that. And so a Fed that should be, I think, should be cutting. Can I just say, banks have discovered that they have funding deficits. These regional banks, they’re not money center banks. They don’t have colossal sums of other instruments that they can sell off to meet liquidity needs. They have illiquid pools of mortgages to corporate America. And what you can do with that is you can package them like a CDO, these illiquid tranches, and you can offer it to the big money center banks and they’ll give you Treasuries. And then with the treasury, you into the eurodollar system and then they’ll address your funding. Now, the funding is coming I believe the funding is coming from the inflation in that everything is 15% or more expensive, but the underlying business health and revenue isn’t there. And so the corporate customers are their cash balances are coming down and down and down, creating the deficit which these banks can’t fund. Like I say, we’re in a depression. And the preoccupation is how far will the Feds raise rates? It’s going to get worse. The economic fallout, the consequences of this, like finding you remember, we have what percentage of the economy is the Frankenstein businesses that were supported by the fact that the carry was so low?
How much of the economy is the conceitful economy, which hasn’t marked the market, is I am full of angst.
Tony
But are we here partly because interest rates were kept so low for so long? I mean, that was really on some level, what was behind Silicon Valley Bank is they were holding this debt that was so far underneath the market that they couldn’t keep up with their cash needs. So is that part of the problem? If they cut rates, it puts us back into that environment?
Hugh
Yeah, that is the problem. But the deeper problem again, is beg of thy neighbor policy. We’re. Missing, like I say, $15 trillion of global economic demand. And I think that’s because China et al, pures a policy of making things cheap and keeping its current. Imagine if where are we on the remembri? We’re six.
Tony
Nine.
Hugh
Yeah. Seven. Eight. They call it seven. It was at nine when we created NAFTA many years ago. So nine to seven in terms of appreciation, the damn thing should be at four. The Chinese should be the citizens in the household sector should be really rich, they should be buying tons of overseas products and we wouldn’t have that deficit. But again, owing to the Thai pad episode and how we’ve organized trade flows, that hasn’t happened. And so, again, that’s why the per capita GDP for the ordinary folk in the States has barely budged, which is why we’ve had to keep rates on life support. But of course, the consequence is you blow up asset prices and trying to get the two balance between the two. I don’t envy anyone that decision.
Tony
No, it’s painful. And as we see housing prices come down to earth, if that happens here in the States, that’s where most people’s wealth is based. Right. So if their portfolio is coming down a bit, if their house price is coming down a bit, there are a lot of delicate balances, delicate, say, household balances, that will be upset here in the States, if not globally. So I think you have a great point. I think it’s a really difficult dilemma. I hear people all the time talk about how dumb the guys of the Fed are. They’re not stupid people. I don’t think they’re stupid people. I think they understand the problem. I think it’s a very complex issue that they have to get out of.
Hugh
Right. Yeah. Can we ask Tracy? But on oil, why is oil so weaker? And where that huge surplus has come and it’s changed the shape of the curve, there’s no demand for it. Can you speak to that?
Tracy
Yeah. I think part of the problem is a lot of Russian oil is still on the market that most were anticipating. It not be. We are seeing China demand come back, but not as fast and furious as everybody had anticipated, and still kind of very soft, even though mobility data has improved significantly. Still, their demand for oil is because they were stocking it for a year in their surplus. So they have a lot of surplus. So obviously they’re going to drain that first, while oil prices are high and making deals with Russia for cheap oil. And the other part of it is that interest rates are high, and that is because when you’re talking natural resources, they’re particularly exposed to rising rates, right. Because trading houses rely on bank credit to buy, transport and store these commodities. So with higher rates, what is happening is these companies are either having to sell right away at any price because they can’t hold it like they used to and wait for a better time to sell when the price was higher or the opportunity was better. So they’re having to sell it right away for whatever price that means, which is also causing downward pressure on prices right now, realistically speaking and hearing from some of the big trading houses that they’re having to forego some trades.
Tracy
Right. And so that’s stranding product with the producers. So I think that’s why we’re seeing weaker commodity prices pretty much overall.
Hugh
Do you have data on the driving statistics in the continent of North America?
Tracy
Yes, I do.
Hugh
Am I making it up to say that here we are, so many years after the pandemic when we know that everyone was kept at home and that the mileage is not really changed much?
Tracy
It really depends on the area, I think. Right. So we’re kind of still seeing more limited in, say, some of the blue states where you’re seeing a lot of uptake in some of the red states. Obviously, in the south there’s a lot more mobility, or the mobility data is a lot better. If we go and we look at TSA, I mean, TSA, we’ve been wobbling, like just above 2019, just dipping just below and then just above. So that data is still pretty strong. So that looks good. But mobility data is very regional in the United States.
Hugh
And I guess with anyone shouting at the screen saying it’s the adoption of Teslas and electrical vehicles, I hear you. But the whole notion of this curse of inflation, that it doesn’t persist, or a sign that it’s unlikely to persist, is when you see changes in economic behavior where you have discretion. You cut back because you just don’t. Have the financial wherewithal to support a wallet which your wallet is not 15% higher. But the price of goods and services are 15% higher. And so maybe driving would be discretion in that sense. Anyway, thank you for that.
Albert
Yeah. On top of that, I’ve talked a lot about Spr releases timed with the Fed selling oil futures to bring down the price of oil in their mind to help combat inflation. I mean, that’s something that’s happening.
Tony
Happened.
Albert
Last year for a little while. And I know that they’ve been doing it again this year. And, I mean, I heard through the grapevine that it was up to $800 million worth.
Hugh
Really? So, Tracy, I thought that had come to an end. The biden policy of selling the reserves, the oil reserves.
Tracy
We have the last little bit sold in December of 22, and that was from that 180,000,000 barrel release that was released throughout the year. There’s about 26 million barrels to release this year. That was scheduled back in 2015. That’s part of a whole different deal. It was part of the upgrading of the Spr, paying for the upgrades of the Spr. So that release will still happen. The thing is, traders were looking at at these prices the government was going to rebuy. Right? And so they did hold an auction on in January and they didn’t get any offers. They didn’t get any bids so they decided not to do that. And people are definitely looking at prices this low because really their target area was $68 to $72. So at these prices they were looking for the government but it looks like that’s just not going to happen because I think they are very happy with prices this low and they know if they start reflecting the spr that’s going to raise prices.
Tony
Okay great, thanks for that and Tracy, I appreciate the cargoes or the pricing and the urgency of the finance of commodity sales. How long do you expect that to last? Do you expect that to continue to last for the next couple of months or is that something that we’re just kind of in this period where things are changing really fast and it’s a relatively temporary issue?
Tracy
Yeah, I think it’s a relatively temporary issue. I think really what we’re going to I still think we need a few more months to really see what Russian oil is or is not off the market. And by the way that is getting very difficult to track these days because they have their own fleets and you have a whole gray market there. But from whatever Sts satellite information that those people gather they are seeing a lot of product build up on water that’s not going to be able to be sold because February 5 is when that policy enacted with the ban on products. So I think we still need a few more months to see where that goes. I still think we need a few more months and I’ve said this for months now when China started to reopen I said I think this is not going to be like it’s going to cause commodities to skyrocket. I think it’s going to be very bumpy. I think particularly the property sector is still a mess. They’re not building anything there’s not really creating a lot of stimulus right now and they have a lot of oil stored.
Tracy
So I think they’ll need to kind of work through those issues a little bit before we really see China demand take off. Maybe an H, two of the share if the whole world is not in a global depression.
Tony
Yeah I remember a few months ago I remember a few months ago talking about that when China was kind of supposed to open in Q One and there were a lot of cheerleaders saying it’s going to be a rocket ship, it’s going to take off really quickly. And I think what we talked about here was it’ll be slower than most people think and that’s come to pass right?
Albert
Yeah they’re pragmatic, they staggered their reopening. They’re making moves for the next six to twelve months on commodities. Which leads me into my section today is what they’ve done in the Middle East with brokering a deal between Iran and the Saudis. I mean, this is specifically done because the Chinese are the biggest clients of both parties. So you’re going to have to appease your biggest client and come up with some sort of truce. But it’s a short lived truce. As the Russians, the Iranians and Saudis start competing for more Chinese market share, since they are the biggest buyers on the Earth at the moment, tensions will inevitably come back up. They’ll bubble up again and this truce just doesn’t have any legs to it.
Tony
The most surprising part to me is that China just a few months ago was still under this kind of wolf warrior diplomacy kind of theme, right? Very aggressive, very direct, very unlike what I’d seen in China for decades before. And now they’ve changed really quickly to this dove policy of we’re going to negotiate peace in the Middle East, we’re going to negotiate peace between Russia and Ukraine. What happened there? Why is it just easier to sell stuff in a peaceful environment than it is in war environment? Or what is it? Because they’ve been the biggest buyer of tiny crude for a while, so that’s.
Albert
Not necessarily it’s mainly to do. The United States is leaving vacuum, their newest foreign policy, leaving vacuum in the Middle East. They’ve just basically abandoned it. We abandoned Afghanistan, we’ve pretty much abandoned Africa at the moment. And the Middle East is we’re not visible at the moment. So inevitably people like China and Russia are going to sit there and go and fill the vacuum. And it’s very easy for them to leverage their purchasing power on Iran and the Saudis and say, hey, cut a deal between you two so we can keep these trade deals going. Now I think also the Saudis are leveraging their oil reserves versus the United States and say, hey, if you don’t become a little bit more friendly with us in the defense sector and start pushing back on the Iranian nuclear aspirations, we’re going to cut deals with China. And I mean, I would do the same thing, to be honest with you.
Tony
So why this may sound like a stupid question, but why doesn’t the US come alongside these discussions and say, hey, it’s peace, let’s negotiate. Let’s get involved with this and support it? Why would the US. Not do that?
Albert
Well, it’s much more complex to say, let’s just have peace. I mean, the Iranians and the Saudis absolutely despise each other. The Israelis are also a major lobbying group in the United States. They certainly don’t want to see Iran benefit financially over this and push that right into their nuclear program. So there’s a lot of moving parts at the moment. And specifically when you talked about Russia and the Ukraine brokering peace there, the reality is the Russians are not going to leave their annexed areas and the Ukrainians are not going to accept that at best, you can get to a status quo, as we were a few years ago. But in terms of peace deals, it’s just not realistic.
Tony
But over the weekend, didn’t the White House come out and say, ukraine is a sovereign nation, but basically we won’t let them negotiate a peace deal with Russia right now? There was something like that that came out over the weekend. So how can the White House supposedly recognize Ukraine as a sovereign nation, but also not allow Ukraine to negotiate a peace deal? That doesn’t really make sense.
Albert
Ukraine’s defense is completely based on US. Armaments at the moment. So of course they can use that as leverage. And, I mean, the United States loves specifically the Biden administration loves to have Putin as a scapegoat for inflation. The moment the Russians marched in there, the term Putin price hikes came out and all over the news. It’s just one of those things where politics has reared its ugly head trying to influence economics. And here we are.
Tony
Great. Okay, so let’s take a quick look at what we expect, say, this week or the week ahead. What are you guys looking for? Tracy, we’ve seen crude way down over the past two sessions. What do you expect to happen in energy? Is this likely to continue with crude continuing downward, or is this very temporary?
Tracy
I think it is a temporary move. I mean, if you look at this, even though we have some softer demand, we are heading into higher demand season. Right. And so, again, there’s a lot of recession fears right now, too.
Tony
Right.
Tracy
So that reared its ugly head again, because of all of the banking crisis. And you also had a lot of what we saw, too, is when US treasuries spiked, right? Because everybody was short spiked. There were a lot of margin calls. And so it was kind of sell what you have to. Oil been sideways for three months, and so sell what you have to. And so I think that was part of that initial push down just from the price action, because we’ve seen that before. But I think it’s going to take a couple of months to digest all of this, to see where we’re at. Let’s see what the Fed does decide to do. Again, if the Fed decides to do nothing, commodities would love that, right? Yeah, they could.
Tony
Love it. Everyone would love it.
Hugh
I’m not sure I’d love it. I’m not sure I’d love it. And I’m not sure commodities would fly. When you say the Fed does nothing, the Fed sits at 5% rates. Or if we’re in the 1970s, the Fed sits there content with rates at 20%. I think oil has done something extraordinary. I mean, from the high tick with the Ukrainian invasion. I mean, oil the oil price is halved. I mean, oil is trading at levels prevailing 2004. That’s extraordinary. And it speaks more, I think, again, to my notion of this silent depression, an aggressive tightening of policy which is appropriate for asset price inflation, but is sheer misery for the ordinary folk.
Albert
I’m actually looking for a 25 basis point rate hike just to agitate you. But I agree with actually, I agree with you. I think that the Fed needs to actually cut rates if you want to see commodities start going these sky high parabolic moves again. And I don’t think we’re close to that at the moment. I do think that a pause would push commodity prices up, but I don’t think it would go parabolic like it did before.
Tracy
Oh, yeah, definitely it would be parabolic.
Albert
Yeah.
Hugh
Of course, if I was to talk my book, I want the Fed I want them being ECB. Like, I have to be cautious of how I say this because I don’t want them doing malevolent things to ordinary folk. But if I was to top my book, I’m really very enamored, very long of the very long end of the treasury curve. Because, again, to repeat myself, broken record depression in terms of price, if we ignore the Carry On Treasuries, which is, again, you could say fanciful, but we’ve wiped out 20 years of price performance, which is to say you’ve had profound mean reversion. And so I do like mean reversion events in terms of global asset. I don’t like mean reversion for individual stocks or individual kind of eclectic risk positions. But the generic give me something trading at the 20 years. So to my mind, where the treasury bond trades, where the inversions are trading, is that most likely we have for the curves to be correct? They’re really imagining a situation where the Fed could rapidly unwind like it did from September 2007 from five and a quarters to terminal of zero. Not a terminal five and a half, six or terminal of zero.
Hugh
And so you’ve got to think, how do you get to a terminal of zero? Well, you get there by inflicting, again, just a colossal deadweight cost of economic pain on the economy. So you can conspire how that would come about from this intellectual reputation or agency trap where they’re just forced to continue with hiking.
Tony
Yes. Over the next week. What are you looking at here? What are you looking in the very short term? What are you paying attention to in the very short term?
Hugh
You don’t want to know.
Tony
Oh, I do.
Hugh
My insights for these markets come from not watching them a great deal. I mean, I’m heading to the most outrageous party in Paris on Wednesday, thursday night. I’ll restock maybe Monday on the West Coast, next week in the US, and we’ll see what’s happened. If I had to guess, I’d expect there’s a huge desire to buy the markets here. The fed’s done something. We’ve even resolved the long standing corpse of Credit Suisse. You look at the equity market, it’s not really indicative of any great danger. The commodities. I mean, yes, I was talking about oil, but the commodity complex, it’s not kind of signaling any profound falling off a cliff. There’s just been a profound revision, I think, coming from hedging activities at the very short end of the treasury curve. Even the long end of treasury curve, it’s not really done anything. So the notion, I think and I was speaking to friends who manage risk, and they’re all agitating, and we were looking at banks. If you look at Irish listed banking securities, they’re way above where they were trading september, October last year. They’ve had a pullback for certain, but they don’t look whole.
Hugh
So I think the presumption is still going to be to feed and come back and try and chase a rally higher. That would be my guess.
Tony
Very good, guys. Thank you so much. This has been a fantastic discussion. Hugh, I’m glad we can keep up with you. Really good kind of long term views, and I really appreciate your perspective. Tracy, Albert, as always, thank you so much for your time, guys. Really appreciate it. Have a great weekend. And you have a great time at that party in there, right?
The European Union will allow members to offer subsidies that match those offered by the US Inflation Reduction Act to prevent an exodus of green energy projects. The White House’s $369 billion initiative has been criticised by many countries, which fear it could attract local companies to move across the Atlantic.
Roger Hearing discusses this and more business news with two guests on opposite sides of the world: Stefanie Yuen Thio, joint managing partner at TSMP Law in Singapore, and Tony Nash, chief economist at Complete Intelligence in Texas.
Tony Nash, CEO and founder of Complete Intelligence, joined BBC Business Matters podcast, to discuss a range of topics from autonomous vehicles to green energy subsidies.
Nash shared his thoughts on the future of AI and autonomous vehicles. He discussed the challenges of ensuring self-driving cars can navigate changing road conditions and the safety concerns that come with autonomous driving. Nash also discussed the potential of AI in the transportation industry and the need for continued development in this area.
Nash also provided insights on Joe Biden’s tax plan, specifically focusing on corporate taxes and unrealized gains tax. He discussed the potential impact of the tax plan on companies and individuals and offered alternative solutions to the proposed policies.
Nash also discussed the transatlantic race for green energy subsidies in another episode. He explored the role of government grants in spurring innovation in the green energy industry and discussed the challenges facing countries caught in the middle of geopolitical forces. Nash also highlighted the importance of consumer pressure in driving environmentally friendly products.
Transcript
BBC
Hello, and welcome to Business Matters. I’m Roger Hearing. Coming up on the program today, the European Commission is allowing member states to subsidize companies with green energy projects. They’re trying to forestall a drift of such firms to the US. Where state aid is already in place. Also, as pro Western protests go on in Georgia, we take a look at the strength for the economy in a country that really desperately wants to join the European Union. President Biden’s budget plan see a big tax rise for rich individuals and companies. So how’s that going to go down?
Stephanie
What he’s promising is we’re going to have European style benefits, but still have incredibly progressive taxes, and that’s just not realistic.
BBC
And self driving cars are on their way, but how can we make them safe on crowded urban roads? And I will be joined throughout the program by two guests on opposite sides of the world. Stefanie Yuen Thio, who’s joint managing director at TSMP Law Corporation, is joining us from Singapore. And Tony Nash, founder of the AI firm Complete Intelligence, joining us from Houston, Texas. So clearly, Tony, let me come to you and ask, well, what’s going on down in Texas at the moment?
Tony
Hey, Roger. Well, we have the Houston Rodeo, which is the largest rodeo in America, and it sounds like a throwback, but it’s actually a really big deal. They raise about half a billion US. Dollars for scholarships for Texas students. So it’s a big deal here in Houston, and it sends a lot of kids to university.
BBC
Yeah, and worth watching, too, I imagine, isn’t it?
Tony
Yes, it is. Yes, sir.
BBC
But you don’t take part, I imagine, Tony. I mean, the picture in front of my mind at this moment is quite.
Tony
Last year, but I’m not good for 8 seconds on a horse, so I’ll just sit in sidelines.
BBC
The let’s hope you’re good for 60 minutes on the radio, and I’m sure you will be. Anyway, welcome both. Let’s first of all talk about what’s happened here in Europe, because really it’s a transatlantic issue. But Europe has moved to try and level the playing field for companies there who want to set up green energy projects. There’s been fears that very generous new subsidies for US firms brought in by President Biden would drain Europe of green energy projects as businesses moved across the Atlantic to take advantage of what was over there. Well, now the European Commission has relaxed the rules on state aid for projects aimed at speeding up energy storage and the use of renewable energy and wants that take out carbon from industrial processes. EU member states will have until the end of 2025 to set up their schemes. What’s your take on this? It’s your side of the Atlantic that has really upped the ante on this with the Inflation Reduction Act covers a multitude of things, but one of them is this enormous amount of subsidy, over $300 billion, and then it starts this war with the EU over it, really.
Tony
So, Roger, the first thing I want to do is start a green energy company to game both sides of the subsidy plan. Right. So I think it’s interesting. It started in the US and obviously it’s just a truckload of money, and like everyone has said, it’s just a race to get somewhere. And I think it’s really hard to believe that this race is a credible one when Germany is burning more coal than they have in decades. Right. So I think that is it going to stimulate innovation? I don’t think so, because it’s grants, right. These are grants that are being given out by government, which I think I.
BBC
Don’ think they’re necessarily direct grants. Some of them may be, but it’s a mixed picture, I think.
Tony
Yeah, it’s mixed. And so those grants will be the first to go and they’ll be given very inefficiently, and then the tax credits or the other things that are done, if they’re in small batches, then they could kind of engender some competition. But if there are very large tax subsidies to be given, then it’s just going to be pigs at a trough. That’s all it’s going to be here in the US, in Europe. Europe is not unique. It’s the same thing here.
BBC
Well, indeed, but at the same point, I’ve put to Stephanie, I mean, isn’t in the end, Tony, the problem that you can’t leave it up to the market to do something that actually matters much longer term than most markets really have anything to do with?
Tony
Oh, well, you can. When you look at emissions, the US has been well ahead of kind of targets for years, because for the most part, we’ve had markets that haven’t subsidized kind of inefficient companies to do this. Of course, we have companies like Cylindra, which was a big story 15 years ago or something, and other wasteful green tech companies. But for the most part, when you look at, say, the US auto industry, other industries, they’ve done they’ve worked very, very hard to reduce emissions. And the US auto industry, even on petrol-fuelled cars, has done an amazing job at reducing emissions. And of course, there are subsidies that go to US automotive makers, but they’re not new and they’re not a large part of the revenues that those auto makers get.
BBC
What’s the incentive for them to do this? Because there has to be some incentive.
Tony
Consumers want it.
BBC
Consumer pressure.
Tony
Why do people make a car Blue? Or why do people put a Bluetooth connection to your ipod or your iPhone in the car? It’s because consumers want it. So the more consumer pressure there is to have environmentally friendly automobiles, it moves in that direction.
BBC
That’s very interesting. But Tony, let me bring you in on this, because it is an interesting picture of a country that is in a very difficult position, caught between Russia and the west but also with an economy that clearly doesn’t basically function. It seems to be held together entirely by aid.
Tony
And wine.
BBC
And wine. The wine is very nice, don’t get me wrong on that.
Tony
Yeah. It’s in a tough position. It’s between some big powerhouses and they had a conflict with Russia a decade or so ago, so it’s a very kind of tenuous position, and it’s definitely not something that’s easy to get out of, I don’t think.
BBC
Tell me, the other thing is that being caught in the middle of very big geopolitical forces, what was very interesting, Georgia. Georgia’s economy right now seems to be run by mainly by Russians who fled from Russia, which is an extraordinary situation, isn’t it?
Tony
Yeah, it is. Roger, I’m really not sure. The basis of this protest is supposedly that NGOs have to register because of their foreign influence, foreign money. But that is required in a lot of countries, so it’s required in Singapore, for example. Right. So I’m not really sure why this is such a problem. If foreign newspapers, like in Singapore, every foreign newspaper has to be approved. Yeah, and I I’m sorry, I don’t mean to be picking on Singapore, but but this is the case in a lot of countries, and so I’m just puzzled as to why this is a problem, especially if there’s so much foreign aid there. I just don’t understand it.
Stephanie
Tony, can I hazard stephanie, come in. Yes. Yeah. Let me hazard a guess. What’s happening in the Ukraine is a very big part of the consciousness of that part of the world right now, as it is for the rest of us as well. How Ukrainians are getting their message out there, how they’re garnering support internationally, is through social media and the foreign press. So I can imagine that any move that tries to muzzle foreign ownership of media is going to look like it is a very authoritarian move. And by and large, we get worried about things like that. And Singapore has been criticized, as Tony, you’ve pointed out, for having those rules, and I can accept that. I can appreciate that that is an issue. Having said that, international interference in national issues has become an increasing thing. We’ve seen the effect of troll farms in Russia on the US elections in the past, for example. And while we think we don’t want there to be constraints on independent and credible news organizations, what if you had an Islamic State take a very large percentage of the news outlets shareholdings?
BBC
Yeah, it’s one of those issues. It has to be applied not in general, but in specifics, and then see how it plays out. And I think that is absolutely the problem in Georgia. No doubt we’ll hear more from that country… Of the Manhattan Institute. Right. Tony, I’m going to let you get your teeth into it, but I will say, first of all, there’s a sense in which this is a phony budget, isn’t it? Because he doesn’t even expect necessarily to get it through Congress.
Tony
Yeah, it’s not going to make it through Congress. I mean, it’s just not. I mean, look, the capital gains tax that he’s proposing is higher than the ordinary income tax of the US. Meaning if you work for a living and you pay taxes from your salary, the capital gains tax he’s proposing is higher than that. And so these people who are actually taking risk on investments, they’re going to pay a higher tax for putting investment money into the market. That’s just ridiculous, and that stuff won’t make it. The thought that companies are going to pay higher tax is just silly because it’s not going to happen. I mean, there are several tax attorneys who, if you believe that’s going to happen, then you need to talk to tax attorneys and understand and CPAs and understand how things really work.
BBC
You’re saying, Tony, that the taxes are not going to happen because he won’t get through Congress, but you’re saying it’s a silly idea.
Tony
I’m saying the corporate taxes won’t happen because it’s unrealistic. So companies pay tax and that’s fine, but they also employ a lot of people. They make investments, they generate intellectual property and so on and so forth. So do we want to tax them more? Sure, maybe a little bit more. But to take a plan like this and aggressively state that you’re going to make companies pay a lot more, it’s really questionable, especially as earnings are collapsing. Publicly earnings in publicly traded companies are collapsing right now, so we’re going to put higher tax on them. And you saw this in the UK when there was the pressure on Gilt six months ago, right? You can’t put this type of thing forward if you don’t have a legitimate plan. And so for Biden to say, if you don’t have a better plan, well, I have a better plan. Why don’t you tax electric vehicles for the miles they drive? Because they don’t pay any fuel tax in the US.
BBC
Yeah, but that’s not going to fill the gap, is it? I mean, if you compare these enormous companies with huge profits, some of them, particularly in the energy sector, the financials as well.
Tony
It’s net positive, right? So it’s net positive. And anybody who thinks like your guest said, people are going to game that $100 million. I mean, that’s just silly, right? Anybody who makes under $100 million, they’re going to distribute it to family and shell companies and LLCs and other things. Nobody’s going to be worth $100 million.
BBC
It’s that they tax people. The people who earn over $400,000. That was the figure, wasn’t it? That’s where the burden is going to fall. But to a lot of people, that seems very reasonable. It’s an awful lot of money.
Tony
What’s? An awful lot of money for $400,000. Yeah, but how many people who earn $400,000 are really going to pay it? Right? I mean, they will, of course, but most of them are also going to have a lot of deductions, too. So you would have to raise the standard deduction unless those guys are going to circumvent. The other really silly thing which your guest was really good at talking about was the tax on unrealized gains. Okay? So imagine if you own a stock and it’s gone up two or three times and you haven’t sold that stock yet. That’s what an unrealized gain is. So imagine this. You own a house and the value has gone up by 50% and the government comes to you and says, hey, I know you haven’t sold your house yet, but I’m going to tax you on that sale of that house anyway, right? That’s exactly what this unrealized gain tax is doing. It’s saying everybody who owns a house that’s gone up in value, the government’s going to come in and tax you on that gain in that house. And you own a house and you’re like, wait, that’s not fair.
Tony
I haven’t even got that money yet. Right? So let these guys make their gains and tax them on those capital gains. That’s fine. We don’t need to hate rich people just for being rich.
Stephanie
Also, Tony, does the house owner get it back if the house price falls?
BBC
And how do you measure it? What’s the measure of value anyway? It’s full of difficulties, clearly. Well, definitely they will find ways around it. Well, let me come back to you then, Tony, on this, because we’ve said basically what you don’t think will work with what Joe Biden is promising or suggesting. If he is attempting to increase the size of the state, which it seems he is, and perhaps a bit parallel to what’s happening in Singapore, how should he be seeking the money for that?
Tony
Well, I think the first thing he needs to do is look at why he’s hiring 17,000 new Environmental Protection Agency agents, right? I mean, you know, we need to understand why we’re hiring more people into the government rather than just putting the heads aside and saying we’re going to grow government, we’re going to be greener, and so on and so forth. There was a law passed last year that said there would be something like 70,000 new Internal Revenue Service agents. And once the new Congress came in, the first thing they did was attack that and defunded because Congress has the power of the purse. So effectively what Biden is doing is he’s trying to anchor the budget discussion. I don’t think many of these things are actually going to happen. This is a negotiation. We have the debt ceiling coming on. We have a number of other things happening with regard to federal government revenue. So all he’s doing here is trying to anchor the conversation very high. And I think what you have in Congress right now is you have a set of Republicans who are not going to negotiate with that.
Tony
What they’re doing with the budget ceiling is they’re ticking off item by item the things that they want and getting the federal government to give in on things one by one because the bureaucrats do not want the debt ceiling to be a problematic issue.
BBC
Well, yeah.
Tony
Is it likely to Republicans on things one by one? Of course.
BBC
Are we going to find the new debt ceiling problem, which seems to be.
Tony
Oh, my gosh, Roger, there’s going to be so much drama about the debt ceiling. Oh, my gosh, it’s going to be the end of the world and full fifth grade of the US. Government and all this garbage. It’s it’s not going to be an issue. It’s never going to be an issue.
BBC
Okay. Interesting. I mean, Singapore, I suppose. Tony, would you would you put your faith in in autonomous vehicles? I mean, they, they have tested some, I think in Texas.
Tony
Yeah. I was driving in Dallas probably a year or so ago, and I was on a very crowded highway, and I looked next to there was a big semi truck next to me, and it was supposedly an autonomous driven semi truck, but of course there was a driver there. And to be honest, I found it terrifying. I heard an interview with one of the grandfathers of AI. His name is Stuart Russell. This was probably about three years ago. And he has been in AI since the 70s or something, and he was involved in self driving cars in the 90s. According to him, and I’m sure the technology has come a long way in three or four years. But at the time he said that we were no further with self driving cars at the time of that interview, which I think was 2018 or something, than we had been in the 1990s. That’s extraordinary. It is. And I work for an AI company. I mean, it’s not magic. It’s code and math. And that’s really what it is. It’s computer code and math. And as Stephanie pointed out, we have trouble updating apps. Right. And so if you’re going to be moving along at 100km/h or whatever and put your faith in a car and other people’s cars, I think when everything is automated, that’s different.
Tony
Right. If we’re 100% self driving cars, then that’s a very different story. But when you have some self driving and some not, there are so many unknowns in the environment, and how can a car know if something walking along the side is a child or a mailman or whatever, right. And you just don’t know what they’re going to do. So I don’t think cars on their own have the compute power to understand what’s going on around them. I suspect that a lot of what we’re being told is marketing more than actual capability. I would really like to talk to somebody and understand if it’s actual capability, because I just don’t believe it. I want it to happen, but I just don’t believe it’s.
BBC
Isn’t it I mean, what you said they want it to happen because I certainly feel it will be hugely useful. I mean, elderly parents being able to get places, for example. But all sorts ways in which actually it’d be really useful to have such a thing. I suppose we feel. And, Stephanie, I’d be interested to get your intake on this. We feel that at this point, with all the technical know how, we have self demonstrated that we should be able to do this. I mean, it’s been a staple of science fiction films, probably going back to the 19th century, that these kind of things would exist.
Stephanie
Yeah, but I have a question on AI. We’ve been talking about Chat GPT and how biases get into it. Now, if you’re trouble, who is setting the safety standards for these self driving cars? If there is a person walking on the street, is it going to make a distinction between a minority race? If there are two people and it has to pick one to hit and it can’t stop, for example, does it pick the minority race guy to hit? What does it do?
BBC
That’s like the famous trolley example in a philosophy class. Do you run over the fat person or not? And these kind of things, which you can’t really expect, I suppose, a self driving car to think of. But I suppose that the point of this. If everything is autonomous, then, as Tony says, perhaps the issue isn’t really a big one. But I would say with all these caveats you’re putting in there, Stephanie, the fact is there are a lot of very bad drivers out there already. Is it worse to have one that’s autonomous?
Stephanie
No, I totally want to have a self driving car, frankly. I would like to not have to drive me around. I would like my husband to not have to drive around. He thinks he’s a race car driver. He’s not really that good. So I think that would be great. But I agree all the cars should be autonomous. And maybe we should have speed limits.
BBC
Well, yes. And you could impose them automatically very easily, couldn’t you? That would be one of the things. And Tony, I suppose you’re in AI. Okay, I take on board your point. You’re saying it hasn’t come people reporting it hasn’t come that far since even the 1990s. But it must be something that AI can take on, surely.
Tony
Sure, AI can take on a lot of things. But is it there right now? And would I want to drive in it right now? Probably not. And Roger, going back to your question about is it worse for a machine to, say, be a bad driver than a human? Absolutely. Yes, it’s worse.
BBC
Why?
Tony
Because the unique function of that machine is to drive you around safely. That driver person does not have a unique function, right? So if that machine is specifically made to drive you around safely, that’s the only thing it’s there for. So it should be able to drive you around safely. And until that can happen, we should absolutely not have autonomous vehicles on the road.
BBC
Okay, but take the bad drivers. Who knows what the function of the bad driver is? But if they hit you, they’ll still do damage, and that’s really what matters. Principle, surely.
Tony
Of course they will. And to go into any country and get a driver’s license. Anybody can get a driver’s license, right? And so that’s a kind of least common denominator standard. The worst driver can still get a license.
BBC
And the worst robot might be a better driver.
Tony
Yeah, but that’s that robot’s 100% job, and unless they can do it in the top, I would say, decile of drivers, it shouldn’t be on the road.
BBC
All right, well, I think they’ve got a big, long way, I think, to persuade either of you, really, that it’s happening. I think Stephanie probably would prefer it probably more than you would. I certainly would love it. Not least for the fact I can go to a lovely English country pub and after perhaps consumed a little bit of lovely, I can just get in the car and it’ll take me home. No issues. That’s what I’m all about. Anyway, thanks to both of you for being with us. Your rodeo of business Matters has been survival, I’m very pleased to say, Tony. And we’ll welcome you all back soon, I think. But thanks for listening to Business Matters. Bye.
In this episode of The Week Ahead, the hosts discuss three key themes: Silicon Valley Bankruptcy, the Federal Reserve’s Quantitative Tightening (QT) and systemic risks, and America’s energy policy.
The discussion begins with a focus on Silicon Valley Bank (SIVB), which had a major issue raising capital and faced a bank run on Thursday. On Friday, the California bank regulator shut the bank down. SIVB had $175 billion in deposits, $151 billion of which were uninsured. One of the discussions surrounding the SIVB collapse is how venture capitalists have been affected.
The hosts then move on to discuss the Federal Reserve’s QT and systemic risks. They note that the US has been experiencing strong data and inflation, and Fed Chairman Powell hinted at a 50 basis point increase this month. The hosts discuss whether the Fed will accelerate QT in this environment, what that could look like, and what risks it would pose to the US financial system.
The third theme discussed is America’s energy policy. Host Tracy Shuchart mentions a speech given by US Energy Secretary Jennifer Granholm, which didn’t seem to give her more confidence in Granholm’s competence as an energy secretary. The discussion touches on the problems with America’s energy policy and how it affects the country’s overall economic outlook.
Finally, the hosts share their expectations for the week ahead.
Overall, this episode offers a comprehensive analysis of current events and trends in finance and policy, with a particular focus on the implications of SIVB’s bankruptcy and the Federal Reserve’s actions. The hosts provide insightful commentary and thought-provoking questions that will be of interest to anyone following these issues.
Key themes: 1. Silicon Valley Bank(ruptcy) 2. Fed’s QT & systemic risks 3. America’s feckless energy policy
This is the 56th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash. Today we’re joined by Joseph Wang. You may know him as @FedGuy12 on Twitter. He’s a CIO at Monetary Macro and a former senior trader at the New York Fed. Joseph, we’re really happy to have you here. Thanks so much for joining us. We also have Albert Marko and Tracy Shuchart will be joining us during the show. There are some key things we want to talk about. First is a hawkish Fed of course we can’t talk about that without the Silicon Valley Bank things, events that happened today. So we’ll cover that a bit. We’ll get into the systemic risk of quantitative tightening and the likelihood of that happening, as well as America’s rudderless energy policy. And we’ll talk to Tracy about that in detail.
So guys, thanks very much. There’s been a lot going on this week. Albert, I know you’ve been on the road. Joseph, it’s your first time here, so I’m really glad we can have this conversation. Guys, let’s start out with Silicon Valley Bank. I mean, this is something that just kind of happened yesterday. It actually happened with a communications announcement on Wednesday coming in the wake of another bank failure.
And it was really bad timing, it was really bad advice for them to do this. And we’ve just seen a bank explode right, or implode. So can you help us walk through what actually happened from your perspective?
Joseph
Yeah, well, first of all, thanks for having me on the show, guys. I love your show and I do listen to it. So it’s real honor to be here today.
Silicon Valley Bank. So as of recording today, it looks like they’ve been taken into receivership by the FDIC. So basically it’s bankrupt. Now, Silicon Valley Bank over the past couple of years, if you look at their equity prices, they soared really high, especially during the crypto boom. They were known as a bank that would lend a lot to the financial tech sector. And as the financial tech sector imploded, it seemed like that kind of hurt them as well. These past few days you saw it stock price steadily decrease. So if you’re a bank, you have two big concerns. The one is solvency. Are your assets worth more than your liabilities? And the second is liquidity. Do you have enough cash on hand to meet investor withdrawals. When I put money in a bank, so I am an investor in that bank, right. So I eventually lent money to local bank and local bank bought from me and I can go and get that money back anytime I want. And that is part of the problem of a bank. Your liabilities, they are short term, so they can disappear anytime you want. But your assets tend to be longer dated, things like loans, let’s say a five year, ten year loan.
So I can’t really comment on the solvency situation of Silicon Valley Bank. I suspect that they are insolvent simply because I read that they’ve been making a lot of loans to these fintech companies and we all know how that turned out. But you can actually get pretty good insight on their liquidity situation by looking at their regulatory filings. If you want to study a bank and I study bank, so you want to look at something like this.
That’s all this is a call report. A call report is a financial report that banks file. It’s literally 100 page reporting form, and it comes with instruction manual that’s 800 pages in leads. So that’s why I can actually keep a reference here. So if you look at Silicon Valley’s financials, you’ll see that it’s a bank that is vulnerable to liquidity runs. It might not seem so on the surface, but so just for the audience, Silicon Valley Bank has about $210 billion worth of assets. It’s largely funded by deposits. Now let’s look at their asset side first. Now if you’re a bank, you got to keep liquidity on hand because what if everyone starts to ask for their money back? You want to have some liquidity on hand to meet those redemptions. So Silicon Valley Bank has actually a pretty good portfolio of liquid assets. Of the 210 billion in assets, about 120 billion are securities. Securities are good because you can sell them. That’s what a security is. If you have a loan to local company, you can sell them. That’s illiquid. Of the 120 billion, 80 billion are high quality liquid assets. So in the banking world, you want to have high quality liquid assets because you can sell them easily to raise cash.
These are Treasuries and Agency MBS. So so far, $80 billion of high quality liquid assets. Sounds like a great liquid bank. You dig down a little bit more, you find out they’ve already pledged about 50 billion of those away. So they’re already using that to either to secure borrowings. For example, let’s say you are a huge investor. You’re putting money into Silicon Valley Bank, but you don’t really know if you want to take that risk. So you could ask for some collateral. So that could be a possibility as well. So the bottom line is they don’t actually have that much liquid assets, even though they look like they do. Now let’s look at their liabilities. It doesn’t look good either. So normally if you and I okay, I don’t know about you guys, but when I put money in a bank, I have less than 250,000. So it’s within secured by the FDIC. But if you have a lot of money more than 250,000, then it’s not secured by the FDIC. Then you have credit risk. When you look at the depositor profile of Silicon Valley Bank, you can see that they have $150 billion unsecured deposits.
So those are institutional investors who basically lent maybe unsecured, maybe definitely uninsured to Silicon Valley Bank and they could lose everything. If Silicon Valley Bank goes bad, down really badly, they probably will, they’ll get something back. But it’s not good to lose money when we put it in the bank. So they have liabilities that are runnable and they began to run. Now I’ve been hearing anecdotally that everyone was like, get your money out of Silicon Valley Bank. So I’m sure they were. Now you have if you’re a Silicon Valley Bank, that’s a huge, huge problem. You have no liquidity. Everyone is asking for their money back. Your last lifeline is to borrow from, let’s say, the Fed or a Federal Home Loan Bank. It looks like they’re already borrowing from the Federal Home Loan Banks and I don’t know if they can borrow even more. A Federal Home Loan Bank is basically a government sponsored agency whose job is to provide cheap loans to the commercial banks they’re already lending to to the Silicon Valley Bank. In theory they could lend more, but they have a lot of exposure to Silicon Valley Bank. So the Federal Reserve Bank of San Francisco, which is the bank that’s lending to Silicon Valley Bank, 20% of their loan book is to Silicon Valley Bank.
So if you’re a CFO there, do you want to increase your exposure to this bank that’s probably going bankrupt? So yeah, it’s over for them, which is why the FDIC souped in.
Tony
Those are amazing details and it’s exactly what I wanted to hear. Now what I had read earlier was that there are $171 billion of deposits at Silicon Valley Bank and 175 billion but 151 billion of that is uninsured. So basically $24 billion people can pull $24 billion out, but there’s $151 billion that they may or may not get back. Right. So for a lot of these VCs, early stage tech companies and so on, I don’t know if private equity firms or investment funds bank there, but certainly it seems to me to be a systemic risk, especially in the venture capital community. Is that a fair assumption to make?
Joseph
I don’t think it’s systemic to the banking sector and we can talk about that. But these guys who in that community for sure, Tony, I imagine that a lot of people in that community are banking with Silicon Valley Bank. And if Silicon Valley Bank goes under, they’re going to have to have haircuts and maybe it’s a lengthy process. Maybe they get tied up in bankruptcy court or something. So that’s a liquidity problem for them. And so for that community, yeah, I agree, it could be a big problem.
Tony
So if I’m a limited partner in a venture fund today, I’m checking with that venture fund to make sure that my cash is okay. Is that the process that people would be doing? For people who don’t know, limited partners are the investors who put money into a venture capital fund. And my assumption is a venture capital fund would likely store that money in Silicon Valley Bank. And if they can’t access all of well, they could take the first $150,000 of that. But if they can’t get beyond that, then it’s not just the VC that’s hurt, it’s that limited partner. Is that correct?
Joseph
Yeah. So that losses, like you mentioned, partnership losses flow through from the entity to the partnership. That’s what being a partner is about. I imagine there are some rules depending on your general partner, limited partner, things like that, but yeah, it’s investors that get hurt.
Tony
And so the allocation just both of you guys probably know more about this than I do, but the allocation of, say, venture capital from, say, a pension fund is a relatively small allocation of all of the allocations of, say, a pension fund. So I would suspect that this probably isn’t a systemic risk back to, say, pension funds and other investment funds like we had maybe in 2007-8. Right. It’s probably less of a systemic risk than that was.
Joseph
Yeah, I totally agree. I don’t view this as a systemic risk.
Albert
I agree with that. Tony. I don’t think anything systemic is going to happen because SVB Bank goes under. I mean, SVB Bank is the FTX of the fintech banking world. I mean, everything on there, everything that they invested in, is based on trust, and not very much for the fundamentals at A. So it’s not a surprise that it went under as the Fed has been raising rates. Everyone knows that if the rates rise, the tech sector is one that gets hit the most. So it’s not really a surprise that this happened now.
Joseph
Yeah, I totally agree. When the Fed is raising rates, it’s trying to slow down the economy through sectors that are interest rate sensitive. I think the great irony here is that we all expected that to be real estate, right? But real estate is fine, but we miss the fact that the other really interest rate sensitive sectors is tech. And we see big layoffs in tech. So it’s actually all the well paid people who complete on Twitter who are having a bad problem, but the more blue collar industries seem to be doing fine.
Albert
Yeah. Housing got a boost because there’s a lot of cash buyers. People were cashing out at the behest of bloodstone, buying everything, but they were cashing out three and four times the value of the homes that they had a mortgage on. So they go and buy other homes, pure cash. There’s no mortgage risk in the system for the rate. Just like you were saying, the housing sector is not really affected by rates at the moment. You can see that because the houses are still going up and still a little bit of a shortage. But the tech sector was always the biggest loser of the hawks.
Joseph
One of the things that I hear is that there’s the fiscal stimulus from all the construction stuff, like is flowing into the state and local governments. And so that kind of construction spending seems to be supportive of employment, at least in the construction sector. So the guys who, if they’re building residential houses, maybe they can go and do something that’s benefiting from fiscal stimulus.
Tony
Sure. Here in Texas and probably in Florida, where Albert lives, there is construction all over the place, and it’s helping the tax base, it’s helping the overall impact of related jobs and other things. So it is still very strong, at least in the south.
Albert
Well, look at the layoffs. It’s all been tech and no construction. Construction has a shortage of workers at the moment, that’s the best indicator that you can have at the moment.
Tony
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Tony
Right. Okay, in talking about that strength, let’s talk about the Fed a little bit. Okay. If we were talking two days ago, there would probably be a bias toward the Fed becoming more hawkish. Right.
All the buzz two days ago was, well, we’re going 50. Fed is going to be more hawkish. It’s going to be tough. But over the last 24 hours, things have really started to lean away from that. So what do you see as drivers of the Fed being hawkish and drivers of the Fed being less? So we can’t say that they’re dovish. Right. But it’s more the degree of the rate rise. So what do you see in the calculus that they’re thinking through?
Joseph
Yeah, so let’s level that a little bit. So at the last FOMC conference, Chair Powell basically said that from now on, we’re going to do 25 basis points. He said that through his statement. So the language was that rather than talk about the pace of the hikes, we’re going to talk about the extent. So that’s kind of a that would seem like a done deal. And from my experience with the Fed, very slow, very conservative organization. 75-50-25-25-25, you know, you don’t go from 25 to 50. Now, that’s what everyone assumed. And also corroborated by, let’s say, President Mester. And then Chair Powell kind of threw that whole thing upside down this past week when he was testifying before the House and Senate. He was basically suggesting that, you know, if the data is still strong, we’re going to do 50 until the market began to price that in. So the question ultimately is, is data strong? And that has to do with what happened today with the non farm payrolls and what happens with the CPI report next week. Now, when you’re looking at market pricing, like you suggested, Tony, they seem to be taking out that 50 basis point hike today, Friday, and that could be in part because of fear contagion in the banking sector, I don’t know.
Now, looking at the non farm payroll itself, it looks like the jobs number over 300,000 was comfortably above Bloomberg expectations of about 200 some thousand dollars. But there was a little bit of a mix in it as well because of the unemployment rate increased. I think the pace of a wage increase is also moderated as well. So it seems to be on the stronger side, but not unambiguously. So my perception from this is if the Chair Powell is basically upending everyone’s expectations and putting 50 on the table, the presumption is 50. And this was not clearly weak. We got to watch CPI next week as well. As long as CPI is not like super, like a big disaster, I think the presumption should be about 50 basis points for the March hike.
Tony
So you think the presumption is 50 now?
Joseph
I think today’s headline employment was pretty strong. It’s not something that is weak enough, I think, to take away the presumption. Again. Everything could change with CPI next week, but we’ll see.
Tony
Thank you very much. That’s okay. We know you’re busy, so thank you so much. So Joseph, with the jobs data, there were 50,000 department store jobs in that jobs data. And to me that seems like a statistical extrapolation from an old model or something. I mean, I don’t know of any department store that’s hiring. So when these things come out, what are we supposed to think about that type of data?
Joseph
Yeah, so a lot of people get into the guts of the report and the Fed actually, internally, they have their own model for stuff like this. I would be hesitant to be looking into too much into these adjustments. As you mentioned, they matter. But then you can look at every single job report and say, oh, it’s actually not as strong as it is, or not as weak as it is. For all these little idiosyncratic reasons. I would just take it as it’s presented and knowing of full well, of course, that it is a statistical abstraction of what reality is.
Tony
So is it fair to say you see it more as a kind of a direction than something that’s more specific?
Joseph
Yes. And also if you just average this one with the past few months, it does seem like the labor market not slowing, has decent momentum and there could be revisions going forward. I mean, January was revised slightly, slightly weaker. So it’s just not obvious evidence that data is weak from my reading.
Albert
Tony, for a long time I’ve been saying the Fed should have been doing 50 basis points months ago, but here we are now talking about 50 after doing 25 a few times. I don’t think that they’re going to do 50. I think more that what they’re going to end up doing is talking about QT and doing QT for longer rather than rates at the moment, just because I think Powell and Yellen and the entire crew over there is a little bit worried about the economy, especially after the bank failed. And looking at the jobs numbers, I just can’t see more than that’s. I just think that things will start breaking. If we go 50, we’ll be down 200 points on the S&P, and things will start breaking. And you start wandering down to 3500 on the S&P, you actually make it a financial crisis.
Tony
Isn’t that kind of what they like? They kind of want some things to start breaking. Right. Not that they don’t bankrupt people, but they do want some things to start breaking.
Albert
They keep talking about a soft landing, and that’s the plan at the moment.
Joseph
I agree with Albert. I think the right policy would just be emphasized QT a bit more. It makes perfect sense. I guess we’ll talk about QT in a bit, but it’s a good policy from my perspective, because when you do QT, you’re putting upward pressure on the rates that actually matter to the economy. You hike the Fed funds up and down. Nobody really cares about the overnight rate. When you’re talking about economically sensitive rates, like mortgage rates or like your auto loan rates, those are like the five year, ten year sector, and that can be influenced by QT. So you want to slow the economy down, you want those rates to go higher. But I think the Fed is pretty stubborn when it comes to QT, in part because they don’t really understand they don’t feel like they understand it well. They feel that they understand the overnight rate a bit better.
Tony
Okay, so let’s talk about that. QT is on our agenda, so let’s move to that. So in terms of rates, Joseph, you’re the 50 camp. Albert, you’re the 25 camp. Let’s move to QT. We have been undertaking QT for, what, ten months now or something, and it’s been gradual. Albert, you smile when I say that. What’s your thought?
Albert
Well, I mean, we’ve been doing QT, but then it’s been offset by Yellen’s TGA activity.
Tony
Yeah. Now what are you hearing about the TGA? Has that slowed down?
Albert
It slowed down now, but once the tax revenue comes in late April, she’ll have that again in May.
Tony
Okay. So if we have quantitative tightening, which means the Fed is selling things from their balance sheet into the market, probably at a discounted rate, which takes money out of the out of circulation and it tightens the money supply. Right, but if we have the Treasury issuing funds from the general account, it’s offsetting those QT efforts. Right?
Albert
Yeah, that’s exactly what it’s doing. She’s actually, right now, as we speak, being questioned by the TGA from the House Ways and Means Committee. That’s exactly what she’s been doing, and I think it’s more like why she’s doing it politically rather than anything with economic policy in mind.
Tony
Okay, so what are the politicians generally asking her about, Albert?
Albert
Well, they’re asking her about her sterilization of QT by using the TGA and the effects of inflation because of it at the moment. I have a list of the questions that I can definitely give you guys for afterwards if you want to post them up here. But that’s what they’re asking her about. Why is her action why is she talking about rates when she is a CFO of the country? She is the Treasury Secretary. She’s not the Fed chair. She should be talking about rates one day after Powell comes out being hawkish.
Tony
Right. It’s hard to quit the Fed, I guess. Okay, moving on.
Joseph
I have a question, Albert. Do you have any views on who might be the next vice chair? I mean, right now the frontrunner seems to be Janet Everley, this academic in Northwestern, but I watched the hearings and everyone there was like, from the Democratic side was like, “”oh, we got to have an Hispanic vice chair. We got to have an Hispanic vice chair. And Janet Everley, maybe she has distant relatives or maybe she’s going to write a cookbook about tacos or something like that, but she doesn’t appear to be Hispanic to me.
Albert
Yeah, I don’t know. That decision is going to be made by Brainard who they want is the vice chair. That goes with their liberal policies and enacting and using the Fed to push those political agendas. That’s what they’re looking for. I mean, it could be Hispanic or black or white or whatever, but the base case is that they need someone with a liberal slant in their view to help them out.
Joseph
Yeah. Janet Everly definitely has a liberal slant. For you guys who are not aware, she thought it was a good idea to have a higher inflation target. Maybe that will be in the future, not with Jay Powell, but maybe in the future, maybe like 3%, maybe 4%. Who knows?
Albert
I think 3% is definitely coming no matter what. I don’t think it’s realistic for us to get back down to 2%, especially with the Fed members being former liberal than they were a few years ago.
Tony
Okay, let’s talk about the three 4% rate at some point.
Tony
But let’s get back to QT. Joseph, can you talk us through some of the if the Fed were to accelerate QT, which seems to be something that you’d like to see them do, more of what forms would that take?
Joseph
They could just simply raise the cap for Treasury. So right now the Treasuries can match. The QT pays for Treasuries is a maximum $60 billion a month. They could raise that. So what happens mechanically is that you can think of it as the private sector having to hold more Treasuries. You’re increasing the supply of Treasury debt that must be held by the private sector. So basic supply and demand, increasing supply prices for Treasuries decline and so yields go higher. So that’s a way that they could try to tighten policy by making, let’s say, longer dated interest rates higher. And I think it’s helpful, especially in today’s context. So investors look at the world, look at the future based on their experience in the past. And our experience over the past decade was a Fed who would just cut rates at the drop of a hat. And so because the investor community believes that you have a very, very deeply inverted curve and that’s a big problem because as the Fed is hiking rates on the front end, you don’t see that as much in the ten year. And so you can see, for example, mortgage rates continue to go down as they did in January, thus essentially undoing all the hiking the Fed is doing in the frontend.
Joseph
So you really need the market to either believe that the Fed is higher for longer, or you could have the Fed engineer it by just boosting the supply of longer dated Treasuries. And it’s hard to convince the market of something and the market has a reason to believe that JPowell and his committee of largely dovish committee is just going to cut rates. So it’d be easier to just boost the supply of Treasuries through QT.
Albert
Okay, that’s something that nobody talks about, is durational liquidity. Nobody speaks about that right now with the Fed and the Treasury. I haven’t seen one analyst talk about duration liquidity.
Tony
Okay, so can you guys talk about that? How would they change? Well, first of all, if we focus more on QT, would that potentially pose a threat to, say, banking systems or there are other potential systemic threats that QT could pose for the US.
Joseph
Yeah, it could blow up the Treasury market.
Tony
Okay, tell us how that wouldn’t tell us.
Joseph
So I think there’s huge the great systemic risk today is not in the banks or the private sector. It’s in the public sector. It’s in the Treasury market. And we saw kind of a prelude to that with what happened with the gilt market in the Bank of England last year. For those of you who don’t remember, last year we saw gilt yields basically 30 year long good data gilt yields basically explode higher late last year, and in part because, one, the Bank of England announced that they were doing quantitative tightening and also because the government announced that they were going to issue a whole bunch of gilts. Now there are some levered players in that market who basically blew up. Now if you recall throughout late last year, okay, the summer of last year, there’s a lot of articles about Treasury market liquidity. This is something that I’ve been writing about since last January. And Treasury market liquidity is not really strong, in part because the size of the Treasury market is just growing so quickly. It’s not growing in proportion to the underlying market. So I think about this as like a stadium that gets bigger and bigger, but the exits don’t get any bigger.
Joseph
So 20 years ago we had about $7 trillion in Treasuries outstanding. Today we got about 25. And Biden is going to promise that he’s going to issue even more through his spending. And the underlying market liquidity in the market hasn’t scaled in the same way. 20 years ago we were doing $400 billion a day in cash transactions. Today it’s 600. So again, there is some potential for fragility. Now the market got was looking pretty dicey in the summer last summer, but it got bailed out when recession fears predominated and people began to think that Fed is going to cut rates. Recession, you got to buy Treasuries. But in the event that those recession concerns go away or inflation stays persistent, you can have, I think, some real discontinuous event there where yields spike higher like they did in the UK, which of course wouldn’t lead the Fed to respond. Yeah. So that’s what I view as I’m not really worried about banking or anything like that. So one thing that people have to be aware of is that the banking system has really changed a lot over this past decade. So an easy way to look at that is just Fed QE, right?
Joseph
So now banks have $3 trillion of basically liquidity from QE on their balance sheet. They didn’t have that preg. There’s also a lot more regulation. Now banks are really, really boring businesses. Back then it was exciting. Everyone is making huge bonuses and so forth. But now that’s all in the tech sector.
Tony
Okay, so you say that the gilt blow up happened because of long dated yields. Is there anything, if we move into QT, is there anything the Treasuries could do? Could they move that to the shorter end of the curve to avoid that?
Joseph
I think that would be a great idea. So one of the things that they floated is a buyback operation. So what they would do is they would issue bonds and use that proceeds to buy old bonds. Now I think it would be a good idea to issue shorter dated bonds and buy longer dated bonds. They basically change the duration profile. I don’t think that’s what they want to do. So far they’ve been pretty adamant that they want to make it a maturity bond. Now I’ll give you an example. Let’s say you issued a 30 year bond and. After ten years, it rolls down to a 20 year bond. Now it’s an off the run bond. So an off the run is something that was issued, not recent, and that off the run market is very, very illiquid. So what you could do is you could issue a new on the run 20 year on the runs are very liquid because they’re the recent vintage. Take that money and buy back the old 30 year, which became a 20 year. So you don’t really change the duration of the debt outstanding, just the liquidity profile. That’s what they’re floating.
And maybe that’s something they’ll do. I suspect that it’s not going to be enough. If they want to do something like that, they probably will need to rely well, it’s not going to work, so they’re going to have to rely on the Fed. Just like in the UK, they relied on the Bank of England.
Tony
In Japan. What they’ve been doing particularly kind of seven to ten years ago, the Ministry of Finance was issuing shorter duration debt to buy longer duration debt, and the BOJ was buying that shorter duration debt and letting it expire at maturity. Is that something that we could do here? Where the Treasury would issue shorter duration debt, the Fed would buy it, they would pay off the longer duration debt, and then it would just go into nowhere?
Joseph
They could totally change the maturity structure of Treasury debt. It’d be a really good idea if they did that. They don’t actually need the Fed to buy it. There’s a ton of demand for cash at the front end in the US financial system right now. There’s so much demand that people are putting it into the Fed’s reverse repo facility, which is about $2 trillion. So that means that the Treasury could issue $2 trillion worth of Treasury bills, and the market would just lap it up like that. So they don’t need the Fed to buy it.
Tony
Okay, while we’re here, while we’re talking about people buying Treasuries, I saw some notes over the past week or so where people are saying China is selling their Treasuries, everyone needs to worry. Can you talk to us about that? Joseph Albert, can you talk to us about that? To me, that seems laughable, but it is laughable.
Albert
They need dollars to keep even if you look at if you look at over the long run, I think over the last, like, five years, yeah, sure, they had bought a lot of Treasuries and now they’re selling Treasuries. But it’s pretty even at the moment, if you look going back five years, I don’t even take that kind of argument seriously. When people say that China is going to sell Treasuries and dollars going to crash and blah, blah, blah, buy my crypto, buy my gold, it’s what it usually is. So I personally don’t see it as a big deal. I mean, you know, that’s just the way I think about it, so pretty pretty explicit about it.
Tony
Joseph, what do you think?
Joseph
Yeah, it’s hard for China to find a substitute for Treasuries. So Brad sets there at the Council of Foreign Relations, he’s an expert on this and he has done some pretty interesting detective work. And one of the things that seems interesting is that the China foreign reserves actually hasn’t changed all that much over the past several years. So based on their publicly disclosed data, it stayed around, let’s say three, three and a half trillion over the past few years. But if you recall, China has been making a lot of money through exports. During COVID for example, they were exporting like trades to the US trade deficit with China between US exploded higher. Right. So where is all that money going? It’s not going to the sovereign fund. It must be going somewhere else. I think part of it is going to the commercial banks, but I don’t really know how their data works out. I think they definitely have a huge problem in that they have a lot of exposure to the US. That kind of gives the US political power over them, just like the US could seize Russia’s sovereign reserves. It’s a problem for them.
I don’t know how they can solve it. I’m sure they want to solve it, but so far it seems like they’re stuck, at least for the moment, in Treasury.
Albert
It is a big problem for China because when Yelling calls them up and said, you got to help us out in inflation and crush commodities, you’re going to have to do what Yellen and the Fed say just because of how much they’re held off. I absolutely agree with you on that one.
Tony
Let me bring Tracy in here because I don’t like it when she’s quiet. So, Tracy, what do you think about the issue about Chinese selling US treasuries? Do you see that as an issue from your perspective? Does China have other options? What do you think they’re doing with the money they’re making on US. Export, on exports to the US?
Tracy
Well, I think if we look at the big picture, right, we have seen increased central banks buying gold and selling US treasuries, but we have to look at the bigger picture. More people own US debt than any other country in the entire world, so that’s not going away soon. So I hate to cater to these people and say, yeah, central banks are wearing a lot of gold, but that means that they’re shutting us right? Because it’s simply not true. You still look at the highest countries that own US debt still continue to be the same one china, Japan, et cetera. That’s not going away anytime soon. It is notable in the fact that looking at the gold market, which has been particularly lagging, I think it’s very interesting if we’re looking at the commodity side of things because we’ve seen last year particularly we saw outflows of gold flows, people investing in gold, whether it’s physical, ETF, et cetera, literally for eight months straight. I think that kind of makes this market interesting. But again, I don’t want to conflate that with central banks are buying gold, digging US. Treasuries. That means nobody likes us.
Tracy
Debt anymore.
Albert
That’s an important fact that, yeah, whenever they sell gold or Treasuries, they’re just raising my opinion. They’re just arbitraging for dollars later on. It’s nothing systemic that’s a threat to the US dollar by any means.
Tracy
That was my point. Let’s not make this a bigger issue than it needs to be that we have often seen, yeah, central banks can.
Tony
Walk and chew gum and spin plates and all that stuff at the same time. I think they’re capable. They’re very smart people are capable of doing all this stuff. So okay, just before we move on from QT, albert, is there anything else on QT that you wanted to bring up that you’re watching?
Albert
No, Joseph pretty much talked about it extensively, and there’s not really much I can add. I just think that the proper thing for power to do right now is to accelerate QT and keep rates as they are at the moment.
Tony
Okay, so with housing remaining relatively strong, do you think that they’ll sell off more MBS as a part of their QT portfolio, or do you think they’ll just keep it in the same proportion that it’s been now?
Albert
I think they’ll just keep it in the same proportion right now. I mean, housing at the moment is a big political problem because homes are unaffordable at 70% mortgage rate. So they’re going to have to do something they’re keeping an eye on. That I can guarantee.
Joseph
Yeah. I also note that Powell has been asked his point, Blake, and just said no. He can always change his mind. Powell has a reputation for being a pivotal like he just did. But to Albert’s point, mortgage rates are 7%. That’s kind of already a big drag on housing. If it went to 8%, would that really make that much of a difference? It’s already very high, and you’ve already.
Tracy
Seen housing prices come down extensively, right? Redfin just came out and said 45% decrease in luxury homes and 37.5% decrease. So I think what we’re seeing is housing prices decrease in response to the increase in mortgage rates.
Tony
Okay, very good. Okay, let’s move on. Since we’ve been talking about the US. Government for the first two segments, let’s move on to the US. Government for the third segment and talk about America’s rudderless energy policy. So, Tracy, you were tweeting about a speech that Jennifer Granholm, U. S. Energy Secretary, made earlier this week, and I want to kind of parse that through with you because she is the spokesperson for US. Government’s energy policy.
And there just seems to be a lot of mixed messages. And I’ve got a tweet on the screen about the grand home speech where you said she said, we’ll still need fossil fuels in 30 to 40 years, then to send it into how the Inflation Reduction Act makes the US. Irresistible for new energy. So can you talk us through kind of what were you thinking of as you heard her, and what were your big takeaways?
Tracy
Well, the first thing I want to note in that speech is that for the last two years, this administration has been pushing on the energy industry, right. And has been talking about how they have all these profits and they’re not.
Tony
Producing greeny energy companies. Greedy.
Tracy
That’s been the mo, right. For the last two years. And then in this speech, she did like, 180 when asked the question.
Tony
How.
Tracy
Do you think oil companies, oil and gas companies are responding? She said, we’re very happy how oil and gas companies are responding to our request for like, she gave them props, which is literally 180 degree. So to me that I was like, what? Because really our production has not really increased at all. But suddenly she’s at Fair a week giving props to the energy companies because.
Tony
The CEOs were there.
Tracy
Well, right. So it’s a huge mixed message. The other important thing, I think, to take away from that particular speech was that the US. Wants to move on to energy transition. We want to move away from China. We want to be able to mine our own metals and minerals in the US. For this energy transition. But she was quick to add that the permitting process is a nightmare. It takes ten years just to get a permit. And then if you get lawsuits on top of that, to get to an idea from, I want to build this mine in the US. To actual fruition is a ten year permitting process, and then it’s then plus however many lawsuits you have. I thought that was really interesting and that she actually admitted that the permitting process was completely horrible. Since her administration, or the administration that she works for, has said, what we want to do is streamline this permitting process. We’re going to give people all these incentives to build mines, et cetera. Basically, what she did I take away from the speech is basically what she said was completely opposite of what this administration has been telling us, and that is we have all these incentives.
Tracy
We can build all these mines, no problem. And we love the fact that the US. Oil and gas companies have responded to us and are producing more, which is outright not true. Sorry.
Tony
Okay.
Albert
These are political pipe dreams by the Biden administration. As long as the EPA is there and staff with environmental Nazis, there’s no way that manufacturing and mining is going to propel to the next level in the United States.
Tony
Biden budget proposes 17,000 more EPA staff.
Albert
Oh, yeah, that’s a great sign. That’s a great sign.
Tony
But what they’re saying, tracy, tell me if I’m wrong. They’ve already pushed all this money or they’re already planning to push all this money out into the market. Okay. And this week, the EU developed a proposal to kind of complement the US. And compete with the US. So there’s dump trucks of cash now out there to develop alternative energy. But both the US. And Europe have very restrictive policies on getting those mines together. So out of one side of the mouth, they’re saying they want alternative energy for a safe future. But the reality is they’re paying companies to have Congolese children mind cobalt. I mean, that’s the reality of the situation, right.
Tracy
Situation is it’s not in my backyard. Right, right. That’s the reality situation.
Tony
We want cars that plug in, and we don’t want people to know that Congolese children are mining cobalt. But that’s the crude, stark, horrific reality of these policies today.
Albert
Absolutely, yeah. If you want an American built iPhone or American built Tesla, from the battery on all the way up, it’s going to cost you $5,000 for an iPhone and $190,000 for a little smallest Tesla you can possibly buy.
Tracy
Yeah, it doesn’t matter because it’s never going to be enough, but it doesn’t matter. You think Yellen went to Africa, right? Her trick on Africa, all we heard was she went into Africa to join the renewable generator. That is not why she went. She went to go make deals for mining in Africa. It’s really the back of that situation.
Tony
Wow, that’s terrible. I mean, it’s just the rainbows and unicorns of the policy as it’s portrayed versus the reality, the ugly reality of this industry is pretty horrific. So, Tracy, as you watched Grand Home, what did you think about the oil and gas sector? Did you think, okay, everything’s fine, I don’t have to worry about all this restrictive stuff for 510 years, they’re just going to keep on with status quo?
Tracy
No, I think once you’re looking at the oil and gas sector and you have to look at what actual oil companies said. So you had Scott Sheffield, a pioneer, say there’s five good years left of the permian. That’s a scary thought. Right. And there’s no incentive to drill more because the government’s telling you that in ten years, we want you totally phase out. And so we are going to have a serious problem. And I have said repeatedly, I think that the 13.1 million barrels per day the US. Produced at the end of 2019 in December is probably the height of that’s. It that’s the height of shell, unless something drastically changes within policy.
Tony
Okay, so it sounds to me, since there’s five good years left to the permian, since the US. Government wants this phased out in ten years, there is no ability for oil and gas and money firms actually to have a capital planning cycle. Right. Anything that has longer than a five year payback just is not worth investing in, is that fair to say?
Tracy
I would say that’s fair to say in the United States. Now, if we look offshore, which is really interesting, and that’s where we’re seeing a lot of investment in, say, Guyana or Namibia or a lot of offshore sector kind of seems to be the focus right now in other countries because they just don’t have the same policy hurdles that the United States does.
Tony
Okay.
Albert
Yeah. All places where the EPA is not at.
Tony
Right. So the entire US energy policy and renewables policy is just a big Nimby policy, like you said, just not in my backyard.
Tracy
It is right now. We’ll see what happens. There’s a project going on in Alaska right now which people should be paying attention to their policymakers want this to go through. I sincerely doubt that it’s going to go through because no majors want to invest up there because they run into a bunch of lawsuits. Right. And so why would you knowingly, even if you bought the land rights or the leases, it’s a horrible place because you know that you’re going to be faced with a million lawsuits and give me a million hurdles and whatever. Even if you look at the recent Gom auction, now, you have environmentalists suing anybody that bought leases. It’s a lose lose situation if you’re really trying to explore more gas in the United States right now.
Tony
Okay, so when you say it’s a horrible place, do you mean specifically that Alaska is a horrible place? Because I think we have, like, three there.
Tracy
Alaska is amazing place. I have friends from Alaska.
Tony
Okay.
Tracy
I’m just saying the problem is that you run into a whole lot of regulatory issues, and then you run into a whole lot of lawsuits that are going to take place. And really, that’s a whole separate issue. Now, I really wrote about this in 2020 was the land that they auctioned off is part of a reserve?
Tony
That’s always a good idea.
Tracy
Probably should have never been. Right? And that’s why it really got no interest. It did get a bid from Chevron again, but I don’t see that project going forward ever.
Tony
Okay. Yeah, it’s crazy. And as I try to figure out the policy and I talk to you and I talk to other people, I just can’t figure out what we’re going to look like in five years. And if I was in charge of capex budgets with upstream, downstream, midstream, I honestly wouldn’t know what to do.
Tracy
Because there’s that’s why we continue to look at these companies, continue to focus on dividends, capital, discipline, and paying down debt. I mean, you have to remember, these studies were not making money for years.
Tony
That’s an important point. So when the President of the United States says that Chevron is a terrible company for giving large dividends and doing large share buybacks, they’re doing that because they cannot spend that money on capex. Because they don’t know what the environment is going to be like in five or ten years, is that correct?
Tracy
Yes, exactly. And that’s the point. And they’re trying to gain shareholders. You have to look, two decades ago the oil and gas sector was 20% of the SF 500 weighting wise. Right. And at the lowest in 2020 we were a little bit below 2%. We’re now at about 4%. But you can see where that market has fared fairly poorly.
Tony
Yeah, but Tracy, it’s all going to be AI software forward, so just complete intelligence.
Tracy
It’s going to be chevron AI.
Albert
Yeah, I’ll fund it by a new Silicon Valley bank.
Tracy
That’s right.
Tony
Okay guys, we have a big week ahead going into leading up to the Fed meeting. So what are you all expecting? Joseph, what do you expect to see next week with the various prints coming up?
Joseph
It’s all about the CPI. I mean, I want to know if it’s actually strong. If it’s strong, then we got 50 basis points blocked in right now. Like you mentioned, Tony, that’s been taken out of the market. It could be a violent repricing. So that’s what we want to focus. So I’m suspecting that a lot of people are pricing in rate cuts in part because of what they perceive to be some risk in the banking sector. I just don’t see that. And so when we see that come out of the market, we could have rates go back to expecting a more higher for longer stance by the Fed.
Tony
Okay, great. What is a high CPI to you?
Joseph
I haven’t checked this expectations yet, but whatever is higher than expectations.
Tony
Okay, so literally higher than expectations, if it’s higher than the consensus, then that’s a high CPI.
Joseph
Yeah. If you think back a couple of months, we’re seeing CPI go down. Right. Deceleration, I want to know if it really just did reaccelerate or if it just kind of gave back. What the increase from last month?
Tony
Okay, great. That’s perfect. Albert, what are you looking for next week?
Albert
Same thing CPI is to make a break for the Fed on 25 verse 50. I’m hoping somehow they’ve managed to manipulate the CPI number to make it somewhat in line with the consensus. Hoping for a nothing burger probably be the best option at the moment. Something meaning consensus. If core CPI is hot, like Joseph said, fifty S, fifty S locked in.
Tony
And if super core CPI is hot, that just reinforces wage expectations and it’s all this super circular situation. Right? Okay, so if we do see a 50, do you see an impact on equities? Like a negative impact on equities? Do you think it’d be sideways?
Albert
Without a doubt. Without a doubt. I think if they go out and do 50, I think we’re down 200 points in the S and P pretty quickly in a week. If they do 25, we might even rally 100 points. You know how it is, we’re in bitcoin world now in the S and P. Right?
Tony
Exactly. Okay, that’s good to know. Tracy. We’ve seen oil kind of move sideways. We see energy kind of move sideways lately. What’s happening and what do you expect to see?
Tracy
You know what? I think we talked about this the other week. I continue to think it’ll move sideways. I think we’re in a range. OPEC is very comfortable with that $80 to $90 range for Brent crude oil. And so I see no reason for much to change in that. I think as we head into high demand season right, june, July, August, we could see an uptick in prices. But for right now, the market is very comfortable.
Tony
Okay. And then this Saudi Iran peace agreement that was announced today, do you think that has an impact on crude supply? Do you think that could push crude prices down?
Tracy
I don’t think that, no. Because OPEC has existed for a very long time. Iran is an original member of OPEC.
Tony
They were the founding member. Right.
Tracy
So that relationship has existed cohesively beyond any of the other geopolitical problems that they have had. And Saudi Arabia has always said that this relationship will exist beyond whatever other problems we are having. So I don’t think within the oil market, it really changes any dynamic because that relationship was already solid.
Tony
That’s good to know. Okay. Thank you so much. Thanks for your time. Thanks for all your knowledge. Have a great weekend. And have a great weekend. Thank you.
In this BFM 89.9 podcast, CEO of Complete Intelligence, Tony Nash, discusses the February US equities market and gives his predictions for March. Nash predicts another down month for US markets, albeit not as much as February, with China also being down markedly. He also expects Malaysia to do well and increase by about 1%. Nash also comments on US earnings season, stating that the quality of earnings reported so far is not great and that only $0.88 was matched by cash flows for every dollar of profit, with some companies passing along price hikes successfully but for how long can they keep it up. Nash also discusses interest rates and a more hawkish Fed, which could lead to the dollar rising. He also comments on a newly formed House committee aimed at examining economic competition between the US and China.
Transcript
BFM: BFM 89.9. Good morning. You’re listening to the Morning Run at 7:07 on Thursday the 2nd of March. I’m Shazana Mokhtar with Chong Tjen San and Wong Shou Ning. Now, in half an hour, we’re going to discuss Malaysia’s bilateral ties with the Philippines in light of our Prime Minister currently on a visit there. But as always, we’re going to kick-start this morning with a recap on how global markets closed.
Overnight, US markets were mixed. The Dow was up marginally by 0.2%, the S&P 500 down 0.5%, NASDAQ down 0.7%. Asian markets were also mixed. The Nikkei was up by 0.3%, Hang Seng popped it up and was up by 4.2%, Shanghai Composite up by 1%, Straits Times Index down by 0.2% and the FBMKLCI was down by 0.3%.
It’s everywhere.
That’s right. Well, we’re going to try and kind of peel some trends with Tony Nash, CEO of Complete Intelligence. Tony, good morning. Let’s review what happened back in February. It wasn’t such a great month for US equities. We did see the Dow and SP 500 both lose 4% and 2.6%, respectively. Where do you see the stock market heading in March? Is it going to be more volatility or perhaps brighter skies on the horizon?
Tony: Oh, yeah, it’s going to be pretty choppy. Generally, we expect US markets to have a down month, not down as much as it had been in Feb, but we do expect another down month. Obviously, if the Fed comes in with a very hawkish meeting, then we could see more chop there. We do expect China to be down this month as well. That kind of goes against what we’ve seen in News early this month, but we are seeing China down markedly, say more than 2% this month as well. Good news is we expect Birth of Malaysia to be up about 1%. So while we see chop in others, we may see Malaysia do squeak out a good positive month.
BFM: And Tony, as the US earnings season starts to taper off, what is your assessment of the results that have been released so far? In particular, the most cyclical consumer-facing companies?
Tony: Yes, so the quality of earnings reported so far is not great. So for every dollar of profits, only about $0.88 was matched by cash flows. That’s the largest discrepancy since at least 1990. So that means 12% are from kind of non-cash earnings. So it’s really accounting and other things. So what we’re seeing, especially on the consumer side, is some companies are passing along price hikes, and we see some of them doing that really successfully. I think we’ve talked about that here before, where they’ll hike between eight and say 15% and their sales volume will be down maybe 5%, something like that. That’s really helped the top line and margin expansion. But the real question is for how long can they keep raising those prices and kind of sacrificing transaction volume. So there’s a real question there. But many of those companies have said they’re going to continue to raise prices into later in ’23. The problem is when we run into a company like Coals, which is a retailer here in the US that reported today, and it was all bad, they’re losing customers they’re not able to keep with their costs and other things.
For those companies that cannot pass along price hikes, for whatever reason, it’s really bad news for them. The inflation they’re importing from their vendors is just squeezing their margins, and in some cases, they’re losing money. So, I don’t think the quality of earnings improves from here for at least two quarters. That’s just something to think about as we go into the next Q1 and Q2 earnings.
BFM: Okay, I want to come back to interest rates, Tony, because I’m reading Bloomberg and it seems like the Street is now expecting a terminal rate of 5.6%. Honestly, this changes every day. It was 5.4% not too long ago. But what does this mean for the US dollar? Are we back to the reign of King Dollar again?
Tony: Well, if we see a more hawkish Fed, then I would say yes, that’s probably the case. So, what we would likely see are things like 25 basis points, at least for the next three meetings, if not longer. If we continue to see hot inflation, as we have over the past couple of days, they could do a surprise 50. I don’t think that’s what they’re going to do, but we can’t rule it out. We could also see quantitative tightening, meaning the Fed could unload more mortgage-backed securities or other things, accelerating that from their balance sheet. Because housing is still pretty hot, actually. Prices aren’t moving that much, so we could see the Fed move on MBS or some other things to accelerate that off of their balance sheet. I don’t think that’s highly likely, but it’s a possibility. All of those bode well for the dollar and dollar strength. If that happens, we would definitely see the dollar rise generally.
BFM: Can we take a look at what’s happening over in the US Congress, Tony? There’s a newly formed House committee aimed at examining economic competition between the US and China. I think they held their first hearing earlier this week. What was the outcome? And do you think, as a result, we’re just going to see more trade conflicts between these two superpowers?
Tony: Yeah, so there’s a lot of focus on decoupling from China. There will never be a full decoupling from China. I don’t think we’ll even have a majority decoupling from China. But there are some key industries, like semiconductors and pharmaceuticals, some healthcare aspects that people really do want to decouple from China because we saw through the pandemic that supply chains are very, very dependent on China. Americans want many of those core things closer to home. They’re focused on decoupling. For some reason, people in Congress are just becoming aware that the CCP is in charge of everything in China. So they’ve underestimated the influence of the CCP and they’re waking up to the fact that they’re central in China. We had a couple of former national security advisors suggesting things like accelerating the arming of Taiwan and helping Chinese circumvent the Great Firewall, those sorts of things. And then, of course, human rights. They talked about CCP police outposts that are in US cities where there are actually these CCP outposts that will pursue Chinese nationals within the US, among other things. It’s taking a pretty tough stance on China. I’m not sure to what extreme that will go and what policies will be adopted yet, but I think it’s definitely trying to at least uncover some of the things that Americans haven’t been aware of.
Keep in mind, a little bit of this is theater, right? It’s people in Congress holding hearings to publicize some of their agenda. So, I think it’s a little bit of that so that they can then move into legislation and move the needle just a little bit. I don’t think we’ll see anything extreme, but you will certainly hear some extreme talk over the next couple of months.
BFM: Yeah, but does this change the way fund managers invest? You’ve got this continuing geopolitical tension between the US and China. Is it going to stop, for example, American fund managers from buying Chinese stocks?
Tony: I think it definitely puts China as a higher risk for US portfolio managers. And certainly over the past couple of years, more US portfolio managers have become aware of the risks of investing in China as supply chains close down, among other things. So, I think you will see more of a tighter risk calibration and more weighting of risk for Chinese equities. So, it could potentially not be good for American money investing in Chinese exchanges. Absolutely.
BFM: Tony, thanks very much for speaking with us. That was Tony Nash, CEO of Complete Intelligence, giving us his take on some of the trends that he sees moving markets in the days and weeks ahead. As he was talking about how March is possibly going to be down, although not as down as February, I couldn’t help but think, ‘Oh, beware the eyes of March.’ But, yes, it’s still choppy out there, especially as the FOMC will be having their meeting this month. I think everyone’s going to wait and see how much they’re going to hike those rates.
Yeah, he gave some predictions on Malaysia as well. He thinks the market will possibly be up by about 1% in March, but the market has been quite disappointing in Malaysia. And he also expects the China market to be down in March by about 2%. And we spoke about the geopolitical risk which may impact US fund managers as well.
In this episode of “The Week Ahead,” host Tony Nash is joined by Brent Johnson, CEO of Santiago Capital, and Tracy Shuchart, a commodities trader at Hilltower Resource Advisors, to discuss the most pressing economic themes for the upcoming week.
One of the key topics of discussion is the Federal Reserve’s “Q2 Danger Zone,” which Brent believes could be a potentially scary time for the economy. He notes that we are still less than a year away from the first rate hike, and it often takes 12-18 months for rate hikes to show up in the economy. By the summer of 2022, we will be right in the heart of that time period, coinciding with YoY inflation numbers that should come down due to the crazy comparisons from the previous year. Brent warns that even if inflation remains somewhat sticky, we could see a bunch of disinflationary prints at the same time, which will make it challenging for the Fed. Moreover, by that time, Owner Equivalent Rents are expected to fall, adding to the Fed’s challenges.
Tracy then delves into the topic of oil production and cuts, specifically Russia’s decision to cut 500k barrels. She explains what this means for the market, how it could impact crude prices, and who will be hurt the most – Asia or the West. Tracy also raises an interesting point about Russia’s decision to smuggle oil through Albania despite the cuts, leaving us with questions about their motivations.
Finally, the discussion turns to commercial and industrial loan growth, which saw a sharp rise after rate hikes started. Tracy explores why this is happening, and what it means for the economy. She believes that companies are taking out loans to fund capital expenditures, which is good news for the economy as it indicates that businesses are investing in themselves and their future growth.
Key themes: 1. The Fed’s Q2 Danger Zone 2. Capex & C&I Loan Growth 3. 500k fewer Russian barrels
This is the 55th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, everyone, and welcome to The Week Ahead. I’m Tony Nash. Today we’re joined by Brent Johnson and Tracy Shuchart. We may be joined by Albert Marko at some time, but we’re just going to focus on Brent and Tracy right now. Guys, thanks so much for taking the time to join us. I really appreciate it.
https://youtu.be/yYom7Zqezio
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We’ve got a few key things, themes we’re going to cover today. First is the Fed’s second quarter danger zone. There’s a lot setting up for Q2, and Brent’s going to talk us through that. Then we’re going to get into Capex and CNI, commercial and industrial loan growth. And then finally, we’re going to talk about those Russian barrels that are coming off the market this month, and Tracy will talk us through the impact there.
Okay. Guys, thanks a lot for taking the time. Brent, when I asked you what you want to talk about, you really want to talk about this kind of Q2, potentially Q3, these issues that we may see in markets in that time. Can you help me understand or help us understand what are you looking for there? Because there’s a lot going on, of course, and you can talk us through a number of items. But I have a tweet from Daniel Lacalle, who’s joined us a few times talking about the ECB under pressure for faster rate hikes.
We’re seeing similar stuff in the US. But markets keep going up. What are you thinking?
Brent
Well, I think there’s a couple of very, I guess, poignant and competing narratives fighting each other right now. And they’ve been fighting each other for a while. And I’ll explain why I think they’re fighting each other. But I’ll also explain a little bit about why I think Q2 and Q3 have the potential, again, there’s no guarantee. We’re all speculating here. But has the potential for one of these narratives to kind of come to the fore or something to change dramatically in Q2 or Q3. So I think the first narrative that has been around for a year now, so we’re almost still not yet, but very close to now, the one year anniversary from the first rate hike. And I think a lot of people forget that it hasn’t even been a year yet since they started raising rates. And typically when you raise rates, it doesn’t have an immediate impact in the economy. Sometimes it takes nine months, twelve months, 18 months for those rate hikes actually kind of work there through the economy and have the full effect of them show up. So we’re not even to a year yet, but in another three or four months we’ll be in the 12- to 18-month range when they typically start to show up.
Now, in the meantime, we continue to have inflationary prints that are stickier than some people have expected. Again, part of the reason markets have been pretty favorable for the last two, three, four months is the expectation that rate hikes would slow and potentially even reverse and maybe we even get to a cutting cycle. And as a result, the markets are front running that. But now in the last couple of weeks and so at the beginning of the year, we had a big rush up in bond prices as rate hike expectations came down, and stock prices and commodity prices. But for the last month, let’s call it since the, to the last week of January, 1 week of February, I’ve kind of turned it violently sideways. We’ve gone up and down and up and down and up and down, but kind of just treaded water. And actually if you look back two years, we’re kind of where we were a couple of years ago. We’ve gone up and we’ve gone down, but we’re kind of where we were two years ago. But because of the stickiness, the relative stickiness of the inflationary prints, this idea that rate hikes are now going to go the other way is starting to get a little queasy.
And maybe they’re going to have to go back to 50, maybe they’re going to have to go longer, maybe they’re going to have to go higher for longer. And so now markets are trying to figure this all out. And so the reason I think once we get into Q2 and Q3, it gets very important is for two reasons. One, if things stay sticky in the meantime, the Fed may have to either keep hiking or continue to message higher for longer. And then if at the same time all of the previous interest rate hikes start to show up in the economy and then at that point we are going to be in the heart of the year-over-year inflationary prints. And those will most likely show negative. Even if inflation is still high, it’s probably, you know, I think was it last June or last July we had the 9% print in inflation. So even if this year it comes in at 7%, it’s going to show a negative two year-over-year. And so that puts the Fed in the position, okay, inflation is starting to come down, we’re making progress. But you still have high inflation.
So does that mean that they stop or do they start? And it’s going to be at the same time where all the previous rate hikes are going to be showing up in the economy. Right.
Tony
Sorry, go ahead.
Brent
No, but my point is we’re getting to the point where a lot of the decisions that have already been made would naturally start showing up in the economy, but we’re not quite there yet. In the meantime, the Fed is in a tough spot as to whether to continue rate hikes or to slow them down because we are seeing some disinflationary pressures. Right. And so they’re in a tough spot right now.
Tony
Yeah. When Powell spoke, gosh, I think it was in the last meeting, he talked about the lag effects of Fed policy, and it was almost in a defensive way, saying, hey, it may not look like much is going on, but there are serious lag effects to our policies and you better watch out. And I think that’s when they rolled out the 25s or they started rolling out the 25s.
I’m not sure that at this point I see an end to 25s. Sam Rine’s on the show talks several times about how it’s at least 25s until mid-summer. Right.
Brent
I think so.
Tony
And I think we’re starting to get some nervousness from the pace of inflation in Europe. And I think that’s kind of bleeding over here a little bit because people are seeing the prints in Europe and saying, gosh, is that coming our way too? The ECB is going to have to hike faster. And so what’s that going to do to say, the dollar and other things as well? And when we have a relatively strong dollar, the impact that’s having on commodity prices, it mutes them. Right?
Brent
So now you just touched on something else that’s very important to understand. Okay. So if Europe is pressured to keep hiking, or at least hiking more than expected, that has the potential, again, no guarantee. Not everything trades on rates, but it has the potential for the dollar to fall more. That’s why the dollar has fallen for the last four months, is the pace of rate hike expectations. So if we already have sticky inflationary data and then the dollar starts to fall in price again, that can actually provide a tailwind for the inflation that the Fed is trying to counteract. Right. So again, it puts them in this tough spot. The other part that you just mentioned is, and this is where it gets tricky as well, is if you look over the last year, but not just last year, if you look over the last ten years, oil is about where it was a year ago and about where it was ten years ago. Natural gas is below where it was a year a you go. Huge drop off in about where it was ten years ago. Corn is about where it was ten years ago.
Wheat’s about where it would… Copper? You look at all these commodities, they’ve actually come down quite a bit from a year ago. But what has remained the stickiest is the wage data or sorry, wage inflation. Those costs, I know we’re going to talk about that at some point as well. And that could be more to do with a structural issue that the Fed has really no control over. Right. If people have, they’re retiring, they’re moving out of the workplace and they’re just not coming back. And so you have a demographic issue where there’s just not enough supply of labor. It pushes up the price of labor. That is something the Fed could influence, but not as easily as they can influence asset prices. And so, again, you get into this situation where I think everybody knows the further down the road we go, the higher the likelihood we have some kind of an event, right? Whether that’s a crash or just a volatility explosion or whatever it is, I think everybody knows that something down the road is not going to be good. Now, whether that’s six days or six months or six years from now, that’s the debate.
But I think we all know that there’s the potential for this great event. And again, if we get into Q2 or Q3 and it hasn’t happened yet, and you have this confluence of all these events that I’m talking about and in the meantime, asset prices have gone higher or at least held where they’re at, you have the potential for this bursting of this bubble, for lack of a better word.
Tony
Right? Go ahead, Tracy.
Tracy
Sorry, I had a question. So we’re seeing that two-year and five-year inflation expectations start to rise again. So what do you make of that? And what does that mean for the Fed and the Fed’s decision? Right?
Brent
Yeah. Well, I think this gets to everything we’ve just been taught it puts them in a tough spot because they’ve already… They have very clearly started to slow, right? Now, they have said we’re going to maintain and we’re not cutting and we could be higher for longer. But there’s no question that they have, at least for the last four months, have not been hiking at the same pace that they were last summer. But the worst thing for the Fed is if they’re back at 25 basis points now, or if they were to indicate that maybe we’ll have one more hike of 25 and then we’ll be done. But then you get inflation starting to rise again. I mean, that’s horrible for that. That’s the worst possible thing for the Fed and it throws their whole object not objectivity. It’s not that their repu… Not that their reputation is great anyway, right? But after getting the last couple of years so wrong, for their credibility to be challenged again is a really tough thing. And I’ve mentioned this before, you cannot underestimate, in my opinion, you cannot underestimate the influence of getting it wrong would have on Powell’s legacy. And I think he’s been very clear that he doesn’t mind having asset prices lower.
In fact, I think he wants asset prices lower. And so while I completely understand the argument for they’re going to have to cut, I don’t think he can personally take the risk of stopping hikes too soon because the risk of stopping too soon is extremely high for him personally.
Tony
I want to go back to your wages point for a minute. So, you know, when we have a company like Walmart make their minimum wage $15 and then that cascades through the economy because it doesn’t hit everyone immediately, you know, there’s a lag to that hitting the economy too, right. What you talk about? And it doesn’t just hit people making below $15. Those people who are making $15 are like, wait, I was making 15. Now everyone’s making $15. So it cascades up a little bit, right. And it cascades out. And so that takes months to hit also. Right. So that just happened in January, this impact on wages, at least for the next couple of months, right, or do you think it happens?
Brent
I think so. And again, when we get to an event, let’s call it either a credit event or a contraction in the money supply or a bursting of an asset, whatever, when we get to an event and things turn the other way quickly, then that stuff can change quickly. But until that happens, there is a tailwind for them to get worse or for the structural wage inflation for them to work themselves through the economy. And the other thing that I think many people forget this is that and I got to be careful how I say this because… I don’t want to confuse people and I don’t want people to think that I’m just absolutely bullish, because I’m not. I do think we’re going to have one of these credit events, and I do think disinflation is more likely than runaway inflation. But until we get that event, there is an inflationary tailwind, not just because of the things we’ve already talked about, but because of the higher rates. And what I mean by that is, as long as the banking system doesn’t contract and there’s not a deflationary crash, the higher rates are actually pumping more money into the economy.
Right. It wasn’t that long ago you had to go out ten years on the yield curve to get anywhere close to 4% return on your money. Now you can put your money in the closest thing to cash and get 4% on your money. So the people who have the money in their accounts are getting more money pushed into it because the Treasury has to pay higher rates. And that’s just now, kind of, again, the federal funds rate has been slowly ticking up, but some of those rates that people receive are just now resetting higher or have just started to reset higher in the last couple of months. And the further we go along without this “event”, more money gets put into their account in the form of interest payments. And that’s a tailwind because now you have more money to spend.
Right. No, the point that I just want to make is that I believe that we’re going to have this event and I think we’re going to have it sometime this year. But until we have it, there’s a tailwind. So it’s almost like it’s going to be speeding up into the wall.
Tony
How much of that tailwind, Brent, is… People have put on pretty easy trades for the past few years? And how much of that tailwind is people who have a little extra money in their account who just want to make that one last trade, right?
Brent
I think there’s a lot of that. I think there’s a lot of that. And that’s typically why it ends badly, right. If you think about an exponential curve, it goes up and up and up and up and up and up, and then it crashes and it’s because those last people are trying to get that last little trade in. And the other thing that I’ll say is I think this is really important to understand and we were talking about it a little bit before, so it’s repetitive but for the people on the show. It was last summer Q3 of last year where the yield curve inverted. Actually, it inverted just slightly in Q2 of last year. But then the real inversion took place in Q3. And at the end of Q3, we had a point where the stocks were at their lowest level in two years. The VIX was at its highest level in two years. The dollar was at its highest level in two years. And I actually at that point, I even sent out a tweet that said to probably do for the dollar to pull back. And I bought, I took off all my equity hedges and I actually bought equity calls and people were like, why the hell are you doing this?
And I said, Because the yield curve is inverted. And they said, that means there’s going to be a recession. And I said, yeah, but usually that takes twelve to 24 months to show up. And historically in that twelve to 24 months, between the time the inversion happens and the recession arrives, you typically get a run in equities. And so that it kind of goes counter. Everybody thinks higher rates, you don’t want to own equities that’s bad for growth, but in actuality it ends up that way. But in the short term it’s actually typically, historically good for stocks. And so to be honest, and I fully admit it, that trade worked, but I sold it way too soon. I chickened out because I see this wall coming, right? But had I held it for this last six months. It would have been a monster trade, but I sold it after, like, one month because I chickened out on it, to be quite honest. But that’s something that’s very important to understand. And here’s the other thing, and I’ll give you some historical context and it’ll explain two things. It’ll explain the magnitude of the run that can happen, and it’ll also explain the horrendous result that can come up afterwards.
And that is it. From 1926 to 1929… Let’s call it, from 1920 to 1926, you had seen stock prices run very high. It was like the Roaring 20s, right? And then in 1926, the yield curve inverted and it stayed inverted until 1929. And in that time period, from 1926 to 1929, the long-term US Treasury fell 30%. So if you were invested in bonds during that yield curve inversion, you lost a lot of money, just like last year, right? But guess what stocks did over that three-year period? They more than doubled. They went up 150% with the yield curve inverted for three years. And now we all know what came after 1929, right? After that last trade, to your point, pushing that last trade into the market, then you had the huge fall. We could very easily have something like that again. Now, I personally am not in the camp that we’re going to go into another Great Depression. I don’t think it’s going to play out that way, but I can’t rule it out. But it’s all of these cross currents.
It’s because I understand the tailwinds and it’s because I see this massive wall that we’re racing towards that I think right now is the hardest environment I’ve ever seen to be an investor, or at least to be an investor with conviction, I think it’s very hard. The good news, and I would encourage people to think about this, the good news is that in the last ten years, if you didn’t have conviction, it was very hard to sit on the sidelines because you got no return in your account. Interest rates were zero, but you can now sit on the sidelines, wait for clarity and get paid 4 to 5%. That’s not a horrible idea. Right. So, anyway, that’s kind of my soapbox moment.
Tony
These are all great points for it. I guess it’s just time for people to be careful. I don’t think you’re saying the sky is falling today. I think you’re saying, just don’t hold the bag. Yeah.
Brent
And I’m not saying you can’t make money. I’ve used this analogy with clients a few times to explain what I mean, because I said, Couldn’t stocks run another 15 or 20%? And I say, yeah, absolutely they can. I said, It’s like when Evel Knievel jumps over the fountains at Caesars Palace and then his son does the same thing. Well, Evel Knievel crashed and broke every bone in his body. Robbie Knievel landed the jump and was fine. Got a lot huge glory, but they did the same jump. So whether you landed well or land poorly, if you took the same amount of risk. So I’m not saying you can’t make money over the next six months by being in the stock market. I’m just saying you’re taking a lot of risk in order to do it. And if you don’t want to take that level of risk, you can sit in T bills and get 4.5%. That’s not a horrible that’s not a horrible sideshow. Right?
Tony
Right. Yeah. And just for people who aren’t familiar with Brent, I don’t know who isn’t? But he’s not a total doomer. Right. You’re not this, you know, permabear.
Brent
And I try not to be.
Tony
I just don’t want people to think you’re kind of a permabear coming on and try to spread kind of the permabear gospel. You do change your views as markets change, and this is just kind of a sober view on kind of where we are.
Brent
I own a lot of equities for my clients right now. We have participated in the run, but we have not been levered on it. And I’m not all in on that trade, but we own stocks in our portfolio. We think it’s time to be careful. We think you should have some hedges, we think you should have some cash. But we’re not sitting in our bunker just waiting for the sky to fall.
Tony
Great. Okay, that’s all good to know. Time to be very, very sober about things. You mentioned loans and interest rates, and Brent, you were mentioning some things about commercial and industrial loans. And Tracy, you’ve talked about capex, especially in energy, pretty regularly. And Brent, you were saying something about the CNI loans have risen over the past year, even as interest rates have gone up. Can you talk us through that?
Brent
Yeah. So this is kind of another part of the narrative. The combating narratives that I think people forget is many people didn’t think the Fed would ever be able to raise rates. But not only did they raise once, they’ve been raising them for a year now, and they’ve raised them aggressively. And the markets have not collapsed, to many people’s chagrin and many people said, well, as soon as the Fed starts raising rates, they’re no longer going to be increasing the money supply. Okay, that’s fair. And I know a lot of people think that the central banks just print money and flood the market with money. But where the real printing of money comes from, where the real creation of money comes from is when banks loan money. When you go down to your bank and you take out a loan, they don’t and let’s say you take out a million dollar loan, they don’t take somebody else’s million dollars and give it to you. They create it out of thin air. That’s rational.
Tony
Million dollars?
Brent
That’s right. That that’s a new million dollars that’s now in the economy that wasn’t there before. And so a year ago, loans had been coming down aggressively since COVID so they’ve been ramping up, I want to say, like in 2020, it was around $2.4 trillion. And then after COVID, they did all these PPP loans and it spiked to like $3 trillion. And then since the PPP loans, it’s just been steadily every month down, down, down. But I think it was last March or April, it stopped going down and it actually started to tick up. And now it’s been going up for a year, and so it’s up about 10% or 15% from the bottom. So that’s the creation of new money. And despite the fact that the higher rates have not yet caused anybody to go bankrupt, it’s starting to happen. And BlackRock had this happen to them with one of their funds recently. But despite the raising rates, you haven’t seen mass bankruptcies yet. And not only that, you see new loans being taken out. The existing supply of money is still there because we’re not getting the big credit contraction, and new money is being created through new loans.
And so again, you have this tailwind that’s actually speeding things up towards this wall that I believe we’re heading towards. It’s kind of part of the same thing we’ve already been talking about, but it’s just another facet of it.
Tony
No, it’s good. Some economists are going to ride in and say “that’s not technically new money.” But it is new money, right, because it’s circulating in the system and people are using it. Okay, so what drives that? I mean, it seems to me that when you have interest rates kind of steady for a long period of time, people tend to say, well, I can always put that investment off until tomorrow. But then when you see interest rates start to rise, people wake up and go, whoa, wait a minute, I better make that investment before it rises even more. Is that what’s happening?
Brent
I’m actually not an expert on this, and I don’t know for sure, but here’s my theory on it. And so I’m sure we’ll get a lot of people that tell me I’m wrong, but this is kind of how I think about it. I’ve been on record in the past as saying low rates are deflationary for the reason you just explained. If the market condition is so bad that the Federal Reserve has to resort to these extraordinary measures and pull interest rates to zero, is that really an environment where you want to go borrow a million bucks? Maybe, but that’s kind of scary, right? And so I kind of feel like low rates keep people from borrowing money and keep people and it’s borne out, if you look at these reports, that’s typically what’s happened. But if you are in an industry and you are competitive in that industry, and you want to remain in that industry, and you have not taken out that loan. But then let’s pretend as an example, you own a shoe store in Dallas, right? And you compete with a couple of the malls and a couple of the other independent sellers.
And a year ago, they took out a loan and bought more inventory and increased the size of their showroom or whatever it is. And you didn’t. But now we’re a year ahead. Market is holding up. Everybody’s going to those new stores to buy shoes. They’re not coming into your store as much. And in order for you to compete with them, you need to build a bigger showroom. You need to buy more, whatever it is. Well, now your loan costs two or 3% more than it did a year ago. And so now your question is, if I want to remain in this business and the crash doesn’t come in the next two months, if I wait another three or four months, our rate is going to be 2% higher? And so they’re kind of behind the eight ball. And so what I think happens is, as interest rates start to rise, if you need the money, you will borrow it. And we get into…
Tony
A friend who is doing a restaurant franchise who’s going who went through that exact process in terms of deciding when to take out money. It was extremely low. Interest rates started to rise and he felt urgency to get his loan locked in and got it locked in because of the change of rate, right? And the perception of the future change of rate made him so those expectations play.
Brent
I did the same thing. I bought a place in Puerto Rico last summer, and I think our mortgage is around 5%. It had been like 3%. If I’d have done it three years ago, we did it at five, and now I think they’re at six or seven. But that was part of my calendar calculation. It’s possible that rates will go higher. Now, it’s also possible that they’ll crash the three, in which case I refinance and I’ll be fine. But the point is, as money gets more expensive, if you’re going to stay in business, you need money. And so we get into this other theoretical thing where money is a gift. And I say money is a gift and good. And a gift and good is something that typically when something rises in price, the demand falls. But not with a gift and good, with a gift and good is as demand rises, price rises. Or as price rises, demand rises as well. And it’s because you just need it. It’s like this drug you just have to have. And as interest rates start to rise, you will pay more and more and more. And people say, well, if it gets too high, they won’t pay.
And I always say, okay, maybe but if high interest rates keep people from borrowing, then explain to me why Visa is in business and why loan sharks exist. They exist because even though they have rates, people need money and they will borrow at high rates. And so I think that’s kind of what we’ve seen as well. Again, I think this is all going to end, but all of this contributes to where we see markets at today.
Tony
Yeah, I think you’re exactly right. Tracy, can we change this focus of capex to energy? Because it’s pretty well known and you’ve talked about several times that energy hasn’t invested in the upstream since 2014 or something, right? So do you think that rising interest rates and there is some change in the tone of ESG speak in the US over the past couple of months? Do you think the rising interest rates may push some of these companies to start investing in the upstream, or is that just completely ridiculous?
Tracy
I’d be hesitant to say, yeah, I think oil companies are going to jump on board with this because we still have this rhetoric in the west saying that we’re phasing you out in ten years. We want you gone. And so oil companies are therefore they just don’t want to spend the money. And it doesn’t really matter what rate it is at. It’s good news. We’ve seen Vanguard leave the Zero Alliance, and we’ve kind of seen a lot of these banks kind of push back and a lot of these investment funds kind of push back on this ESG narrative. But I just don’t think that’s quite enough until we see governments really focus more on ESG. And even though, say, for example, and it seems hypocritical, we’ve seen Germany, for example, their coal usage skyrocketed in 2022 as they’re closing nuclear plants. Meanwhile, they’re pushing this green initiative. The problem is that since natural gas prices have come back down to prices that they were pre-summer of 2022, I think that they’ve become very complacent. This is how natural gas prices will stay, and natural gas prices are going to stay low.
But that’s looking at the European economy, on the other hand, the damage has already been done. We’re already seeing some deindustrialization in Germany. You have BASF leaving forever. You have a lot of smelters across the whole of EU that are just not going to come back online when they had to. In fact, a lot of them started shutting down in fall of 2021 before the Ukraine invasion. And the thing is, you can’t just reignite those glass furnaces. It takes a lot of money. You have to keep them running 24 hours, 24/7. You know, we’re just not seeing that industry come back, unfortunately. And the ironic thing is if we go back to BASF in particular, they are moving to China, who is buying cheap Russian oil.
Brent
Crazy, right?
Tracy
Because it’s cheaper to do business over there in general. But so I think at this point and we’ve also at one of that, we’re also seeing companies, oil and gas companies, in the UK, sort of because of their windfall taxes. That’s affecting business as well. And so they have decided to either leave the UK altogether we just had Suncor in Canada sell all their assets in their joint venture to BP. And we heard from Shell, Equinor, and BP all said that whatever we wanted to invest in UK, we’re not going to do that anymore because of these windfall taxes. I think that we’re running up against a lot of problems here that are more government-oriented, bureaucratic-oriented than our state central bank oriented, rates oriented.
Tony
We have had some state governments in the US push back on ESG. Right. And we did have a bill in Congress that passed that was pushing back on ESG, but there’s a veto coming or something on that bill, is that right? Governments are getting involved to some level.
Tracy
Absolutely. We have 20 states right now, basically, that are pushing back on the ESG narrative, saying, we do not want our pension funds investing based on ESG. We want our pension fund, our state pension funds, investing on what we think is going to make us money.
Brent
That’s going to make money. Imagine that. Right?
Tony
That would be a good focus.
Tracy
So there are 20 states involved in that. Texas is one of them. Florida is one of them. So that’s still kind of going through the court system at this point. And as far as this new, the amazing thing is this ESG legislation that will likely get vetoed was that it passed the House and the Senate. That’s huge. That’s a huge shift, right? Not by a small margin, I mean, relatively speaking, when we’re talking about other pieces of legislation. So the narrative is shifting in the US. So I think it’s too early to say where this is going to go, but it is definitely something worth keeping your eye on.
Tony
Great. Okay. All right, that’s good. Let’s talk about the Russian supply cuts going into this month. They’re going into this month, Tracy, what does that mean? Can you kind of put that in perspective of their overall supplies?
Tracy
Yeah, I think in general, what people expected was when they announced this and they announced this in a month ago, that oil prices were going to skyrocket. But I don’t think they were doing that to raise oil prices and stick it to the west, right. And raise oil prices that they wanted to see. What they wanted to do is narrow that spread between urals and ESPO, which are their two main crude grades with respect to Brent, because that’s how the prices quoted, European oil prices are quoted in Brent minus whatever the spread is. Right. So what they wanted to do is they wanted, after the price caps and all of the sanctions, et cetera, they wanted to, we saw those prices, those front month prices in those particular grades fall dramatically. And so I think what they want to do is narrow the spreads. And so really, that’s what I think that whole thing, that whole decision was aired for.
And then you also have to understand that Russia includes condensates, which is those lighter oils within their total oil production, whereas the rest of the world does not. And so we don’t really know exactly where that 500K is coming from. Are they those like NAFTA, or is it pure crude? And where that really remains, just so people kind of understand the market over there.
Brent
I think Tracy and I might be wrong, but you’re the expert here, but I think another contributing reason that they cut production is, to your point, in order to get that spread closer, right? Because the discount was pretty significant. Right. And a month ago, I think they announced the production cuts, and a month ago, they announced that tax revenues were falling and as a result, they were going to have a budget deficit this year. But what I didn’t see until kind of a couple of weeks ago was that as a result of the production cuts and as a result of the tax revenues falling so severely in Russia that they are changing the way taxes are calculated on Russian producers.
Tracy
Exactly. Exactly.
Brent
And they are doing and this is not going to be in favor of the Russian producers, they’re going to increase the taxes on the Russian producers to try to alleviate that budget deficit. So I don’t know that they were 100% correlated, but I don’t think that they’re unrelated. Right? In other words, if they’re going to tax Russian producers at a higher rate, and it is taxed on the difference of the spread between the west and Europe, they not only want to get the spread closer or the price higher, the discounted price higher, and then tax at a higher rate. So it’s kind of a double whammy on the producers.
Tracy
It’s a double whammy on the producers, but it’s income for the government.
Brent
Right, exactly. No, exactly.
Tracy
You know what I mean? And this is the same thing I was kind of talking about earlier on another podcast. What is interesting is that Russia is suddenly buying this huge fleet of vessels, right? So they own the vessels and they’re now insuring themselves. So the government’s making money no matter what. They’re just paying themselves. So Russia is not really losing money on this, even with the price cap and with that spread being lower. Now, if you look at and moving on to that, there was just an independent study done that assessed the international sanctions impact on Russian oil imports. And I think it was researchers from Columbia University, University of California, and the International Institute of Finance. And what they discovered is really that Russian crude oil is really selling for $74 right now, all is said and done, which is well above the $60 price cap. All we hear from mainstream media is they’re losing money, they’re losing money. But in reality and I read this paper, and I’ll post it on Twitter later if anybody wants to read this paper. It’s very interesting and it’s very well done. They essentially are selling oil above the price cap, and there’s no way to stop. There’s no way to stop.
Tony
Yeah, sanctions are great, but if there’s no enforcement mechanism, they don’t mean anything. And the Russians know that. Russia, Iran, China, they all know how to circumvent.
Tracy
Iran is the most sanctioned country in the entire world as far as the oil industry is concerned, and they’re still making money, and they’re still able to export, so.
Brent
Shows you how powerful oil is.
Tony
Right, exactly. So, Tracy, who does the 500,000 cut hurt? Is it hurting Asia more, or does it hurt markets generally, globally, just because it’s crude oil?
Tracy
Well, I think, again, it’s very hard to decipher because we don’t know what 100% is being cut. Is it all oil, or is it just these light condensates? And so I think in general, I don’t think it hurts anybody in particular, because if the markets were that worried about it, well, it would be at $100 right now, easy. Right? And so I don’t think markets are that worried about it. I also think markets are kind of let’s wait and see what this actually is. And that brings to a second point, is that right now what’s happening is that we’re having a bifurcated market, right? So the oil market, which did its thing for 30 years, 40, 30 years very nicely, trade routes were settled. We were in this crew. Now we have literally a gray market. I mean, we always had a black market in the gray market, but, I mean, now we’re talking 10 million barrels a day in the gray market, not a few million barrels wherever else. So we’re talking about a large 10 million barrels, which is approximately Russia. And this is a gray market right now, right, because they have their own vessels again, their own insurance. They’re doing ship-to-ship transfers. They’re doing all these shady stuff offline to kind of mitigate and get around Western sanctions in any way possible. And so we really are seeing this market where it’s going to be harder and harder if you’re a barrel comes here, it’s going to be harder and harder to actually track these barrels because that gray market has exploded in volume.
Tony
Interesting, you tweeted a story about some Russian crude being seized in Albania. So that’s one of the, I guess, paths to circumvent. Can you talk us through that and why that’s important?
Tracy
Well, I think that it was interesting because this is not something that, you know, again, there are offshore ship-to-ship transfers going everywhere. You know, particularly if you look off, Spain is a very big on ship-to-ship transfers, right, in Greece. I just thought that was interesting because my first thought was five minutes later, it’s going to be on the black market via the Albanians.
Tony
Sure.
Tracy
But yeah, I mean, they just happened to get caught and too bad that Albert’s not here. He could probably better explain the Albanian relationship.
Brent
It was probably him.
Tony
Okay. I guess the message that I’m getting pretty consistently and tell me if I’m wrong, these are sanctions put on by Europeans, but through Albania, through Greece, through Spain and other places, they’re circumventing the sanctions. When I say “they”, I mean people in Europe are circumventing the sanctions that their own governments put on. Have I misread that?
Tracy
No. I mean, I think that everybody’s trying to kind of find a way around the sanctions right now. And you have to remember, this only applies to seaborne Russian crude. I mean, we still have gas pipes into Europe and we still have oil pipes into Europe right now. So it’s really only seaborne crude.
Tony
So when it’s piped, it’s fine.
Tracy
Yes.
Tony
That’s amazing. Really amazing. Okay, great. Hey, guys, listen, let’s just take a quick look at what you guys are expecting in the near term. What are you guys looking for, say, for the next week? What’s ahead? Tracy it sounds like energy markets are kind of sideways for a while.
Tracy
I think we’re kind of stuck in this $70-80 range right now in WTI. OPEC is very comfortable at $80-90 range for right now in Brent. And so, you know, I think that as we move closer to, say, high demand season and we get more clarity on China and what their domestic demand is going to really look like, I think we could definitely see a push to the upside. But for right now, I think markets are very comfortable where they are, and I think OPEC is very satisfied where markets are right now.
Tony
Okay, great. That’s what events happen, though, right?
Tracy
When everyone’s coming, right? Exactly. You never know what could happen. You had what the story this morning from The Wall Street Journal say EU is leaving. I was like, what? No, they’re not. And they retracted the statement.
Tony
You leaving OPEC and all that stuff? Yeah. Crazy. Brent, what are you looking for in the next week or so?
Brent
I kind of think we’re going to continually have this violent sideways. I think markets are going to go up one day and they’re going to go down the next. And I think in general, I don’t think we’re going to get real clarity in one direction or the other until at least the Fed meeting. Possibly. We do have CPI that comes out a week before the Fed, so that will have a big impact, no doubt, unless it comes in right on the number, which in which case it will be violent sideways again. But I’m trying to just be nimble right now. Again, I don’t have any huge convictions either way right now. I kind of have my long term view while I understand the short term tailwinds, but I think it’s a time to be prudent rather than a time to try to be brave. So that’s kind of a cop out answer, but that’s kind of the truth right now.
Tony
No, I think that’s a great way to put it. Time to be prudent rather than time to be brave. I love it. Okay, guys, thank you so much for your time. I really appreciate it. This is great, great insights. So I appreciate it. Have a great weekend. And have a great weekend. Thank you, thank you.
