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Energy Market on the Brink: Russia, CNY, and the Fed’s Dilemma

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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.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Michael: https://twitter.com/mnicoletos
Albert: https://twitter.com/amlivemon
Tracy: https://twitter.com/chigrl

Transcript:

Tony

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.

Albert

Thanks.

Michael

Thank you very much. Have a great weekend, too.

Tony

Thank you.

Categories
Week Ahead

The Great, Great Depression: Navigating Banking Risks, Rising Rates, & China’s Changing Global Role

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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.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Hugh: https://twitter.com/hendry_hugh
Albert: https://twitter.com/amlivemon
Tracy: https://twitter.com/chigrl

Transcript

Tony

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?

Hugh

Nice white shot.

Categories
Week Ahead

Systemic Risk: Silicon Valley Bank(ruptcy) & America’s Feckless Energy Policy

Explore your CI Futures options in this March Madness Promo.

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.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Joseph: https://twitter.com/FedGuy12
Albert: https://twitter.com/amlivemon
Tracy: https://twitter.com/chigrl

Transcript

Tony

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.

Albert

Thanks, Tony.

Joseph

Bye, guys.

Albert

Thank you.

Categories
Week Ahead

Inflation 2.0, Bullish Metals & Oil, and Russian Supply Caps Discussed

Learn more about CI Futures: http://completeintel.com/futures 👈

The Week Ahead with Tony Nash brings together experts Tony Greer, Albert Marko, and Tracy Shuchart to discuss the key themes affecting the markets. In this episode, the focus is on Inflation 2.0, Market Chaos, and Russian Supply Caps.

Albert Marko leads the discussion on Inflation 2.0, and explains his view that inflation will re-accelerate this year. He talks about how various factors such as the Federal Reserve, a potential recession or slowdown, and war could impact his thesis. He also mentions the upward revision of December Consumer Price Index (CPI) and the upcoming release of the January CPI.

Tony Greer then takes the lead on Market Chaos and explains why he is bullish on metals and oil. He discusses his views on copper and explains his outlook on crude oil, which he tweeted about in January.

Tracy Shuchart focuses on Energy and the Russian supply caps. She talks about Russia’s announcement to cut production to 500k barrels per day and what this could mean for crude quotas and price caps. She also discusses the impact on natural gas.

Finally, the experts provide their expectations for the Week Ahead.

Key themes
1. Inflation 2.0
2. Market Chaos: Bullish Metals & Oil
3. Russian Supply Caps

This is the 52nd episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Albert: https://twitter.com/amlivemon
Tracy: https://twitter.com/chigrl
Tony Greer: https://twitter.com/TgMacro

Listen to this episode on Spotify.

You can also listen on Apple Podcast using this link.

Transcript

Tony Nash

Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash. And today we’re joined by Tony Greer. Tony is with TG macro. He does the morning navigator newsletter. He’s an OG with RealVision and he’s just very, very popular and we’re really lucky to have him today. We have Albert Marko, of course and Tracy Shuchart. We’re very fortunate to have both of them today. So thanks guys, for taking the time to talk with us today. I really appreciate it.

Tony Greer

My pleasure. Thanks for asking.

Tony Nash

Great. So we’re going to start today with Albert. We’re going to be talking about inflation. Albert, you’ve said several times over the past several months that we’re going to have kind of a re-acceleration of inflation this year. And we just had an upward revision of the December CPI. And of course, we have another CPI, the Jan CPI is out on Tuesday. There was a viewer question talking about kind of your Inflation 2.0 thesis.

Can you talk us through that? What are you thinking of when you think through that and when do you think it’ll materialize?

Albert

I’m looking at multiple variables at the moment. Russia probably reactivating some of the military operations in Ukraine, which I think we started to see the last couple of days a little bit. We have China reopening. The Europeans have been in a zombie state, so they’re technically reopening, so their demand is coming back. All that’s going to be inflationary, in my opinion. But the biggest factor that I see has been Yellen’s use of the TGA to offset QT.

Tony Nash

What’s the TGA?

Albert

Well, the treasury general account. So she has a big slush fund of money where she can place wherever she wants. And what that’s been doing has been helping rally the markets purely out of political reasons. And when you have a net zero quantitative tightening cycle, it’s like, what do they expect that to happen at the moment?

Tony Nash

Let me back up just for people who aren’t… So we had a Fed meeting last week. They raised by 25, they’re continuing QT incrementally. Right. And so what you’re saying is that Yellen is offsetting that QT with spending from the TGA?

Albert

Yeah, it’s exactly what I’ve been saying. I’ve been at this for quite a long time. She’s gone hog wild on the treasury bills in the recent months and that’s pretty much the reason we got a stock rally. You’re looking at the duration of liquidity, which is very, very important and nobody really wants to talk about that at the moment. So I mean, these stock rallies have gives a perception of a solid market and overall economy aiming to help the Biden administration for purely political reasons. Right. And this revision, yeah, it was revised and people think it’s an incremental revision, but it’s a 33% rise and CPI from the for the previous data, so it’s not incremental whatsoever.

Tony Nash

Yeah, month on month it’s, it’s a little bit elusive for people to understand how big of a revision this is. Whenever economic data come out, anybody who follows me knows I always say wait for the revision. Right. Especially with OECD countries, wait for the revision because they hide stuff and they leak it out in previous data, other things. And so, as you just said, Albert, there was a 33% revision in the December CPI. That’s massive, right?

Albert

Yeah. Wage inflation is spiraling out of control. We have not just the United States, but now you have the Bank of Japan reporting more inflation from their side. In fact, the Australians did the same thing. They’re having hot CPI numbers. I mean, if we have a hot CPI number coming Tuesday, I mean, it’s just not going to be pretty for equities, in my opinion. And I think that’s why Jerome Powell would soft last week, just because he sees the data and he knows what’s coming.

Tony Nash

So what is a hot CPI number to you?

Albert

I think anything above what the consensus is, whether it’s even 0.1 or .2, anything that’s sticky in the core CPI is going to be hot.

Learn more about CI Futures: https://www.completeintel.com/futures

Tony Nash

Tony, you’re wincing there. Why do you do that?

Tony Greer

No, I mean, I was hoping for a specific magnitude, you know what I mean? As a trader, I’m like, how much higher is he expecting? And he was anything higher and I was like, 8%, 9%, 10%, what do we like? That’s all. I’m very interested. I think he’s on the absolute right track.

Albert

It’s hard because the VLS has been using different calculations and methodologies to calculate CPI. They just changed the way they weigh it, so they’re trying to keep it within a reasonable amount. But when you’re looking at fertilizers and fertilizer companies like Mosaic, and then you have nat gas spiking and then wheat spiking today, either that’s Russia ramping up military affairs in Ukraine, or there’s a hot CPI number coming, my opinion, or both.

Tony Nash

Okay. How much of a factor is like the earthquake in Turkey? Or is any of that a factor?

Albert

That’s a huge factor, Tony, because that’s going to start cutting off, that’s going to start up cutting oil supply, and that’s one of the prime components of inflation. And I’ll let Tracy get onto the details of that. But that’s one in many variables that we’re going to start looking at.

Tony Nash

Okay, when you say inflation 2.0 is coming, are you looking at say, Q2 or something when that will kind of reemerge or what’s your timing on that?

Albert

I’m thinking Q2 at this point. Originally I thought it would be in September or October, but I think the timeline definitely come faster.

Tony Nash

Okay, so what’s driving that is largely kind of energy and ag? Is that..

Albert

Energy, ag, and specifically just the market just being just rallying relentlessly, it just won’t go down. And that’s spurring commodities. Copper, oil, you name it, wheat, grains, everything.

Tony Nash

Okay, if I understand you correctly, just to reiterate what you said. We have more money going into the money supply because of the spending from the TGA that’s offsetting QT. And that money in the money supply is going to people who are driving up commodity prices, driving up equity markets, and potentially driving up real estate. Right. Because we saw some real estate numbers this past week that were not discouraging. Right. I mean, real estate isn’t dying like many people thought right now. And mortgage rates are generally kind of going down. So it seems like we have money going into those things, which is kind of the opposite of what the Feds here are trying to achieve.

Albert

Yeah, the mortgage rate ticks down just a little bit and all of a sudden the spurs on buying. So everything that the Fed has been trying to do is just not happening. Labor, housing, stocks, everything, literally everything.

Tony Nash

Okay, and so how much longer can Yellen use the TGA, does she have unlimited capacity there?

Albert

No, she doesn’t. And Congress can definitely put on oversight on that. But she started off in… Well started off, but she had about 160 billion per month just prior to the midterms. But now she’s down to about 50, 60. Yeah, but that’ll get replenished in April when the tax money comes in for the use.

Tony Nash

Okay, so it will be muted in Feb-March. But she can go guns blazing again in April.

Albert

And this is part of the negotiations with the budget, with the Republicans and the Democrats is trying to limit what she can do with the TGA at the moment. They won’t say it publicly, but they’re certainly trying to.

Tony Nash

Okay, very interesting. Okay, so for those of you guys out there, check out the treasury general account and just see what’s out there, I think that would be really interesting to look into. Okay. Anything else on this, Albert? Is inflation 2.0? Is it going to hit the US or hit, say, Europe or Asia or where do you think?

Albert

I think Asia and Australia is up first for inflation and then leaking over the United States. Obviously I don’t think we’re going to see 9.9 prints on the CPI, but steady 6-7. We definitely see that.

Tony Nash

Okay, great. All right. And then do you think that tapers off in say, Q4 or something like that?

Albert

I think so. I think it’ll start tapering off again. I think it’s going to be in a cycle.

Tony Nash

Okay, great. All right, so we just put out our I just tweeted out our Complete Intelligence CPI print expectations for the year and we think on average we’re going to be about 5.3% for the year. So we’re probably a little bit below your expectations. All right, Albert, thanks very much. I really appreciate that.

Albert

Thanks.

Tony Nash

Tony, let’s move on to you. When we spoke before this discussion, you talked about market chaos like you enjoy it. Are you having fun with this?

Tony Greer

Yeah, I am. This is the kind of trading that benefits, a more active trader, I think, like me, and somebody that’s not afraid to get flat things and take advantage of what looked like absurd price opportunities in the immediate term and things like that. So, yeah, I’m having a good time with this, Tony. I really am.

Tony Nash

That’s great. Can you talk us through kind of… You seem to indicate that you’re pretty bullish on metals and oil, so can you help us through that? And let’s look at metals first. I’ve got a chart for copper up and that price has obviously come down recently. But why are you so bullish on metal? Is copper included?

Tony Greer

Yeah. So let’s go right into it, Tony. The copper is definitely included. What got me so bullish was last year, I remember spending the whole entire second half of 2022 watching copper pound 6500 on the LME. Right? And for me, that equates to the 2017 and 2018 peak in copper, from which point it failed and faded lower and then traded down below 5k during the lockdown. So we saw the big spike to 11k, where everybody thought copper was going to the moon.

Tony Greer

All of that was essentially the lead in to the Biden Administration. That was the lead into the Biden administration. The pivot to electronic vehicle was that big copper rally to 11k and it consolidated there for the entirety of 2021. Then in 2022, copper backed off and pounded the highs from 2018 at 6500, held, and got back up above its moving averages. So when you see that and it coincides with another fairly tight physical market, another backward dated commodity, another commodity where inventories are nosediving, so you’ve got the supply side really on your side. The sort of argument against that is that China is storing and taking a lot of copper off of inventory.

Tony Greer

And my response to that is if they’re taking it off inventory, they’re probably not going to sell it anytime soon, so I don’t have to worry about it. That’s kind of the sort of one basic slant of my metal bullishness, right?

Tony Greer

And the other side of it I have in my mind, I’m fairly convinced that the dollar is going to be on a path lower this year. If you notice last year, she peaked at the Bank of England intervention when the guilt market came apart, and then she formed a lower high when Dollar-Yen got to 150 and the Bank of Japan showed up and said, “hold on, hold on, hold on. You guys kill it.” You know what I mean? That was an absolutely inexplicable FX rally that people haven’t seen in decades.

Tony Greer

So with those two central banks at the top, Tony, a curl down below the moving averages, and coincidentally, with the backdrop of two stories, number one, central bank digital currency story seems to be gaining traction. Whether we like it or not, whether it’s good for us or not, I feel like we’re going to have those and that’s going to detract from the purchasing power of the dollar again.

Tony Greer

And then you’ve got the story where it seems like Russia, Saudi Arabia, China, the rest of the BRICS are very interested in starting their own commodity markets, priced in their own currencies.

Tony Nash

Don’t get Albert started on that.

Tony Greer

Yeah, exactly. I was going to say, I don’t know if that’s a fair topic for discussion and maybe he may be a perma petrol dollar and that’s fair too. I don’t know. But I see that as a story, as sort of deteriorating credibility in the dollar, certainly. And that’s just the way I’m leaning. And it’s not something my money is where my mouth is. The dollar for me is a barometer that tells me how much wind am I going to have in my commodity sales. So I do not have any risk on in the dollar.

Tony Nash

Okay, we should actually come back and talk about that at some point in detail. Sorry, Tracy. You were saying?

Tracy

I was going to say we should also factor into this conversation the fact that we’ve had the lack of capex in the mining industry as far as the metals are concerned. That is equal to the same lack of capex that we’ve had in, say, the oil industry. So that definitely factors into the situation as well when you’re trying to transition to EVs, EV charging stations and all of these metals, even windmills as far as copper is concerned, et cetera. The mining industry again, I don’t know how you feel about that, but I just want to kind of throw that in there.

Tony Greer

Couldn’t agree more.

Albert

The only thing I have to say about the dollar moved down and up is I do agree with Tony that I think the dollar will probably go down a little bit, probably 97, 98. Right. But unfortunately, if inflation comes back, they’re going to have to use the dollar to kick it in the rear so we could see a 97-96 and then go right back up to 105 as they try to fight inflation again. It’s certainly possible. This is going to be a topsy turvy of a year no matter which way you look at it, whether it’s going to be dollar up, dollar down, commodities up, down. It’s just going to be all about the Fed and what intervention they do with inflation.

Tony Greer

It’s nonlinear chaos. Right. The curve.

Tracy

Yeah.

Albert

But this is great for a trader, for a trading. You want to see volatility.

Tony Nash

Very good. Okay, Tony, let’s let’s move into oil then. You’re also seem to be very bullish crude and and we have a tweet from you from Jan. 17 talking about crude going through its 50 day moving average and so on and so forth, talking about some serious muscle in crude markets. So can you talk us through that as well?

Tony Greer

Yeah, so that’s strictly a technical look. And to me, oil continues to make bottom formations and fail. Right? That’s what it keeps doing. We keep seeing an inverted head and shoulders, and then it kinda break the moving averages, and then we see another inverted head and shoulders. That’s even shallower than the last one because they can’t pound it any lower, and that can’t break the moving averages and we back off. And now we’ve got another situation where we’ve got another pattern that’s extremely bullish, where we just had the recent low fall between the last two lows, Tony.

Tony Greer

And that’s a little bit of tea leaves, but that formation is called a wiggle, and we haven’t traded lower since we put in that low. That was between those two lows, if you notice. And so now we’re attacking the 100 day moving average. I mean, this could be it. I walked into this year saying technically, I’m not going to miss out on the trade where crude oil goes through the 50 day, the 100 day, the 200 day, and keeps going, right? That’s the trade I’ve got a bullseye on. And if I have to stop myself out of it ten times, I’m going to be in the 11th time, I can guarantee you. So that’s how I’m looking at the world.

Tony Greer

From the supply side, the driver to me has been gasoline demand. Quite honestly, gasoline demand globally is sort of everybody’s concerned about the recession now. Not concerned about recession. I’ve traded through dozens of recessions and I have noticed that many of them don’t put a major dent in gasoline demand. So I feel like we’re set up for that type of move again, where we have steady gasoline demand. We’re able to keep this crack spread elevated at a $30 to $50 level, where they used to be eight to $12. Right. That’s the margin that a refiner makes for splitting barrels of crude into jet fuel and diesel. So with that crack spread and remaining elevated, the rest of the curve remaining backwardated, although that’s another trip that’s going to be non linear and wacky. But with inventories largely diving below five-year average inventories across the board, the demand for diesel, the demand for jet fuel. Demand for diesel was last year. This year, it seems like demand for jet fuel is really coming back quite a bit. So I just see a great supply side story, a fairly good demand side story, and I see resource nationalism everywhere I look, and that’s generally positive for crude oil.

Tony Greer

So when you line all of that up, the stars align with the technical picture. When we do eventually go skipping through those moving averages, the stage is set for it not to come back. I don’t know if that’s going to happen, but as a trader, I’m going to put my chips in that circle and see what happens.

Tony Nash

Sounds very solid. Tracy, I see you agreeing pretty violently. What else do you have to add there?

Tony Greer

Yeah, I want to hear what you’re adding, Tracy.

Tracy

No, I absolutely agree. When we talk about the supply side and the demand side, we really have to take a look at China. And I know we keep talking about the China opening story, but if we do really look at mobility data and I posted a couple of charts on this today, mobility data is up. Right. And then you also have what I think is more important is if you look at flight data and jet fuel demand, which is up once again, because we know that for Chinese New Year, we had a lot of domestic demand increase, but what we’re really looking for is international demand increase. Right. And so we’ve recently seen China flights to Hong Kong increase in full because that flight pattern was shut down. And so I think this is going to be a major forecast, and we have to realize that China has been drawing down on their stocks locally. Right? And so eventually they’re going to have to rebuy on the international market. If they’ve been depending on the stocks that they accrued since they’ve been shut down over the last year, if they’re pulling down those stocks. China is one country that is not the US.

Tracy

Let’s put it that way. They do not want their SPR to go to zero, all right? They really depend on this. And so because they’ve had to draw down on their domestic stocks, I would be looking for them to start buying on the international market again, especially when they’re getting really cheap crude oil right now from Russia. They would start buying.

Tony Nash

When do you think that is?

Tracy

I think now. They are buying now. I’ll post some charts on Twitter again, but according to Bortex data, there is a lot of seaborne crude going to China right now. We know that they get a lot of natural gas domestically through pipeline, and they’re expanding those pipelines, but realistically, crude oil is still seaborne, and so we can track that.

Tony Nash

Okay, interesting.

Albert

Yeah. Tony a lot of people sit there and criticize it like, well, China has been open and they’re not doing anything, and blah, blah, blah. But it’s not a black or white thing with China. I mean, they’re staggering their opening. They’re not dumb, because if they open just full speed ahead, they’d have a commodity inflation issue even worse than the United States would. So they are buying. And I agree with Tony with the oil bull market case, and I agree with Tracy. The supply side demand side is heavy. The Chinese are reopening and buying still. And I think oil goes to minimum 110 this year. Minimum.

Tony Nash

I love it when ours says, I agree with Tony because I’m not used to hearing that. But I know he’s talking about you, Tony Greer.

Tony Greer

That’s fine looking, Tony. Beautiful part. Yeah. The beautiful part about this market, Tone, is that you can find the opposite side of your trade. You just got to open your eyes and ears, right?

Tracy

That’s what you really need to do, because if you have a thesis, you really want to hear the opposite side. Right?

Tony Nash

Tell me about that. What is the downside thesis for oil? What is that downside thesis?

Tony Greer

Drill, baby, drill.

Albert

That’s not politically viable.

Tracy

Which is not going to happen. Which is not going to happen.

Tony Greer

Right. So that’s why you say you can get annoyed at what’s going on or you can make moves in the market, right. You can buy the energy complex and buy oil because that’s the direction it’s naturally going to go if they’re going to try to put this electric vehicle squeeze on by 2030. Right? I mean, that’s almost necessary. And almost the necessary trade is for the Bloomberg Commodity Index to go up 40% from here. If we’re going to fill all these orders to build battery packs and battery power all over the world.

Albert

The only the only other downside for oil is if the government starts playing around in oil futures and trying to sell it down just to keep it relatively safe on the inflation front, which they did.

Tony Greer

It was remarkably effective. It was remarkably effective. What they did with the SPR, you have to say, whether we like it or not, they knocked 30, $40 off the price.

Albert

It wasn’t just the SPR, though. They were sitting there selling down in oil futures in the market.

Tony Greer

They have a president’s working group that’s allowed to do that. I’m sure they are.

Albert

They do.

Tony Nash

Free market capitalism. You got to love it, right?

Albert

Yeah.

Tony Greer

Well, free market, political-driven capital.

Albert

Well, this is what Tony was mentioned this is what Tony was talking about when he said nationalizing commodities and whatnot. Of course they’re inflationary effects, but the governments only care about short term. What’s going to make my voters happy for the next election in six months? That’s all they care about.

Tracy

It’s kick the can theory, right? The Fed does this all the time. We see central banks do this all the time. Why not governments, right?

Tony Nash

Yes. Okay, guys, let’s move on to crude oil, specifically. Tracy, on Friday, we saw Russia announce plans to cut production to 500,000 barrels a day. Brent rose on the news. And I’m really curious. What is Russia producing right now? So are they at that volume capacity? And what does that mean for the crude quota and the price cap?

Tracy

Well, Russia is already producing at their quota according to the OPEC. The thing is, their OPEC quota and I won’t get into the logistics of this, but their OPEC quota is a lot of condensate oil, not straight oil. But aside from those details, we have to go in fact, Russia Euros is trading literally between $40 and $45 right now as we are speaking today on Friday. The the what date is this? I just want to make sure some people the 10 February. And so I think that you have to you know, I think what Russia is trying to do right now is try to bump up the price of oil for themselves, because I think if oil prices are higher for them, even though they are supplying less, they’re going to make more money regardless. I also think that this puts a thorn in the side to the west, because they’re trying to bump up oil prices. When Western nations are trying to push down oil prices. Right. They don’t want to see inflation go higher. And energy is a big part of that, even though central banks don’t realize that. But we have to, you know, it is a big part of the inflation factor.

Tracy

And so what I think they’re trying to do is basically say, I’m going to be a thorn in your side. We’re going to kick up oil prices. I’m also going to benefit myself because oil prices are going to go higher for me. And maybe they reach the cap $60. They’re well below then. You know, they’re still making more money with reduced volumes.

Tony Nash

Okay, so Euro trades at $20 discount, right, at this point.

Tracy

To the price cap.

Tony Nash

Right. But who are they hurting, aside from, say, India and China and a few other countries that are their traditional allies?

Tracy

Well, even if that price went up of your rails, at this juncture, China and India are still getting great deals, right? At $60 a barrel, you’re still getting a great deal. Right. You’re $20, $30 below what Brent and WTI are trading at. And so I don’t think that really matters to them. As far as am I going to lose China and India as customers, I don’t think that’s even a concern of theirs because they realize that their oil is trading well below everybody else.

Tony Nash

So I guess if they’re going to have the same customers, the China India customers generally, why does it matter? Aside from… Why does it matter to Brent that Russia has raised or capped off their production? If it’s going to go to the same markets anyway? I’m just curious. Why does it matter to the non-Euros crude?

Tracy

Because you’re taking barrels off the market, and that is the only thing the market looks at. How many barrels are you taking off the market? If you’re taking 500,000 barrels per day off the market, then these other that’s 500 barrels per day off the market.

Tony Nash

Sorry, what do they have said this before? What are they producing now?

Tracy

They’re at about 10.5, but again, that includes condensate. It’s not exactly 10.5 million barrels of oil per day.

Tony Nash

Okay.

Albert

Basically, how’s the earthquake in Turkey affecting things on the supply side?

Tracy

All right, so if we look at saline ports, we’ve taken 8885 barrels per day off the market as well. Almost a million barrels per day off the market from that specific port. That specific port was supposed to be down for two to three days. That’s looking like a lot longer at this junction.

Tony Nash

Okay.

Tracy

That’s also affecting global markets.

Tony Nash

Okay. So between Russia and the Turkey earthquake, there’s a real impact on markets?

Tracy

Absolutely.

Tony Nash

Okay.

Albert

And of course they’d probably take advantage of it. Yeah, that’s the way things work in that part.

Tony Nash

Of course. Of course. Tracy, we had some viewer questions about natgas. There were probably four of them on Twitter. What new insights do you have in natgas over the last couple of weeks?

Tracy

Well, as far as natgas is concerned, everybody’s asking when is this market going to bottom? Right? Because it’s been just a disaster since summer. We’ve seen like over 40% decline and in my opinion, really what we should be looking at right now, I think we’ll probably consolidate down here for a while. I think what we should be looking for is going into summer because what I think it’s going to happen is that we’re going to see China demand increase because they’re coming back online and cargoes that were bound for the EU will probably go to China now. They’ll outbid the EU because EU is basically full at this juncture, right. So they don’t really need the cargoes. Those cargoes can move to Asia. But during the summer, what we may see happen is increase. And we got very lucky with the EU as far as winter was concerned. And what I think will happen is during summer, if we have a particularly hot summer, air conditioning rises, that means nat gas increases. And so what I think we could see is somewhere this summer we see an increase in prices again because you have to realize that last year EU still had 50% of their capacity filled from Russia before everything went offline. That’s gone.

Tony Nash

Right.

Tracy

I would be looking towards, more towards this summer if you’re looking for kind of price increase. And generally right now I think that we’re probably going to see some consolidation down in this 2, 2.50 area, which is where it’s traditionally traded.

Tony Nash

My neighbors in Texas need more money, so let’s get that pumping.

Tracy

But the thing is that at this, the producers in Texas that their costs are higher, that production is going to drift if we stayed up long enough. So you have to think about that as far as production is concerned anyway, I mean, we are in surplus right now, but that may not last forever.

Tony Nash

Great. Okay. Very good. That’s really good. Thank you for that. Hey Tony, what does next week look like for you? I know we’ve got CPI coming out. What are you looking at for the week ahead?

Tony Greer

I’m thinking like Carl icon, to be honest with you. Tony. No, I’m serious. If you saw his options play, I guess he’s got, I guess it’s 5 billion notional of options that are struck at 40, 50 for next Friday. If you ask me, he’s looking at number, he’s looking at a couple of things. He’s looking first at I think the bond market, the credit markets in terms of the bonds and break evens in terms of yields and break evens trading higher in the last week, they have both vaulted off of the lows. So there’s been a clear turnaround in market based inflation perception. So I think that he sees that and looks on the calendar and sees CPI and PPI next week, knows that inflation is not linear in any direction and maybe is making a bet on and maybe it’s just a hedge, but maybe investing that money on the idea that we have an upside surprise in any of the economic data. The bond market tanks, stocks tank. If rates go higher, they’re going to mash big tech again and he’s probably going to be in the money and his 40-50 puts.

Tony Greer

So that’s how I’m looking at it. I’m looking to see if my portfolio of trades that I’ve got on can weather that type of storm and if I’m out of the way in certain places, if I should join him in certain places. That’s the way I’m thinking about next week, man. I’m trying to stay alive.

Tony Nash

Sounds very exciting. Tracy, what are you looking for next week?

Tracy

Continue, obviously watching the commodities markets, metals, energy, watching China data, the mobility data, flight data, see how this is moving along and we’ll see how that.

Tony Nash

We see a higher CPI, what does that do for crude prices, do you think? Do you think there’s a direct impact?

Tracy

I think you’re going to see crude prices go higher, yeah.

Tony Greer

Tone, what, the dynamics…

Tracy

Counterintuitive, right?

Tony Greer

Yeah. It’s kind of like the market speak to each other, right. Like a dynamic that we definitely saw along the way of the commodities rally as rates went higher last year. Right. Call it the whole period going into the Russia Ukraine invasion, right. It was oil straight up, but it was kind of like the credit market. I called two year yields last year the bat signal, and I named them that because they were getting out ahead of commodity inflation. We were having weeks where the bond market was getting shellac and there wasn’t much going on in the commodity markets, but all of a sudden they would pick up at the end of the week. And I think it was a lot of the time, like the bond market signaling inflation here. The commodity markets are going to go up. And I think that that’s kind of a sort of a cadence that established itself. And so it’s going to be really interesting to see how that unwinds.

Tony Nash

Fantastic. Okay. That’s a really great explanation, Tony. Thank you. Thank you so much. I really appreciate your time. Thanks so much. Have a great weekend and have a great week ahead. Thank you.

Tony Greer

Thanks for having us. Be good. Bye.

Tracy

Thank you.

Categories
Week Ahead

Unveiling Shocking Risks: Markets, Cracks, Freeport, and Ukraine’s Hardware

Learn more: http://completeintel.com/futures 👈


In this video, our first-time guest Jim Iuorio leads the discussion on the topic of whether markets are too good for the Fed. With speculation around CPI, layoffs, and interest rates, the question of the Fed’s direction and potential pivots later in the year is raised.

Jim also delves into the recent success of the metals market and offers insight into where the market may go in the future. He also offers his thoughts on the potential impact on equities if the S&P hits his target of 4060.

Next, Tracy takes the lead in discussing cracks and Freeport. She explains the significance of rising crack spreads and its impact on the market. She also shares her insights on the recent opening of the Freeport facility and its effect on US natural gas prices.

Albert then discusses the risks associated with Ukraine’s new hardware. He addresses the classification of “direct involvement” and its potential impact on European countries. He also offers insight into what actions Russia may take to further complicate the situation and the potential impact on markets such as wheat.

Finally, the team gives their expectations for the upcoming Fed meeting and what to look for in the week ahead.

This is the 51st episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Jim: https://twitter.com/jimiuorio
Albert: https://twitter.com/amlivemon
Tracy: https://twitter.com/chigrl

Listen on Spotify here:

Listen on Apple Podcasts: https://podcasts.apple.com/us/podcast/complete-intelligence/id1651532699?i=1000597046195

Transcript

Tony

Hi, and welcome to the Week Ahead. I’m Tony Nash and today we’re joined by Jim Urio. Jim is at TJM Institutional and he’s with the Futuresedge podcast. Or is it on the Futuresddge podcast, right? Yes. Also with Albert Marko and Tracy Shuchart with Hightower Resources Advisors.

We’ve got a couple of key themes. Obviously, it’s the week before the Fed and we’ve had a really good week in markets. So one of our key themes is our market is too good for the Fed. Second I think Tracy is going to talk about crack spreads and Freeport and what’s happening there. And then we’re going to look at the risk with Ukraine’s new hardware. There’s been a lot of talk about tanks going to Ukraine this week, so we’re going to talk about some geopolitical risks with Albert.

Learn more about CI Futures tiered pricing here.

So Jim, first, thanks again for joining us and watching some of your comments through the week with markets breaking through some of the key levels that you were looking at, the Fed’s direction is obviously a big factor in markets and there’s a lot of conjecture around CPI, layoffs, rates going lower or pause or pivot or whatever you want to call it, and people saying the Fed may do 25 and then pause.

What’s your view on that? You’ve been obviously speaking about this several times this week. So I’m curious, what’s your view after seeing a whole week, where do you think we go from here?

Jim

Well, I’ve been somewhat more of a bull, I think, than most over the last few months. And I’m not trying to take a victory lap or anything, it’s just a fact. And my reasoning was that every one of us knows that these Fed rate hikes have a huge lag period before we feel the efficacy. Fed knows that too. As stupid as the Fed is, this is something that’s so fundamental, but I think they genuinely do know that. So now we’re starting to see things happen. We saw a pretty good PCE report today. CPI has been trending lower too. The only things in CPI that are stubbornly high, consistently, are food and energy, which are the two things that are least rate sensitive. The yield curve is still wildly inverted, signaling to them that they still are in a financially tight market. I believe that the Fed is getting close to having some sort of gentler language. Now, whether they go 25 basis points this time and then 25 basis points again, that’s fine to me. Now, the one thing I do have a problem with is that the Fed Funds futures curve says 50 basis points over the next two meetings.

And then toward the end of ’23, there’s going to be an ease. But they say it’s only going to be a quarter, two and a half point ease. And that I say “no way.” If they’re ever going to actually pivot and start easing, it’s only going to be as if something is burning and something is falling down and then it’s not going to be a quarter point ease. That being said, I still like risk assets. And I have because I think we are nearing the end of the Fed tightening cycle. I believed, I’ve been doing my podcast for the last hour. I wanted the market to settle above 4070. It certainly did, right? We went into the closed pretty strong, I thought. And I think that that green lights the next move higher. I particularly like the metals market, and I’ll shut up in 1 second, I swear to God. I particularly like the metals market because I think that… I don’t mean to talk for so long. I thought copper was being held down by China news, by the Fed, by the strength of the dollar, and all those things have seemed disappeared. And I’ve made good money on that so far, and I plan on keeping those lumps.

Tony

So it’s a good question about metals. What are you looking at? You said China and you said China reopening other things. What are you looking at in metals? Are you looking at industrial metals, copper and so on? Are you looking at precious metals or kind of all of the above?

Jim

Copper is number one and that’s my biggest position. Silver and then go down from base industrial all the way to just gold being pressured. And the gold thesis for me is different than the copper one in that I believed at the time when I started buying more gold, that Bitcoin and Etherium in the crypto market and all that dollar safety hedge or whatever the hell it is, if that was disappearing, then money would go back into gold. Well, that didn’t disappear. Bitcoin is butting up against new cycle highs now, but gold is still doing well. So in that I was kind of wrong on the thesis. The thesis was also the dollar weakening, which happened as well. Once the Pound of the Euro started really bouncing off those October lows, I thought, okay, the green light is on for all these metals. So I’ve done okay in gold, even though my thesis about crypto was wrong.

Tony

Okay, but was your thesis wrong? Do you see crypto and gold as substitutional somewhat at the margin still?

Jim

I don’t know. I was going to ask you that same question. I always did. And I thought that the $3 trillion crypto market was sucking away some of the gold. And I thought that that was a big deal. But then it doesn’t seem to be now, so I guess I can’t answer that. I’m confused, I guess.

Tony

Yeah. I’m curious. What do you think about that, Tracy, in terms of crypto and gold? Do you think there’s a trade off there?

Tracy

This is not really my… Crypto market, is not really my market.

Tony

Internet, say whatever you want.

Tracy

Albert knows way more about this than I do, to be honest, because I’ve never traded crypto, and he’s traded a lot in the past. So I’m going to defer this to Albert.

Albert

Before I do think that there was a correlation between how much money was flying into crypto versus taken away from gold, I think there is no doubt that gold suffered because of that. I don’t think that as the case right now, simply because there’s been too many blow ups in the crypto world at the moment. I don’t really know how liquid it really is. There’s certainly no retail left in the crypto market, so it looks like it’s all institutional. So I don’t know. You can’t really make a fundamental call on crypto at the moment.

Tony

Could you ever make a fundamental call on crypto?

Albert

You could at some point, because institutional money was flying in there because their clients were forcing them to get into the space. So you could make a little bit of a fundamental case for crypto, but as all these ponzi schemes blew up, like FTX and everything, that’s just gone completely out the window at the moment.

Jim

Sure, Tony, I can make a slight fundamental argument of it. When they were adding an additional $7 trillion, throwing it into the money supply, and really being poor stewards of the dollar, that was somewhat of a fundamental argument for crypto, I guess, right?

Tony

Yeah. Okay. Are markets too good for the Fed. As we’re going into next week, are these levels too good for the fed? Is Powell going to come out and really, you know, say, look, this is irrational or whatever, and it’s too much, and is he going to pour out, say, 50 basis points and disappoint a lot of people?

Jim

Just to punish me a rug pull? I mean, I think he’s capable of that. He certainly did at the Jackson Hole meeting a while back. So you have identified, I think, the major risk, and it’ll probably go into that somewhat hedged. And again, hedging is probably going to be expensive going into it because people realize that that’s where the risk is. So on balance, I will say, no, I don’t believe he is. I think he believes that going too far this way. And again, I think he thinks going not far enough in this direction is the worst possible thing. But I also think he’s starting to realize going too far and what that looks like. He sits around and talks about creating slack in the job market, and to him, it’s just an equation on a whiteboard where the reality is talking about people losing their jobs. I think he balances a lot of realities. I think he’s incompetent. His entire tenure has been mostly incompetent, but I think he’s done a pretty good job trying to clean up the mess that he made over the last year and a half, and I don’t think he’s going to do something stupid like that. But, yes, to your point, it is a risk.

Albert

I actually disagree with Jim on this.

I think it’s going to really matter about what the market does. If we start flying into the 4200 before Tuesday on the SPX and whatnot. I think that Powell will come out. I don’t know if he’ll do 50. I don’t think he’ll do 50, but he might come out with a 25 basis point rate hike and then start talking extremely hawkish and dismiss all the rate cuts that everybody’s been talking about, which would be essentially the same thing as doing 50 to the market. If the market says that. If the market here is that we’re not getting rate cuts till 2024, I don’t see that as positive whatsoever.

Jim

I certainly hope you’re right in the near term, too, because I’m short some of those 4200 calls, like, too many. That’s the position I keep checking in my bold position was like, oh, sh*t, they’re getting too expensive. So I actually like what you’re saying a little bit in the short term.

Albert

Yeah, I have a problem because of this is falling liquidity right now and tightness at the same time. I look at the market and I’m like, well, money is starting to fly out into Asia, which we talked about Tony, repetitively for months now. Where are we going to get that $5 trillion incremental money coming into the market to keep this thing afloat? For me, it’s like I don’t see the math adding up to 4300 on the S&P and anytime soon. And on top of that, if you calculate rate hikes and everything you’re looking at the market, 4150 or 4200 is more expensive than 4800 was. It’s technically even higher valuation. So for these things, I’m just like I think we’re probably going to retrace the 3850 on some kind of ridiculous Powell talk. And on top of that, Brainard is talking about leaving. She’s not leaving if Powell is talking about being dovish. She wouldn’t be doing that, in my opinion.

Tracy

I asked a question. I was just saying and that’s for both of you. I mean, considering that the Fed has hiked so quickly, do we even think, and the data has remained pretty good, considering right, so do we think that the rate hikes have actually even been able to filter down into the economy at?

Jim

I don’t, Tracy. I think that that’s the point. I think when you look, just take the real estate market. How in the world is it not going to be a major hurdle for the real estate market to take mortgage rates from 2.8% to 7%? I think that it’s silly to think that if they just left things the way it is, I believe that we would certainly go in recession at some point in time with money being restrictive as it is compared to… I’ve argued for 30 years that rates had to be inorganically low to make up for the fact that we have all these crappy regulations and punitive taxes on companies. They need low rates to function. I think rates are to point now where eventually they would drag on us too much. Albert, do you agree with that?

Albert

I do. But the flip side of that is, like, if Powell doesn’t stay the course, Yellen is using the TGA, in my opinion, from what I heard, to offset quantitative tightening. This could set off another round of inflation if China comes on too fast, or even Europe starts to gear up a little bit and reset their manufacturing sectors with stimulus. The fear I have is a second half inflationary run again, and then we’re going to be talking no more pauses, but another round of 50-75 basis point rate hikes.

Tony

Second half of Q2. I don’t think it’s a second half inflation run. I think it’s Q2. I think it happens a little bit sooner than that.

Albert

Yeah, it could. I mean, you could have any kind of geopolitical event like Russia re-invading Ukraine with some gusto this time.

Tony

Okay, guys, here’s my question, though. We’re talking all this potential dovishness, but all we’ve seen is the rate of inflation slow. We haven’t seen prices come down. Okay, so why would he go to zero? Or why would he just do 25? I’m not seeing it. When you look at the job market, sure, you’ve lost 70,000 tech jobs, but they hired 2 million since 2020 or something like that, right? So it’s nothing. It’s dropping the bucket.

Tracy

Chipotle hiring 15,000 so those people can get a job.

Tony

Exactly. What is it that would tell us that he’s going to go 25 or pivot or whatever? I’m just not seeing that thing because the job market is still really strong.

Jim

So here’s what I would say to that, is that the job market is going to be strong and tighten. It’s a weird kind of anomaly that happened with 3 million boomers leaving the job market prematurely over the last three years. To your point about why would he not stay the course if prices aren’t coming down? Because, remember, ultimately, the end of the day, the inflation was intentional and it was done because of this wild indebtedness all over the board. But I always focus on the five states that could not possibly have paid their bills under any possible scenario. And that’s why for ten years, they kept telling us that they needed inflation. So I think in Powell’s mind, he tells us 2%. I think he’d be perfectly happy with three and a half.

Albert

And they’ll get three and a half because they’re starting to change the way CPI has waited starting 2023.

Jim

Just like when Nixon changed the definition of unemployment back in the 70s.

Albert

The BLS have done that in the past. They changed the way unemployment is calculated. Now they changed the way the CPI is calculated.

Tracy

They changed the way inflation is calculated.

Albert

Perception is reality in the market. We can sit there and b*tch about fake data from China and fake data from the Europe and the US. But perception is reality in the markets.

Tony

Yes. So we’re going to change the rules to win.

Albert

Well, yeah, of course.

Tony

And the CPAC calculation changes this month, right?

Albert

Yeah, January 2023.

Tony

Fantastic. Okay, so you guys are in the 25 basis point camp for next week, right? 25 and very hawkish. 25 and very hawkish.

Jim

Okay, I don’t I like what Albert saying. I say 25 and mildly hawkish.

Tony

All right, we’ll see. I think it might be a little harder than that. So we’ll see. That’s good, though. I appreciate that.

Tony

Okay, Tracy, I want to talk a little bit about refineries and crack spread. You sent out a tweet on Monday about diesel prices.

Can you help us, help us understand what’s happening at refineries and what’s happening with diesel and gasoline and other refined products prices?

Tracy

Well, this is actually the perfect segue because I tweeted out a chart of ULSD, which is diesel, basically. And so we’re seeing those refinery margins explode again. And most people say, well, that’s anticipation of the diesel embargo in Russia and refineries across the world that are not part of Russia are seeing these increases. But that’s not just happening in the diesel market, that’s also happening in gasoline cracks. And so higher refining, basically the long and short, higher refining margins mean higher prices for consumers. Right. So Tuesday we just hit a three month high of $42. And when oil was at its highest price, those crack spreads were at $60. So this should start ringing alarm bells a little bit about inflation. This is why it kind of correlates to what we were just talking about. And so CBs, even though they don’t count energy in the CPI as part of inflation, they should be keeping an eye on these indicators because it kind of indicates that we’re going to see higher gasoline, diesel costs, jet fuel, et cetera. And that could add to inflationary pressures across the board, not only for just the consumer, you and I, but for companies that are heavily dependent on these products.

Tony

And when there’s inflation in energy, there’s inflation in everything.

Tracy

Right, right.

Tony

Second or two tier impacts.

Tracy

Exactly, yeah.

Albert

One of my oil friends was telling me that normally January, February, they’re running at minimum rates, trying not to lose money. But this has been like absolutely insane, where they’re just making money hand over fist right now because the demand is so high.

Jim

Tracy, I have a quick question for tracy, by the way. Is that okay?

Tony

Yes.

Jim

So, Tracy, just last week, I don’t know if it was Chevron or Conical Phillips, where they announced raising the dividend or whatever, paying bonuses and not investing in it. Was that an indication that they still feel that the government is not smiling upon fossil fuel companies expanding their operation?

Tracy

Oh, 100%. Right. For over a year now, we’ve seen elevated energy prices in that seventy dollars to eighty dollars range. Negating, the spikes that we saw from the Ukraine invasion. But so after a year of pretty much stable higher energy prices, we are still not seeing anybody want to invest in this sector. Right. They still want to cater to the investor. They still want to pay down debts. They still want to do higher dividends. They still want to engage in stock buybacks. All to placate the investor. And so that is very telling that after a year, they’re still not willing to reinvest into capex, particularly in shale.

Tony

It’s nothing but downside to invest, right?

Jim

No doubt.

Tracy

Yeah, absolutely.

Jim

It’s maddening when you think about it. Everything seems like it’s such a self inflicted wound. And this is the kind of thing that keeps me up at night. It seems like a government that’s working against us. And I’m not trying to be that guy. I’m not political. I just see policies and they’re asinine.

Tracy

Who wants to invest when they say, we want to phase you out, we want to kill you?

Jim

Right? Yeah.

Albert

Well, this is the problem when politics gets mixed up in economic policy, it starts muddying things up and mistakes become exponential at this point.

Tony

But politics is always mixed up in economic policy everywhere. You know that. I’m not telling you you don’t know, but it’s always there. When I hear you talk about refineries, and it’s been how many decades since we built refineries in the US, Tracy? The 70s was the last time we built refinery?

Tracy

70s was the last major. We’ve had a lot of brown projects, which means we’ve added refinery capacity to already existing refineries, but we haven’t had any new green projects, which means building new refineries. And we were talking about, I think, last week or the week before the expansion that we’re having in Texas. But the problem is that the amount of refining that is coming offline is more than the refining capacity that is coming online.

Tony

Right. So what’s our capacity utilization right now in refineries?

Tracy

Well, we’re down right now because we’re in the middle of maintenance. And we also had Elliot storm, which some refineries, for instance, Baytown, is just coming back up this week from the storm in December. So utilization rates right now at about 89.5%. But, you know, you have to realize that, you know, we’ve been over, well over 90%.

Tony

Yeah, 94 or something like that. Right?

Tracy

Yeah. And we have aging refineries. And so what does that mean? Those refineries are more prone to breakdown because we’re running them at, like, ridiculous max capacity. Right, exactly.

Tony

Okay, so since you mentioned Texas, let’s look at this tweet that you put out a couple of days ago saying that Freeport gets approval.

So USLNG, the Freeport terminal has been approved and reopened. So can you talk us through what that means for European nat gas and what that means for US nat gas prices?

Tracy

Well, for US natural prices, that is positive. And I know that all nat gas prices have tumbled 35% to 45%. Regardless, we’re back into that two area that is pretty much where we’ve been for several years. But it is a good thing. I think the market, I think, spiked 15% or 15% $0.15 sorry, on that move. And they kind of retraced it. I think the market is a very Freeport is an export place. So what that means is that if Freeport being closed basically landlocks US nat gas, which is obviously a negative because we have a lot of it. But I think that the market in general is a little bit skeptical. But as soon as we actually start seeing export capacity increase from that facility, then I think that the markets will be more enthusiastic about the success of that because it’s really been since August since that facility is shut down.

Tony

So you’re saying we should see US nat gas prices rise as we have more export volumes from Freeport?

Tracy

Absolutely. And even this week, Semper Energy announced that their new Port Arthur facility has already been booked. And that facility isn’t even all the way built yet. And that’s another export facility. So there’s a lot coming online and a lot being built out that we will be able to see. I think that just market participants have become a little bit placated because they look at European stocks and European stocks, of course they’re still full. They’ve had a mild winter, but everybody kind of forgets that last year 50% of their storage capacity came from cheap Russian pipeline. And that’s not going to happen this year.

Tony

Yeah. So all of those new roads that are being built in Texas, it may have been started with other money, but it’s going to be finished with European money. Right. So I just want to take this moment to thank our European friends for finishing our transportation.

Albert

About time they give back.

Tony

That’s right.

Jim

Finally, their currency has come back a little bit, so now they can actually buy stuff here.

Tony

Perfect. Okay, very good, Tracy. Anything else on nat gas? Are you still keeping eye on fertilizer for kind of late spring time period?

Tracy

Yes, absolutely. I think that’ll still come into play. I mean, nat gas prices are extremely low right now, which is great news for fertilizer prices. That will give farmers a break. This is all good news in that respect, but I still think we need to keep an eye on this going forward and keep an eye on that gas prices because obviously that’s going to affect fertilizer prices and farming in general.

Tony

Jim?

Jim

Tracy, you talked about diesel before, and I don’t trade diesel. Is the spread between diesel and regular WTI still blown out? And what could possibly get diesel back in line?

Tracy

Well, I think that there’s been a shortage for a very long time. That spreads come in a lot, comparatively speaking. But now it’s starting to blow out again because again, you have the EU embargo of diesel, and they got literally like 95% of their diesel came from Russia. Another dependent project. And I’m sure Russian diesel will go somewhere else. It’s not more about that, but it’s more about really boils down to refining capacity as well. Because even in the United States, we can’t refine. If Europe wants to buy from us, we can’t even refine enough. We’re sending what we have over there as well as our domestic needs. So really, diesel to me comes down to refining capacity altogether.

Jim

That’s an unfixable problem, right?

Tony

Until Russia’s solved, right?

Albert

What about the Jones Act waivers for sending diesel up to these coast cheaper?

Tracy

Yes, they could do that, but they haven’t done that. They’ve done that in the past for Puerto Rico after the hurricane and all of that, but they still haven’t given waivers. Even when prices were extremely high in the United States, when we were at the height back in June, July, when prices, gas prices were highest, diesel prices were highest, they still wouldn’t give Jones Act waivers. You have to understand that the Jones Act came into play into 1920 when we had a fleet of over 1000 vessels, and we now have under 100 vessels that can transport that. So, you know, it’s the government could do it. They’ve chosen not to. Why? I’m not sure, but…

Jim

We can come up with some guesses. They’re either stupid or they’re nefarious. I believe at some point in time you’re going to have to say some of it’s nefarious, where they keep making the wrong decision at every turn. And I apologize for that.

Tony

No, don’t apologize. Look, it’s making it more expensive for people on the East Coast to get diesel. It’s not good.

Tony

Okay, great. Speaking of Russia, Albert, we saw a lot of news over last week about tanks going to Ukraine. And there’s a tweet from Max Abrams, who’s a great geopolitical professor talking about  Russia, says that tanks from the west count as, quote, “direct involvement in the war”.

So I wanted to get your… Jim said what would solve the diesel problem. Obviously, Russia coming back into the market would solve the diesel problem. Now with a lot of Western countries sending tanks to Ukraine, that doesn’t sound like we’re coming closer to a solution on that. So first of all, why are they sending them if they don’t have the people to operate them? Second, tanks are to take land. Right? So what do you think is being planned? And third, how risky is it? Do you think it really implicates these kind of donor countries as direct participants in the war?

Albert

I don’t really buy into the whole direct participants of the war. The rhetoric coming out of Russia is a little bit bombastic in that respect. Referring to those tanks, there’s only going to be about 100 of them, right? They’re not going to be able to push out the Russians with those tanks. On top of that, they’re going to be about six months out until they’re actually even deliver, and then you still have to train these guys and they need supplies, and the Ukrainians don’t really have all that. So the best guess that I have is that they’re forcing Russia to come into a ceasefire in about six to eight months time, which gives them a window now to try to take Dambus and have some kind of wind before these tanks get delivered. Listen, they’re no joke. The Leopard tanks and the Abrams are better than what the Russians have. But in terms of the Ukrainians using them to push Russians out of all Ukrainian territories, that’s just not happening.

Tony

Right. So are these just old tanks or is it a quality kit that they’re getting?

Albert

Well, I think they’re getting like the second tier tanks of what the west has, but that’s still better than what the Russians have or even willing to use for Ukraine. So, like I said, this is more of a measure to force the ceasefire later on in the year.

Tony

Okay. Yeah, Jim?

Jim

Albert, a couple of days ago, when this escalation started in Germany, we announced I immediately put on my screens, looked at oil, wheat, even the defense sector ETF, and nothing really budged. Do you think the market was looking at it like it wasn’t a big deal? Or do you think the market was looking at it as somewhat balanced, perhaps a quicker end of the war and not an escalation, or perhaps an escalation, the two things come around?

Albert

Oh, man, that’s a good one, Jim. I honestly think that the market’s probably in a wait and see position at the moment.

Jim

Numb to the shit kind of. Right?

Albert

Yeah. You got to wait and see what Moscow is going to do. I certainly think they’re going to use wheat and grains and other grains asymmetrical responses to the west to push inflation out over there, make it hurt. That’s the only thing they have. They don’t really have anything else to go after. I mean, the oil that they’re selling to India and China is enough to sustain their pocketbooks for a little while until this gets sorted out. But until there’s some sort of major upheaval in Ukraine, I don’t think the defense stocks will take off or wheat yet. But they will. I think they will. They haven’t moved.

Tony

The defense stocks haven’t moved for a while. If it is we and other AG stuff that is going to be their lever, that probably means the Turks will get more involved in the discussion because they’re the ones who arbitrated the discussion earlier. Is that right?

Albert

Well, they’re trying to get into the discussion. I actually have really good connections with the Turks and their main thing is to distract the West and the Russians into Ukraine while they push their trade deals out into Africa at the moment. You know, the Turks have a great drone, the TB Two, which they sell to pretty much everybody. So that’s as far as they’ll actually get into the war besides making media comments.

Tony

Right, okay. And so what risk do you think there is on wheat? Do you think we see more wheat risks, say, in Q2 – Q3 this year?

Albert

I absolutely do. The Ukrainians, they’re planting a lot less. I think 40% less is what they’re reporting, is probably even more than that.

Tony

Right.

Albert

And on top of that, if the Russians decide to blow up a port or blow up a few ships that are trying to get out with wheat, and all of a sudden, wheat, you know, takes off back to the 900 or $1,000 mark again. So I definitely see that happening in Q2 Q3.

Tony

Okay. That could be exciting. All right, guys, let’s close it up. We’re in that quiet period for the Fed. We have that Fed discussion next week. So what are you keeping an eye on next week aside from the Fed, of course, but what are you keeping an eye on in markets? Tracy, why don’t you get us started.

Tracy

Well, I know that most people are looking forward to OPEC is next week at the beginning of February. My personal stance on that is that I think they will keep everything as is. Right. They made that 2 million cut, even though it’s technically not 2 million, because they were under quota anyway. They said they were going to carry that through 2023 unless something came up that they really needed to address. And I just don’t see anything coming. I don’t see any reason they would need to change this policy stance right now. We have Russian barrels still on the market. We have China is still kind of an unknown because they haven’t really opened up yet. So that’s what I’m looking forward to, or at least that’s what my feeling is about the data.

Tony

Great. Okay. Albert, what are you looking at next week?

Albert

Well, obviously the Fed. I think, is in order with a hawkish tone, but honestly, I want to see how the dollar reacts to all this. And the VIX. The VIX at 17, start looking at some good old put options and call options with the 17 VIX is fantastic. But, yeah, basically what the dollar is going to do. I really want to see if the dollar breaks into the 90s with some kind of bull market talk.

Tony

Excellent. Okay. And Jim. Wrap us up. What are you looking at?

Jim

The unemployment numbers on Friday. Big deal. The last shooter drop is going to be the slack in the labor market that they want. Albert mentioned that level on the dollar. I call it like 101 to 100. As soon as it goes below that, as soon as we get a nine handle on the dollar, I think it greenlights a lot of risk assets. But the thing I’m mostly focused on is unemployment and then the week after that my trip to South Florida. Because every time I leave these damn markets, something crazy happened. So you guys can count on that. I’ll tell you when I’m on my flight. Something weird is going to happen.

Tony

When is that?

Jim

I don’t know. My wife makes the arrangements. I think it’s the next, like a week from next Thursday. I think we’re going on vacation.

Tony

Keep an eye on. Jim, thanks so much for joining us, Jim. Guys, this has been great. Thanks very much everyone have a great weekend. Thanks Jim.

Jim

Thank you guys. Yeah, let’s see you guys.

Categories
Week Ahead

Fed “moderation”, windfall OAG taxes in UK, and building an exchange: The Week Ahead – 5 Dec 2022

Explore your CI Futures options: http://completeintel.com/inflationbuster

On Wednesday, Jay Powell talked and said “The time for moderating the pace of rate increases may come as soon as the December meeting.” The JOLTs data that came from Wednesday showed a slowing in job openings and the employment data from Friday was still strong but moderated a bit. With China announcing some changes to lockdowns, how worried should we be about commodity prices, given the “moderating” Fed? Albert Marko leads the discussion on this.

We also saw the UK announce windfall oil & gas taxes last week. We’ve seen a slew of announcements to halt investment. This is something that Tracy called out well before the windfall tax was announced. What will the impact be and how did the UK government think this would go over? Tracy explains this in more detail.

Given the LME nickel issues, FTX, etc., credibility is a concern at times. Why do these systems fail? What should people who trade know about exchanges that nobody tells them? Josh shares his expertise on what it’s like to build an exchange.

Key themes:
1. Fed “moderating the pace…”
2. Windfall oil and gas taxes in the UK
3. What’s it like to build an exchange?

This is the 44th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Albert: https://twitter.com/amlivemon
Josh: https://twitter.com/JoshCrumb
Tracy: https://twitter.com/chigrl

Transcript

Tony

Hi, everyone, and welcome to the Week ahead. My name is Tony Nash. Today we are joined by Josh Crumb. Josh is the CEO of Abaxx Technologies, a former Goldman Sachs, and just a really smart guy who I’ve watched on Twitter for probably eight years. We’re also joined by Tracy Shuchart, of course, and Albert Marko. So thank you guys so much for joining. I really appreciate your time this week.

We’ve got a few key themes to go through. The first is the Fed talking about, “moderating the pace.” We’ll get into that a little bit. Albert will lead on that. Then we’ll get into windfall taxes, windfall oil and gas taxes in the UK. And finally, we’ll look at exchanges. Josh’s started an exchange. I’m interested in that, but I’m also interested in that within the context of, say, the LME and other things that have happened.

So, again, really looking forward to this discussion, guys.

Albert, this week on Wednesday, Chair Powell spoke and he talked about moderating, the pace of rate rises. He said the time for moderating the pace of rate increases may come as soon as the December meeting. Of course, it’s a conditional statement, right?

But with China announcing some of the changes and lockdowns with things like the jobs number out today, I’m really curious about your thoughts on that moderation. So if we look at the Jolts numbers, the job openings numbers from Wednesday we showed that really come off the highs, which is good. It’s moving in the direction the Fed wants.

If we look at the employment data out today, again, it shows a little bit of moderation, but it’s still relatively strong.

So what does all of this mean in the context of what Chair Powell was talking about Wednesday?

Albert

Well, I mean, the Federal Reserve and the Treasury have been really precise in the wording of using soft landing over and over and over again. And let’s make no, let’s not have some kind of like, a fantasy where they don’t see the data a week ahead of time. And all the words and all the phrases and whatever they leak out to the media, like the Wall Street Journal are tailored to try to get a soft landing.

Powell knew what these job numbers were. So for him to come out uber hawkish, which he has to do because the economy is still red hot at the moment, if he came out uber hawkish Wednesday and knowing what these job numbers are and knowing what the CPI is possibly going to be next week, we’d be sitting there at 3800 or 3700. And they don’t want a catastrophic crash, specifically before Christmas. And also the mutual funds and ETFs and rebalancing of this past week.

So from my perspective, they’re going to keep the soft landing ideology. The only thing that could throw in a wrench to this whole thing is retail sales. And if I think the retail sales start becoming hotter than they really want to see then obviously 75 basis points and maybe even 100 is on the docket for the next two months.

Tony

For the next two months? So 50 December, 50 Jan?

Albert

That’s the game plan at the moment, 50-50. If CPI or retail sales start getting a little bit out of hand, they might have to do 75 and 50 or 75 and 25. But again, this is all like all these leaks to the media about softening or slowing down the pace. It’s just another way for them to “do the pivot talk” and try to rally the markets again. So that’s all it is.

Tony

Okay, Josh, what are you seeing? What’s your point of view on this?

Josh

Yeah, so I’m probably not in the market day to day the same as the rest of you from a trading perspective. We’re obviously looking very closely at commodity markets and the interplay between particularly what’s going on in Europe and how that affects energy markets, which I know Tracy and yourself have spoken a lot about.

Yeah, look, I think the last OPEC meeting, I think the Saudis in particular caught a lot of flack for the supply cuts. But now, looking in hindsight, I think they were exactly right. And so I think there really is a softness, particularly that part of the crude markets and of course, in a very different situation downstream in refining. I think that it would be consistent with a softening economy. But I agree with Albert that the Fed, I think, can’t really afford to change their stance, even though even today’s employment report was a very, very sort of lagging indicator, late-cycle indicator.

So I feel, personally, particularly just coming back from Europe, that we’re really already in recession and I think that’s going to be more obvious next year. But I don’t think they can really change their tune for the reasons that Albert laid out.

Tony

Tracy, we had a revision to Q3 GDP this week, and I was looking at those numbers, and exports were a big contributor to that. And crude was a huge portion of those exports in a revision of Q3 to GDP, it was revised up slightly, I think, to 2.9% or something. Now, a large portion of those exports are SPR, and that SPR release is contributing to, say, lower oil prices and lower gasoline prices here in the US, right?

So SPR release theoretically stops this month in December, right? So it tells me that we’re not going to be able to have crude exports that are that large of a contributor to GDP expansion. First. It also tells me that we’ll likely see crude and gasoline prices rise on the back of that if OPEC holds their output or even slightly tightens it. Is that fair to say?

Tracy

Yeah, absolutely. I mean, I think that everybody’s pretty much looking at they’re going to hold a stance. I mean, they’ve already said this over and over again over the last month. After that Wall Street Journal article came out and said they were thinking about increasing production for the bank. You had all of them come back and say, “no, we’ve had, this is what we have in play to the end of 2023. We can change this, obviously, with an emergency meeting, et cetera, et cetera.” But I think at this meeting, I think they’re probably going to be on a wait and see, or, again, like you said, slight and tightening. Maybe $500.

Tony

I stole that idea from you, by the way.

Tracy

Maybe $500,000. It really depends on what they’re looking forward to, is what they have to contend with right now is the oil embargo in Russia on December 5, and then the product embargo comes in on February 2023. For the EU, also, everything is a lot. It’s predicated on China coming back because that’s another 700 to 800,000 barrels per day in demand that could possibly come back. But I think we all agree, as we’ve talked about many times before, that’s probably not until after Chinese New Year, which would be, you know, March, April.

But those are all the things, along with the slowdown, with all the yield curve inversions, not only here, but also in Europe, everybody’s expecting this huge recession coming on. And so that also has a lot to do with sort of sentiment in the crude market. And we’ve seen this in open interest because what we’ve seen in looking at COT (Commitment of Traders), CFTC data, is that we’ve had a lot of longs liquidating, but we haven’t really seen shorts initiating. It’s really just trying to get out of this market. And so that’s what the current futures market is kind of struggling with right now.

Tony

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Okay, so you mentioned the China issue, and earlier this week we did a special kind of show on what will likely happen in China. Albert was a part of that. We had two journalists as a part of that, long-standing China journalist as a part of that. So we’ll put a link to that in this show. But if China opens at an accelerated pace, Albert, we all expect that to impact inflation, right? And we all expect that to impact crude prices.

Tracy

Not any prices across the board, actually, you’re going to be in especially industrial metal.

Tony

Exactly. So how much of Powell’s kind of “moderation” is predicated upon China staying closed through, say, Feb-March?

Albert

Oh, it’s all of it right now. All of its predicated on it. I mean, right now they’re under the impression that China won’t open until April. But I push back on that, and I think at this point, they might even announce an opening in February. Once they announce it, the market looks ahead for three to six months. So things will start taking off at that point.

I do have a question for Tracy, though, for the Russian price cap, right? I know you know the answer, Tracy, but a lot of followers of mine have always asked me about this in DMs is like, why does it make the price of oil go up? Because from my understanding, is because it limits the supply globally. And then as demand comes back, the supply sector actually shrinks. And I wonder what your opinion was on that.

Tracy

Yeah, absolutely. I mean, I think what you’re going to see with the price cap is that people are going to in Russia already said we’re not going to sell to people that adhere to the oil price cap. Now, again, if it ends up being $60, that’s not really under what they’re selling it for currently at the current discount to Brent. So that’s not that big of a deal. If it’s lower than that, then obviously, yes, that will make a big deal. But they also said that if we have an oil price cap, then we’re going to stop producing, right? Not entirely, but they’ll curb back production, which will in turn make oil prices higher globally, even if that price cap in place. And so that’s kind of their hit back.

But that said, again, I don’t think as much oil is going to be taken off the market with a price cap, particularly at $60. And Russia has already figured out a way around secondary sanctions, obviously, in June as far as shipping, insurance, and certification is concerned. And you have to think, realistically speaking, you’re going to have a lot of shippers, especially Greek shippers, that this is their major business that is going to say, yes, we’re shipping this oil at the “price cap.”

Right. So you just have to keep in mind the games that are played in the industry. But, yeah, some oil will definitely be taken off the market. And Russia also could decide to pull back on production in order to hurt the west to make oil prices rise in the west.

Tony

Europeans love to violate their own sanctions anyway, right? They’ll just buy through India or something, right? And they’ll know full well that it’s coming forward.

Tracy

They’re buying Russian LNG. It’s not piped in right now. Right, but they’re still buying LNG. They’re having it shifting, and they’re paying massively.

Tony

Let’s turn off the pipeline and raise prices on ourselves. Okay.

Albert

They learned from Bible in the keystone, right?

Josh

Maybe I’ll add one more perspective here. You have to remember that oil is Russia’s economic lever and gas is their political lever. And so I actually believe that Russia is actually trying to maximize, we haven’t lost a lot of Russian barrels since the beginning in March, but I think they’re actually trying to maximize revenues right now because not that I want this to happen, but I could see much more extreme gas measures coming from Russia through perhaps some of the gas that’s still coming through the Ukraine as soon as January. You know they want to maximize those political levers, and they’ve already been sort of playing every game they can to contractually even break contracts and minimize gas even since end of last year. So, again, oil is the… They’re always going to want to maximize their oil exports for revenue and maximize their political power with gas.

Albert

Yeah, they do that often, especially in North Africa, where they try to limit the gas that comes in there using Wagner and whatever little pressure they can to stop it. They’ve done that so many times.

Tony

Great. Okay, let’s move on from this and let’s move on to the windfall oil and gas taxes in the UK, Tracy. We saw the UK announced this last week or two weeks ago.

Tracy

November 17, they announced the increase. Yeah.

Tony

Okay, so we’ve seen a slew of announcements, and I’ve got on screen one of your Tweet threads about Shell pulling out their energy investment and Ecuador doing the same and Total doing the same.

So can you talk us through kind of your current thinking on this and what the impact will be? And how on earth did the UK think this would go over well?

Tracy

Well, I mean, that is a very good question. How did they think this would possibly go? I mean, we know that if you’re going to place the windfall tax, they raised it from 25% to 35%, which is very large. And that’s in addition to the taxes that companies are already paying, which in that particular country is some of the highest in the world. Right. And so this is just an added on. So, of course, you have Shell and Ecuador now rethinking what they’re going to do with huge projects going on there. And Total literally just said, we’re cutting investment by 25% entirely in that country.

And so what happens is what’s interesting is that this whole thing occurred after COP27. And what we saw is kind of a change in the language at COP27, where countries were more interested in energy security rather than green energy. Of course, that was part of the discussion, but we did see sort of a language change and people start worrying about countries start worrying about energy security, which makes sense after the Russian invasion of Ukraine and everything that has happened.

So for the UK to kind of do this on the back of that without realizing the implications of what’s going to happen. What’s going to happen is that they’re going to see less investment. Obviously, we already have majors coming out saying we’re just not going to invest here. Right. And that’s going to raise prices in particular for electricity in that country. We’re not just talking about oil and gas, but everything attached to oil and gas, you know, the secondary and tertiary things that are attached to oil prices and gas prices within that country. And so that, you know, that’s going to keep inflation high in their country and, you know, and it’s a very dangerous territory if you’re talking about energy security. Right.

Because UK is an island and they have assets right there. So everything else that they cannot produce there, they have to import. And that’s not cheap either. So you have to think about that. And this all comes at a time where Capex is already dangerously low since 2014 in this particular industry. So it seems like it’s self inflicted harm not only on the citizens that are going to have to pay for this via inflation higher, right. But also their energy security is compromised. Yeah.

Tony

I love the irony of a French company telling the British that they’re taxed are too high.

Albert

Yeah, it’s actually amazing because, like, the Swiss today has stalled all electric vehicles from being registered or imported to secure their grid from blackouts.

Tony

Wow.

Albert

Yeah, that was just maybe like an hour or two ago.

Tracy

And they said that they’re prepared to have like a four tier energy system and basically if you have on your third tier, they’re cutting you off of like you can’t charge a car in third tier.

Albert

Like Tracy was saying, nobody thinks about the second and third order of things, like the electrical grid going out and industrial sector having to buy diesel generators so the power doesn’t fluctuate and ruin their machinery. Nobody thinks about these things, they only think about the marketing material out of Tesla.

Tracy

Right.

Josh

Probably maybe add one more lens to look at this through. And that’s the geopolitical and political lens. I think we’ve had enough three decades of sort of Laissez-faire economics that any politician knows the effects of announcement like that. So I don’t think this was a naive approach, particularly as Tracy mentioned, that this was coming on the back of COP.

I think this was something to sort of give to a sort of a populist base around inflation and we’re going to go after big energy. But at the end of the day, I totally agree with Tracy that everything’s pivoted to energy security and almost wartime footing. And so I think we’re not used to looking at policy announcements or sort of economic policy announcements in that lens the last 30 years. But increasingly we’re going to have to look at all of this through almost a wartime footing way of thinking. So what are they likely doing there? In my view, again, I think they’re kind of giving a, you know, buying some goodwill on the populist front and maybe environmental front while at the same time realizing that they’re going to start having to maneuver all they can to secure hydrocarbon supply. So that’s the way I might read something like that.

Albert

Yeah, I could have said it better myself. Josh I mean, the thing I try to stress to people when you’re looking at foreign affairs and foreign politics is you need to see what’s happening domestically in the country first because that’s what writes the script for what their international needs are.

Tony

And it’s interesting that you both say that populism drove this, it seems in the UK, although it’s impacting the electricity prices, we see populist movements in China, we see it in Pakistan, here in the US. I think a lot of people thought populism died when Trump lost in 2020 and it’s just not true. There is just so much of a populist drive globally. People are tired of the current structures and they want more. So it’s interesting to see and it will be interesting to see the fallout. Tracy do you see other companies moving in that direction of a windfall tax?

Tracy

We did see India, they enacted a windfall tax as well. They’re kind of pulling back on that right now. We have Germany talking about a windfall tax, but at the same time they’re giving subsidies out like candy. But then again, that country is like an enigma right, as far as energy policy is concerned. But I think that’s… What’s interesting about the UK is now they’re also talking about a windfall tax on green energy.

Tony

Oh, good. Interesting.

Tracy

So they are talking about that too, and they’re talking about almost a 90% tax because of all the subsidies they’ve been receiving that will be end up. So we’ll see if that comes to fruition or not. But that would really I mean…

Albert

They going to have to give them loopholes because everyone is going to look at what’s going on in Germany and then spending tens of billions of dollars to bail out the energy company that supplies all their consumers. It’s just silliness. They’re just playing through the populous voice at the moment.

Tracy

The US talked about a windfall tax too, over the last year, but it has just not found footing yet.

Tony

Don’t do it.

Tracy

I don’t think it’ll pass. I didn’t even think it’ll pass with if you had even with like a Democrat-controlled Senate, I still don’t think that’s going to pass because you have too many of those senators in Hydrocarbon that represent Hydrocarbons states.

Tony

Okay, great. Let’s move on to the last segment, which is really looking at exchanges. And Josh, your company has built an exchange, continues to build an exchange. We’ve seen some real issues around exchanges. Well, for a long time, but really most recently with say, the LME and the Nickel issue. And we’ve seen FTX kind of called an exchange and we’ve seen FTX fall apart. I’m really curious first of all, can you help us define what is an exchange and then why do these problems emerge?

Josh

It’s a great question and thanks for that. So I think maybe I’ll step back and just mention kind of how Abaxx have been thinking about because we went out and set off to build a regulated exchange and the first physical commodity focused clearinghouse in Asia about four years ago. And for us, we looked at an upcoming commodity cycle. I had a view that we really bottomed in the energy cycle around 2015, 2016, but we still had to wear off a lot of excess inventories. And probably ten years ago, the market was spending almost $2 trillion a year in energy infrastructure. That number has fallen down to something like one and a half trillion a year. So even though population is increasing and wealth is increasing, we’re actually spending less and less on our infrastructure. So it was only a matter of time until we kind of wore off any excess capacity from the last commodity cycle. So for me, I looked back at you go through these cycles, but the market inevitably is always changing.

Josh

So if you think back to, you think back to sort of 2007, 2008, and that part of the commodity cycle. We were still mostly focused on WTI. Brent wasn’t even a huge price marker. It was really only 2010, 2011, 2012, when you started increasingly see the markets changing. So our view is that this commodity cycle, for all of the reasons and the green energy transition, the focus on net zero, we thought a whole new set of commodity benchmarks was going to be needed because different commodities were going to be featured more prominently this cycle. So that’s why we set out to build the exchange. And I will answer your question. I just wanted to kind of walk through this history.

The other thing that I think happened over the last two decades is with the digitization of the trading space. Again, remember, it wasn’t that long ago that commodity trading was floor trading and people yelling and pushing each other in a pit, right? And so you always have to look at the evolution of markets that kind of evolved with the evolution of communication technology and software and really what’s happened since everything went electronic is we had a massive consolidation of the exchanges and the exchange groups across the world. There used to be like the Nymex itself, which is obviously the core of the Chicago Mercantile Exchanges energy business that had something like five contracts for like 100 years and now there’s thousands of contracts.

Right? So there’s always this evolution of markets. There was this consolidation in markets, but in our view, the exchanges themselves got away from specializing in the industry or the product they serve. And so we think it’s a little bit of a mistake of history that the two biggest energy markets in the world were acquired markets. They see me buying the Nymex and Ice buying the IPE, which was the Brent markets. And so in our view, we actually don’t think the physical market builders really exist in the big exchange groups anymore.

So we saw this sort of classic opportunity. This economy of scale or whatever to actually hyper focus on physical commodities and the physical commodity benchmarks that are going to be needed for the next commodity cycle. 

So getting back to your question. So what is an exchange? Again, this problem of the digitization of everything, we end up creating a lot of conflicts between what is a broker, what is an exchange, what is a clearing house, you know, different entities playing on both sides of the trade. And of course, I have my Goldman Sachs background, so that was always the big debate about Goldman in the 2000s. They’re on every part of the trade.

And really we used to be in this market infrastructure where you really separated all the conflicts in exchange itself for a long, long time as a nonprofit organization, almost like a utility. And you bought seats again to push each other in the pit. That’s where the private entities were, were in the exchange memberships.

So now what we have today is we have broker dealers like Coinbase calling themselves an exchange, even though they’re applying for an FCM license, a Futures Commission license, which again, it shows that they’re a broker, they’re not an exchange. So I think there’s a lot of confusion on what an exchange is. And what you really want to do is separate those conflicts of interest.

An exchange should never have a house position. Exchange is really just the place that matches trades. And a broker dealer is the one that’s someone that nets two clients and then puts that trade onto an exchange. So there’s been a lot of regulation, particularly after DoddFrank and after a lot of the problems in the financial system in 2008, to try to separate these conflicts out. But unfortunately, with crypto and other things, we’ve been starting to consolidate everything again into a conflicted model. So we’re trying to get away from that and focus very much on physical commodities and an unconflicted model.

Tony

Is it possible to separate those things out? I know it’s conceptually possible. But since we’ve gone beyond that separation, I know that’s what you’re trying to do as a company, but how hard is it to convince people that these aren’t the same things? Because obviously there’s conflicts if they’re combined. Right. There’s margin, I guess, in those conflicts, right?

Josh

Exactly. So we wrote a risk net article on this because FTX actually came to the CFTC proposing that they bring their highly centralized conflicted model into the CFTC. And to their credit, the CFTC and the Futures Industry Association, I think they recognized this problematic approach, that they wanted the exchange in the clearinghouse to be separated from the Futures Commission merchants. And at the end of the day, you know, the FCM’s, which is really the prime broker that connects to the clearing house, they do more than just handle administrative work and collect margin. 

At the end of the day, they’re the ones really looking and really knowing their customers’ overall position. So if you look at something like the LME problem, what it really was is you had this big OTC position in one of the brokers that was sort of Texas hedged or had a bad hedge into what was actually so it was a Ferro nickel. It looks like it was a Ferro nickel and sort of integrated stainless steel producer that was hedging against the deliverable contract in an LME nickel that they actually couldn’t deliver into. And there’s actually nothing new about that.

That’s actually how the Nymex really came to be the top energy market. You had the Idaho Potato King, hedging into a main potato that he couldn’t deliver into and cause an epic short squeeze. So this stuff is not, there’s nothing new in these markets. And the main thing is we want to maximize decentralization. We want to maximize the amount of FCMs involved in managing that delivery risk and knowing what their clients’ positions are, and the exchange having enough knowledge to know where the risk sits as well.

So it’s that check and balance. If you leave all of the risk to one entity or to one regulator, it becomes very problematic. That’s why we have the separation of all these pieces of market infrastructure, so that everybody is looking at the risk from their perspective, so that overall we can try to minimize the risk in a more resilient system.

Tony

Okay, Josh, I’m just curious, what should people know about exchanges that nobody tells them? I know that’s a really broad question, but it seems extraordinarily simple. But there’s got to be something that people should know that nobody ever tells them about what an exchange is.

Josh

Yeah, I think that an exchange should never have… We like to say that the exchange should be the scoreboard, not the referee. The exchange should really only be transparently, showing a price, showing that data, executing the price, but it should never have a position and it never should be telling the market what to do. The exchange is the scoreboard, not the referee.

Tony

That’s a great statement. Albert, what questions do you have?

Albert

As soon as he said that I was in absolute agreement. Everyone that knows me knows that I abhor crypto. Right. And what they’ve done. That’s an understatement, I know. But I’ve always said, if you want to do something with blockchain digitalization, you have contracts, whether it be real estate, whether it be commodities, something like that, to create transparency and trust in the system. 

Exactly what Josh is talking about, because I’ve seen and personally heard of manipulation in the oil futures and commodities market that is just outrageous. Absolutely outrageous. And it’s not fair to people like me that trade futures where for some reason I can’t buy a contract because the prices, like the price discrepancies, are just outrageous at the moment. And everyone knows the brokers are intermixed with the exchanges and so on and so forth. But something like this, where it’s digitalized and you’re just a scoreboard, is a great idea.

Josh

Yeah. And I think the other big problem is we look at every price for different assets and think all prices are fair. And if there’s anything the last two years has taught us, that efficient market hypothesis is not right. And so, you know, we look at these prices like they’re all the same. You see a WTI price, you see a nickel price, you see the price of Google, you see the price of a ten year, you see the price of a real estate bond. At the end of the day, it’s the market structure, and you can’t fundamentally change the liquidity or lack of liquidity in a market. Right? And so one of the other problems that we saw, again, this is why we exist, is we think that the commodity markets have gotten hyper financialised and digitized, where people have gotten away from what is the actual underlying price.

So LNG is where we’re focused. We think LNG is the most and this has been our view for five years before, most people didn’t know what LNG was before it was front page news, is that LNG was the most important commodity for probably two decades. And at the end of the day, what is the price of LNG? There is not a clean, transparent price of LNG. LNG is not the Dutch title transfer facility. LNG is not the five people that report on a voluntary basis to the JKM. Right. There really isn’t a price for LNG. And more importantly, right now, there’s not a buyer and seller of last resort market. You can’t go in and buy futures and go to delivery in LNG. That doesn’t exist.

And next year, I think it’s going to be absolutely critical because there’s going to be an all out bidding war for probably the next 30 months between Asia and Europe for that marginal cargo of LNG. We haven’t seen anything yet this year. Next year, and the summer of 2024 is when it gets really bad.

And we need a market that actually, as one of my former colleagues used to say it needs to be a knife fight in a phone booth. Right. You need absolute market discovery. And that physical price has to converge with that futures price. That’s the only fair price. It’s the only fair benchmark. And that’s what we’re doing is doing the hard, hard work to figure out what is a physical long form contract look like to go into delivery of these hard commodities like LNG.

Tracy

And I just want to add on that because everybody’s talking about how European storage is full right now. This year was never going to be a problem. It’s next year there’s going to be a problem. Because you have to realize that they were 50% full. Russia got them 50% full on piped natural gas really cheap. Now that’s gone, right? And so they were paying higher spot prices just to get LNG shipped in. Right. Those cargoes are going to be, next year is where you’re going to see a real problem because a lot of other countries already have long term contracts. And as Qatar said, we have to service the people that we have long term contracts with first. You’re secondary sorry, Europe. Right?

Josh

In Europe, I think, also loses something like 8 million tons per annum capacity up from longterm contracts next year as well that roll off. So there’s actually more spot market bidding. And then on top of that, China is likely to be back in the market. And China last year became the largest LNG importer and they really weren’t even in the market this year. But the one thing that they did do is they’ve been buying all the long term contracts. So even though they’re not buying the spot cargoes this year, they’ve been the biggest player in buying new long term contracts so that they have the optionality. Look, at the end of the day, you know, heating is always going to demand, particularly residential heating in the winter is always going to demand the highest premium because there’s just no elasticity there. You can cut industrial demand. You can probably substitute and power substitution. But if I’m China, I really want the optionality of having that long term agreement. And if prices are high in Europe, I’ll just divert the cargo into Europe or I’ll divert for political reasons diverted to Pakistan or India.

So they’re buying all the optionality, whereas Europe is not buying the long-term offtake. And in fact, they’re buying very short term infrastructure because they’re very focused on, oh, it’s going to be a stranded asset under 2030. So we needed to convert it into hydrogen or something else, right. So there’s a lot they’re really handcuffing themselves, which is going to be again, we need better market infrastructure so the market can sort this stuff out.

Tony

It’s great. Guys, you never disappoint. Thank you so much for this. This has been fantastic. Josh, thanks for coming on. I know you’re a super busy guy. I really appreciate it. And thanks, Tracy and Albert really appreciate this. Have a great weekend. Have a great week ahead. Thank you very much.

Categories
Week Ahead

China Protest context, changes, and market risks: Week Ahead Special Episode

Explore your CI Futures options: http://completeintel.com/inflationbuster

The last couple of weeks has seen rising levels of unrest in China. This seemingly started in a Zhengzhou iPhone factory after the deaths of seven workers and has rapidly spread after Covid lockdowns contributed to the deaths of a family of 12 in Urumqi. Some are even saying the World Cup contributed to domestic unrest. But there’s no getting around the fact that people are just tired of lockdowns.

There’s an old Chinese saying – often attributed to Mao Zedong: “A single spark can start a prairie fire.”

What started this prairie fire and what does it mean for China and the world? We discuss that in this special episode with Dexter Roberts, Isaac Stone Fish, and Albert Marko.

Dexter talks about his retweet of a note from Lingling Wei.

Isaac talks more about this unrest potentially leading to the downfall of Xi Jinping. That seems optimistic, especially for the West. What are some of the probable outcomes?

And on the ongoing risks and market impact, Albert shares his knowledge on the issue. We’ve talked a lot about Chinese markets and the CNY. How will the markets react in the coming weeks? And how Western companies will respond to these protests and the aftermath?

Key themes:
1. Protest Context – Spark and prairie fire
2. Will anything change? “
3. Risks and market impact

This is the 43rd episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Dexter: https://twitter.com/dtiffroberts
Albert: https://twitter.com/amlivemon
Isaac: https://twitter.com/isaacstonefish

Transcript

Tony

Hi everyone, and welcome to the Week Ahead. This Special Week Ahead, talking about China protests.

I’m Tony Nash, and today we’re joined by Dexter Roberts. Dexter is an author. He’s member of the Atlantic Council, the Mansfield Center. He’s a former Bloomberg Business Week China bureau chief, among many, many other things. Dexter, this is your first time. We really appreciate that you joined us. Isaac Stone Fish is also joining us again. Isaac is a CEO of strategy risks. He’s also Atlanta council member. He’s a China-based journalist for Newsweek and has was there for a lot of years. And we’re also joined by Albert Marco, who is a geopolitical maven and knower of all things. So guys, thanks for joining us today.

The key themes today is really what’s the context of the protest? There’s the old saying of a “spark and a prairie fire,” which we’ll go into. Really want to understand that context. Want to understand will anything change? And also what will be the impact on markets? That’s kind of hard to tell, but we’ll walk through that the last couple of weeks.

Obviously, we’ve seen rising levels of unrest in China, particularly over the weekend we started seeing quite a lot more. This seemingly started in a Zhengzhou iPhone factory after the deaths of seven workers. There’s a long story. There are a lot of videos on the internet about that, and you can do a little background on that if you want. And it spread rapidly about a week ago after there were deaths of a family of twelve in Ürümqi in an apartment fire. Again, there’s a lot of background on the internet that I’m sure you guys have seen. Some people are even saying that the World Cup contributed to the domestic unrest as Chinese families saw other people in other parts of the world out celebrating.

But there’s no getting around the fact that people are just tired of Covid lockdowns. There’s an old Chinese saying, it’s often attributed to Mao because it was a title of one of his essays called a Single Spark Can Start a Prairie Fire. And we’re trying to figure out what started the prairie fire and what does it mean to China and the world. I want to look at that with some experts, which is why we have this amazing panel today.

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So, Dexter, welcome. I really appreciate that you joined us. Thank you. You’ve retweeted quite a bit this week about the protests, and you retweeted this one from Ling Ling Wei, talking about kind of some of the origins of the protests.

Can you talk to us a little bit about kind of what are the sparks? Are there things that we’re not seeing on this side of the world that have led to this in China?

Dexter

Yeah. Well, thanks so much for having me and really appreciate it. Great to be in such a great company here.

So, obviously, we all know that there’s tremendous frustration about Covid Zero, the intermittent lockdowns, the unpredictability of life for so many people in China today. And that’s very real, and it’s a huge part of the spark, if you will, that caused the protests. I do think that less remarked upon is the very, very deep economic malaise, which is also a really important cause of this.

In particular, we’re seeing for young people a far less rosy future, if you will, and they are starting to realize that. So we’ve got the obvious economic indicators that are very bad, like the 18% plus youth unemployment rate. And then you look further than that, and I think there’s this sense, particularly amongst young people, probably amongst everyone but the young people that have taken to the streets protesting that the future is simply just not going to be what they had expected it to be.

I’d actually go one step further and say that for them, they feel like the social contract that they grew up under that really has been in place since Dung Xiaoping launched reform and opening in the late 70s.

This idea that your life will always get better, your children’s life will be better than yours, you’ll make money, you can pull yourself up by the bootstraps and do better in China if you work hard. I don’t think people feel that’s necessarily the equation anymore.

Some of the things if you just look at what’s happened in the property sector, that people have become very used to rising values in the property sector, going up and up and up, making a good career, including in the private sector, in the big tech companies, all these things are really in question in Xi’s China.

Xi has shown an attitude that is very, very different from his predecessors about the private economy. And I think this is sort of starting to become something that young people are very aware about. Then you have, of course, you have the isolation of the country, which I think is deeply distressing to a lot of young people as well. It’s a much, much different social contract that they’re being told that they need to be part of if they want to be important in the future of China.

Tony

It’s interesting you mentioned the social contract under Dong. I think it was in 1980. He talked about unifying China because there were all the fractions after the Cultural Revolution. Do you feel like Xi Jinping has continued to unify China? Has he done things to really break that up?

Dexter

I think his idea of how to unify China, he has a very ambitious idea of how to do that. It has a lot to do with nationalism. It has to do with taking pride in the ancient traditions of China. It has to do with taking pride in the earlier communist, the Mao era as well. Look where Xi Jinping took his new standing committee of the Polit Bureau right after the 20th party Congress. He took them out to Yenan, which is all about emphasizing frugality and sacrifice, self-reliance, as Xi Jinping likes to say, the old Mao expression.

So I think he believes that those can be unifying in some way. I don’t think the young people of China feel that that’s very unifying at all. It’s much more collectivist. Anti-individualistic has an almost negative attitude towards making money towards the private sector. And these are all, I think, a bit of a shock for young people in China today.

Albert

Tony, it’s interesting because trying to unify a billion people is not going to be an easy task under any system, whether it’s socialist, communist, capitalist, whatever you want to throw out there. But Xi moving into a more nationalistic arena, specifically with the private sector, has just taken the Western companies out of the equation. They’re all leaving out of China. And what Dexter is saying, what future did they possibly see with everyone leaving, especially the tech sector and the manufacturing sector? They’re just leaving. This is something Isaac can talk about, because I believe this is…

Tony

Yeah, Isaac, what are you saying about that? Are you seeing young Chinese kind of giving up on their careers? Are they frustrated by that?

Isaac

There’s such a wide range of views. And I think one of the things these protests are showing is that you can’t, nor should you try to unify any large population, because then you just squelch out the diversity of opinions. I think the protests are a real sign that a lot of people have been a lot more frustrated with communism in the Communist Party and China’s economic situation and COVID than we had thought. There’s no good polling on any of these issues. There never will be until the party relinquishes. The question of foreign businesses. It’s definitely a trend moving in the direction of reducing exposure to China. However, your average Fortune 500 company is still incredibly exposed to China and to the Chinese market.

Tony

And dependent, right?

Isaac

Yes. Especially dependent both on a revenue perspective, but also a supply chain perspective or regulatory perspective for some of the investors.

And one of the things companies are very slowly waking up to is that, on the one hand, China is not Russia. There’s so many differences between the two countries. On the other hand, there’s a lot of things that have happened in Russia that could be templates for how the future unfolds with China. Most noticeably, the situation in Taiwan.

So, three years ago, US traded 25 times more with China than we did with Russia. The numbers are starker today, but if China invades Taiwan and the US gets involved militarily, companies better have a plan for what they’re going to do with the immediate cessation of their business or the nationalization of their assets, and frankly, how they’re going to protect their Chinese and American staff.

Tony

Yeah, I’m curious about with protests like this, could it become nationalistic like it was against Japanese companies in 2012? Could we see the central government try to pivot to that type of venting?

Isaac

It’s tough to say because the party wants things to be at lower levels where you can be very nationalist because you’re cleaning up the party. And probably the most worrying thing are the calls for the downfall of the party and the calls, the rare for the downfall of Xi. And the strategy seems to be, hey, the center, Beijing is taking care of you. It’s just some local officials or some local jurisdictions are having the problem. So you can be pro-China, but anticorruption or anti what’s happening in HubeiNanchang or nonchang or wherever they decide.

Tony

Right. So let’s go to the next section, which is really looking at what are likely impacts. You talked about people calling for the downfall of Xi Jinping. I think Westerners are making a lot more of that than is on the ground. Is that what you’re seeing as well?

Isaac

I think and I’m really curious to your thoughts on this too. It’s so hard to know fully what’s happening on the ground. There’s so many fewer journalists. Even with the videos that we’re seeing on the Internet, it’s hard to know always how accurate those are and what we’re missing. And it does feel like a small, small number of people calling for the downfall of Xi Jinping is incredibly significant. And at the same time, it doesn’t mean that there’s going to be any sort of downfall of said man.

Dexter

Yeah, no, I think you’re absolutely right. It is very significant that right there in the heart of Beijing, right next to where I used to live, actually in the Taiyuan diplomatic compound, you had those protests. I guess the calls for Xi to step down were down in Shanghai. But having those kinds of very angry people and in some cases saying something from the Chinese Communist Party perspective as extreme as the leader should step down. I think is very notable.

Yeah, I don’t think that’s a widespread sentiment. I think it more has to do with a sense amongst young people that the party and Beijing is less fallible. It’s not infallible that they’re not quite as competent as people thought. And I think Covid Zero has really demonstrated that to people that the economy is a mess. The IMF is now saying, I guess, 3.2% growth for the year. It’s just almost as bad as we saw in 2020.

The script, they’ve gone badly off script. There was this great stirring narrative of how China survived the initial COVID outbreak, struggled when the rest of the world was still doing okay, and then emerged victorious and kept society, the economy recovered.

Only major economy to see, significant growth, I think a year later. Well, everything’s gone wrong now. So I think this sense amongst and again, it’s so hard, as Isaac says, to know actually what people are thinking. But from what I hear and from some conversations I’ve had, it seems as if there’s this feeling that the Party has really badly screwed up and they need to take some responsibility for it.

I think also it’s notable that they’re saying Beijing because as we were saying earlier, for years the party has got by on the argument that we’re good here in Beijing. There’s all these evil local officials, they’re abusing workers, they’re creating polluting factories. All we got to do is appeal to the right people in Beijing and they’ll solve our problems because ultimately the party has our interests in hand.

Now, if we are starting to see, and I think we are, this feeling that the Party, even at the center, has screwed up badly. And of course, the gentleman who’s in charge of everything but the chairman of everything, Xi Jinping, then that is very notable.

Tony

Yeah. So first of all, I don’t believe it’s possible for one guy to control all that stuff. So in the west, people way oversimplify and act like China is a monolithic government and there’s one guy at the center, it’s just not possible for one guy to control all that stuff. Do you guys think he really is the only guy making decisions, the only guy making policy?

Albert

No. I have a contrarian point, though. For my take of this, the question has to be why is China even allowing these videos to leak? Why are they even allowing these protests to get this big? In my opinion is they want to show the world that they are done with this COVID they need a reason to be done with COVID Zero. It’s been hampering their economy and they need to move on. They’re done working with the United States on combating inflation and this is their signal to the rest of the world saying, look, we can’t do this anymore.

Tony

So when you say “they,” who is they?

Albert

When you say they and his cohorts on the CCP, they’re done with this, they’re done with helping the Fed and Yellen combat inflation globally.

Dexter

I have to just push back a little bit. I think they are aware, and I think it’s the reality that if they do, they’re in a really difficult spot, because if they were to actually pull away and all controls, they’re just not prepared, I think, for the outbreak of the pandemic that China would see. They have very little herd immunity. They’re victims of their own success to a degree there. As we all know, and we’ve heard a lot about the there’s low levels of vaccination for the elderly. They have a very fragmented healthcare system. I think ending COVID Zero with one stroke is a recipe for huge problems in China and I think that the leadership knows that, or at least they fear that. I think they’re in a very difficult spot. They do want to move beyond it. I agree. It’s not easy.

Albert

Yeah, I don’t think they’re going to move as the one full stroke and just open up everything. I do think it’s going to be a staged open, but from what I heard, my contacts there said March was the date that they’re going to end COVID Zero, whether it be stages or one full stroke as a debatable thing. But at this point, I don’t think they can last that long. I think now it’s looking more like end of January, early February.

Dexter

I’m going to say really quickly, I mean, the other huge issue is Xi Jinping has associated himself so much with what he sees as a successful, I mean, what had been until not too long ago, it seemed like a successful COVID Zero policy. It turned out it wasn’t successful at all. We know in hindsight, but they have really defined themselves in opposition or in contrast to the rest of the world. So if you watch the Chinese media, the staterun media, every time we’ve reached a new level of mortality, more than a million people have died. These things are top of the news in China and I think the party has tried to tell the Chinese people, you’re safe here, in contrast to the chaotic rest of the world and particularly chaotic America. This is their argument. And if they lift Covid Zero now and they do have the pandemic rips through the population and they do have high mortality, there goes out the window Xi Jinping’s narrative of the grand success of the CCP with COVID Zero.

Isaac

The Spring festival in January, February, where hundreds of millions of people normally travel, would be a super spreader event, like nothing we’ve ever seen before. So one imagines if they do loosen, it’ll be after that. And the record, I do want them to loosen up, and the draconian and arbitrary lockdowns have such a massive toll, but I think Spring Festival will be a big piece of their consideration.

Tony

Okay, that’s a great point. I think you and Albert kind of agree on that generally, in terms of the time frame. So let me ask you, what else will change? Will we see, say, some local leaders go down saying they overly aggressively enforced it or something like that? There is typically some sort of accountability, whether it’s well placed or misplaced in China. So will we see somebody or a group of people or many, many people go down? And I’ll tell you why I asked that.

I referred to this on social media. This reminds me of the April 5 incident in 1976, when Zhou Enlai died and Mao didn’t attend a funeral and didn’t want people to recognize that  Zhou Enlai died. So people started protesting and expressing their, you know, their sadness that Zhou Enlai died. Thousands of people went to jail. Right. And somebody had to pay. It was an outburst like we’re seeing now across China, and it really took two or three years for those people to be let out of jail. Right. So it seems to me a discreet event like that, and it seems to me that the response back then was thousands of people going to jail, and then a few years later, under new leadership, saying, “oops, that was a mistake, let everyone out.” Will it be something like that?

Isaac

I don’t think so. I’d say the base case is quiet arrests and harassment where people disappear or people aren’t seen for a brief period of time, and there’s not enough that people can hang their hat on. I think one of the easiest ways to make this into a movement is to create martyrs. So if a local policeman screws up and shoots into a crowd of protesters, this could really, really spiral. It’s so hard to know. I mean, it’s impossible to predict whether or not that’s going to happen. That could be a history changing moment. I think right now we are before the tipping point, and I think the most likely outcome is these protests subside. We see some more of them this weekend, but they’re not as well attended. And this is basically the high point of that. And there’s probably a couple hundred arrests, but we don’t really know. There’s no good statistics on it. And COVID slowly opens up, and several provincial level officials lose their job in ways that people loosely tied to this event.

Tony

Yeah, I think that’s fair. Dexter, does that make sense to you generally?

Dexter

Yeah, it does. It reminds me of I covered the labor movement before Xi Jinping ultimately destroyed it around 2013, and going back to even the first big labor protest in the northeast of China in places like Dai Qing and Lio Yang. And back then, what they would always do is they would arrest or maybe they would create the ringleaders of the protests. So they put a couple of highprofile people in jail as a warning to the others and then they would do a lot to try to meet the frustrations of the protesters. So then it was about local corrupt officials or corrupt factory managers stealing the pensions or whatever it might have been, and they would announce that. I see sort of yeah, something like, as Isaac was saying, well, they’ll do more. They will loosen on COVID Zero when they can. You already had a statement. I’m trying to remember if it was the Health Ministry or something that seemed to be sort of it didn’t go very far, but it seemed to be sort of saying, we understand the frustrations of the people just in the last day or so. I think they’ll do that.

Dexter

The arrests, of course, they’ve already started talking about the hostile foreign forces that are involved, which is not a surprise. They’ll probably heat that up a bit and blame. They’ll try to make the argument that the young people have been misled by bad people overseas, which they always do. And they did that in Hong Kong and they’ve done that in Xinjiang and so on. But, yeah, I think I do agree with Isaac. I think that’s probably most likely. They definitely don’t want to make martyrs.

Tony

Great. Okay, then let’s move on to kind of the markets impact. So it sounds to me like the general consensus is not a lot. This is not a revolutionary event. We’re not going to see the deposing of Chinese leadership, despite the kind of Western sharing, all that sort of thing. So in terms of the risks and the market impact, Albert, can you just start us on that? Do you see markets impact? Do you see Chinese markets rallying or falling? Do you see CNY devaluing or appreciating? What do you generally expect?

Albert

Well, as I said before, I think this is a signal to say that China is definitely going to be moving beyond COVID Zero. Data is debatable, but they have just an enormous amount of stimulus to unleash. They just did a little bit overnight talking about helping out the property sector and KWEB and Baba and everything is up 7%. It’s uncanny. So, yeah, this is definitely a signal to the US or Europe and say, hey, we’re almost about to open for business. Get your stuff in gear, because when it does, it’ll be a tsunami of money coming in and the markets will rally on it, for sure it will.

Tony

So this is generally could be good for Western markets and Asian markets because China’s lockdown is really I mean, I don’t I don’t mean to be overly simplistic, but I’m going to do it. Ending China’s lockdown is really the most important issue in Asia right now, I think. And it’s the most important issue in markets right now.

Albert

But it’s not good for the west. It’s not good for the United States specifically because it’s going to take inflation back up to where was six months to eight months ago. When China starts moving, commodities start rallying.

Tony

Which is at 78 right now, or something up to?

Albert

110 or 120 easy. That point. On top of that, money from the United States will end up flowing out back into China, in Asia, Singapore, Japan, South Korea. Name your manufacturing sector, but that’s the reality of it. The Fed right now has 60 days to get things sorted out with two Fed meetings coming up.

Tony

Okay, Isaac, what do you see on the risk side as this plays out? Is it just going back to business as usual, no problem, everything’s great, or do you see are there some risks that we’re not kind of aware of?

Isaac

Geopolitical tensions are so much higher than they were preCovid lockdowns in China, and the looming specter of a Chinese invasion of Taiwan still not the base case, but still very likely increased tensions with Japan or India or in the South Sea or the East Sea. These protests, I think really the right assumption is that they don’t lead to further instability, but they certainly could, or certain other areas of disturbance or frustration with the leadership could really bubble up, and that could have very severe economic consequences.

I think there’s also the really important point of the strong leftward turn that China’s economy is taking. It’s becoming a lot more statist and with more investments, more JVs, a flowing of capital into China. This is going to be done under different rules than it was under Hu Jintao or under early Xi Jinping. It’s going to be with a much heavier state footprint, and that’s going to make things a lot more complicated. It’s going to be a different set of rules, even for companies that have been doing this for a very long time.

Tony

So what you’re saying is we are who they thought we were a few weeks ago in the part of Congress, right? There was this ominous feeling coming out of that. And then there was this event, I think, last week in ASEAN where it felt like there was some shine put back on Xi Jinping. And now it feels like that it’s coming back to be kind of who we thought they were.

Isaac

And the narratives keep shifting so rapidly, and they’re going to continue to shift and evolve. I think people need to understand. There’s an old saying, if you’re going to have to remind me how this went, but it’s something that in China, the only thing you know about the impossible is that it happens all the time, and it’s very difficult to know what we’re going to see. But we do have I think Taiwan is the best example of that. We do have a very clear possibility that China invades Taiwan, and that may start World War Three. And we can predict that now, so people can plan not, hey, this is definitely going to happen, but, hey, this is a very real risk, so how do I plan accordingly?

Tony

Okay, so protest not a big deal, but World War Three possible? That’s kind of what

Isaac

That’s the summary. Yeah, put that on my tombstones.

Tony

Very good. Any other thoughts?

Dexter

Yeah, well, Isaac just brought up a big one, which is this increasing status nature of the economy. I think as multinationals going forward, they’re going to do business in a very different environment. We heard that, of course, with Xi Jinping’s 20th Party Congress speech, which, as we all know, mentioned security, whatever it was, 91 times, and market a small fraction of that. There’s a new emphasis. Xi Jinping has made it very clear that he’s willing to make economic sacrifices, productivity growth sacrifices, in order to make sure that the party is secure and China is secure and is on a path that he thinks is correct. He’s got that whole line about that. He’s been saying for years about how we can’t use the second 30 years of China’s history to negate the first 30 years. Meaning we moved too far in saying that reform and opening was the end all to be all and negating the earlier the historical neolism that Y’all talks about, which is negating the Mao era. He thinks there’s important lessons for the Mao era. He’s not a Maoist at all, and he certainly doesn’t believe in bottom up revolution. He’s a very top down sort of guy.

But I do think he has a very different vision for the economy. I do think he’s willing. We saw with the private education sector, he seemingly didn’t lose much sleep over completely wiping out a major industry, forcing markets around the world to shed tens of billions of dollars and sending huge numbers of young Chinese into unemployment with this crackdown on private education and tech. And I think ultimately that’s cheap. I don’t believe I think he’s a very different breed. When I showed up in China, it was Zhang Zumin and obviously Jung Zumin and Zhu Rong Xi.

Very different than Hujing Tao and Win jabao. And then today, and I myself was astonished by who Xi Jinping is. I think he’s deeply ambitious and has very different ideas about where China will go, how it will get there, and those have very big economic implications.

Tony

Wow. I’d love to have a two hour conversation with you guys. Let’s just keep it quick. Thank you so much for this time. I think we can maybe do, if things take a different turn, let’s do another conversation in a couple of weeks or something. But I really appreciate your time and thanks, guys. Really. Thank you very much.

Categories
Week Ahead

FTX, crude & crypto, CPI & inflation: The Week Ahead – 14 Nov 2022

Emma Muhleman, Boris Ryvkin, and Albert Marko join us for this Week Ahead episode. We talk about FTX and why it happened. FTX transferred about $8 billion of customer deposits to a trading arm called Alameda, and they lost it. FTX was assumed to be a regulated institution. It wasn’t. So customer deposits evaporated. There was a desperate attempt to merge with Binance. That didn’t happen. FTX filed Chapter 11 on Friday, and then Sam Bankman-Fried apologized as if that just absolves him and makes everything better.


Albert, Emma, and Boris help us understand what happened here and what it means not just for FTX executives, but for markets in the week ahead.

We also saw some selling in crude markets as FTX collapsed. Emma talks us through that and tells us how long the crypto unwinds will impact commodity markets.

Based on the market reaction to Thursday’s CPI print, you may think inflation is solved. CPI seemed to override FTX worries and there was this huge sigh of relief in markets. Not so fast. Boris, Emma, and Albert talk us through the CPI print and where we’re seeing persistent inflation (diesel, food, etc). Will the Feds raise by 50 in December followed by some 25s? How will this affect layoffs across the economy?

This is the 41st episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Albert: https://twitter.com/amlivemon
Emma: https://twitter.com/EmmaCFA1
Boris: https://twitter.com/BRyvkin

Transcript

Tony Nash: Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash. Today we’re joined by Emma Muhleman. She’s a macro strategist and if you don’t know her, you’re not on social media. We’re also joined by Boris Ryvkin. He’s with Montefly Holdings. He’s also a former M&A attorney with Skadden and a bunch of law firms, and he was National Security Advisor in Capitol Hill. And Boris has an amazing perspective on macro, on history, on markets. It’s really great to have both of you guys. And we have Albert Marko. You guys know Albert. So it’s just great to have you guys. Thanks so much for being here.

Before we get started, I’m going to take 30 seconds on CI Futures. Our core subscription product. CI Futures is a machine learning platform where we forecast market and economic variables. We forecast currencies, commodities, equity indices. Every week markets closed, we automatically download that data, have trillions of calculations, have new forecasts up for you Monday morning. We show you our error. You understand the risk associated with using our data. I don’t know if anybody else in the market who shows you their forecast there. We also forecast about 2000 economic variables for the top 50 economies globally, and that is reforecast every month.

So we had a lot going on this week, particularly kind of in the second half of the week with FTX. Unless you’ve been kind of on vacation or away, you probably know about this already, but I’ll recap a little bit. 

FTX transferred, I think, something like $8 billion of customer deposits to a trading arm, Cart Alameda, and they lost it. FTX was assumed to be a regulated institution. It wasn’t. So the customer deposits evaporated. 

There was a desperate attempt to merge with Binance. That didn’t happen. FTX filed Chapter 11 on Friday, and then Sam Bankman-Fried apologized. We’ve got his tweet from Thursday on the screen. He sent another apology out today. And if that just absolves him and makes everything better. 

So, Albert, I know you’re a huge fan of crypto, so can you help us understand kind of what happened here? And really, what does it mean not just for Sam, but what does it mean kind of for markets going into next week?

Albert Marko: Well, for Sam, you can look at my shirt. That’s I purpose wore stripes, because that’s where he needs to go to. He needs to go to prison. The crypto space has been just littered with fraud. I mean, just incredible fraud. This guy had the nerve to go up into Congress and talk about transparency and central banks are illiquid and there’s no transparency.

Meanwhile, he’s taking customer deposits, not only just setting it to Alameda, right. But then now there’s a political component of it because he was spreading it around to super PACs for the Democratic, for Democrats.

This is a bigger story than people are alluding onto. On top of that, you had a bunch of Republicans come out and say, why was Gary Gesler helping him get through loopholes in the system?

TN: Was that actually happening? Because I saw that gossip on Twitter, but I’m just not sure if that was actually happening.

AM: Well, yeah, this is political season, so I’m not sure if it actually happened. But you don’t just come say something like that, right? You don’t just make those kind of accusations out of nowhere.

So there’s definitely going to be congressional hearings on this. SBF could be in jail at some point in time.

Concerns of where the customer’s money is. This is not funny. As much as I just absolutely despise crypto, this is not funny when you take people’s hard earned money and put it into different outfits without

any transparency whatsoever.

TN: I hear a lot of comparisons of this to Corzine from, like, 15 years ago. Are there similarities between what Jon Corzine did and what Sam did?

AM: That’s a really good question. I don’t think I can really answer that because we know exactly what FTX actually did with all these funds, where they’re at. Because there are stories that there’s penthouses and condos all over the Bahamas and the Caribbean that they can’t even touch yet. We’d have to find out a little bit more detail of what went on, what transpired into FTX.

Emma Muhleman: Because a lot of the deposits don’t invest in them in illiquid private equity investments, including VC funds that were invested in FTX.

AM: Like Sequoia put in a little bit of money and then they get 500 million back.

EM: Sequoia put in like $420 million that they wrote down to zero.

TN: And they got 500 back? It’s a great deal.

Boris Ryvkin: What was interesting was that Kevin O’Leary, he had a Jim Cramer moment with FTX. He said, if there’s one place where I could feel totally safe and fine, it’s FTX, apparently, because he was confident in their compliance capabilities. Because apparently the CEO was like his parents were like compliance lawyers or something. And he’s probably that’s not one of Mr. Wonderful’s more wonderful calls, I think.

AM: Well, when your parents are compliance lawyers, it just means that they’re going to teach them how not to be compliant and not get caught. That’s what happens when that occurs.

TN: Okay, so what does this mean for crypto generally? I know you’ve been not been a crypto fan for a long, long time. So is this an FTX issue or is this a crypto issue?

AM: This is a crypto issue. This ruins the credibility of any crypto that’s even valid in people’s eyes at the moment. Even Bitcoin is the 800 pound gorilla. There’s other cryptos that are trying to be stable and compliant and everything, and it kills. 

TN: Do you know how many crypto pages we’re going to get in the comments to this?

AM: I bring it on because I’ve been telling these people for years that the space has been just a positive scheme after another.

TN: So does this permanently kind of impair crypto, or do you think there’s a time that two or three months from now, everyone forgets about it and people are back in and crypto is back on?

I just think that the crypto excitement is so persistent that I’m just not sure that this hurts it for the long time. They haven’t had that moment yet.

AM: No, not yet. It doesn’t hurt it. Actually, I want to say it actually kind of makes it better because it is weeding out the real problems and showing the problems that are in the space. 

But the bigger problem that they have now is one side of credibility is getting retail money into the space. Retail money is just not going to get into the space, and even institutional money is going to have to think ten times more about getting an investment in the future.

TN: So what was it, thanksgiving of 2019, I think, when all the retail money went into the space Something like that, right? We got Thanksgiving coming up here in the States, and we’re probably not going to have the same effect this year.

AM: Oh, God, no.

TN: Are there any other players, do you think, that are likely to fail as spectacularly as FTX has failed?

AM: I don’t think so. At this point, I think that the FCC is going to have to really crack down on the entire crypto space and really force these guys to be compliant with, your know your customer rules and whatnot. So that’s something, actually, Boris could talk about, but I think they’re going to have to do something drastic here with the whole space.

TN: Boris, I guess from a legal perspective, how much do these guys have to worry? Do you think Sam can get away with this?

BR: I just don’t. No, I don’t. I think that, you know, the issue, of course, is just going to be the chain of ownership, first of all, of all, these shell companies. Where’s the money? Where did the money go? Because the money’s gone. I think it was something I know that there were a lot of jokes. He went from 16 billion net worth to a dollar, and he can’t afford his verification badge on Twitter now.

I think there was specifically because he’s now requesting, what, 94 billion as a rescue package. Once you’re already, and today he officially announced today was that they were filing for Chapter Eleven. So that was the official name today after requesting 94 billion, which was already I mean, when you’re already at that point, it means that nobody’s keeping the book.

So first of all, just in terms of any kind of account, whoever the accountant is, if there even was an accountant tied to this, whoever was signing off on this needs to worry a great deal. It’s not just Sarbanes Oxley and everything related to that, but it’s just simply who are these accountants and who was actually keeping these books? Because these numbers that were being thrown out, putting aside that it was impossible for him to get any kind of rescue package that quickly. But that number, it’s a number that is simply not credible.

TN: I’m going to get really boring on you for a second. Most companies have a DOA delegation of authority, right? And so I would think that to transfer $8 billion, the delegation of authority would go up to the board level. Is that fair to say?

BR: Well, I mean, it should, because again, it depends how these companies are actually managed, right? Because these could be not under US law managed, board managed, or there could be LLCs involved here which are member managed or have separate managers or what have you. It should go to the board level. 

And in any event, you should have the senior management sign off on the accounts, not just the account. Even though that’s the position with public companies now since Starbucks and everything else. But even when it comes to private companies, to have for sufficient transparency, to really have investors comfort, you would need to have that chain of control.

So the DOA would have to come depending on who actually the board would have to authorize the management to give the DOA either broadly upfront or specifically for a specific transaction as it would happen. 

TN: Because of $8 million, that’s still a fair bit of money, right?

EM: There were several acquisitions that he made that were private companies with the tune of over a billion each. So I guess you got like two $1.5 billion private investment, 500 million here. So I guess that’s how that all works out.

TN: You would guess that those have to have board approval at some point, I would think.

BR: I’ve done in the past very discreet deals where it’s sort of like, we’ve already transferred 100 million for this property. Please paper all of that over retroactively.

I’m sure that that’s what happened here. In other words, there was a lot of money moving around, nobody papered over what they needed to paper over. And I would be surprised if there’s  actually a chain where all of the documentation that was needed at each stage of the transfer was actually put in place.

I’m certain that money just moved around all over the place, which makes it now very hard to track because there’s going to be a very limited paper trail to find,  which is going to be a problem for him and everybody who’s authorized per the corporate documents of these companies for having to move the money around. So it’s going to be multiple levels of potential liability.

TN: Okay, so I would guess also that everyone in every crypto company is probably also coming up with their policies, if they didn’t have them already.

BR: So what are the investors are going to start calling to talk major policies. But I think the bigger issue, and Albert sort of touched on this, is the fact that this is an exchange, fundamentally. 

So the issue isn’t we’re talking about Bitcoin as a currency, but if you can’t trust one of the largest exchanges and I forgot that was it, it wasn’t Coinbase, it was one of the others that pulled out of an attempt to that’s a last minute shotgun. Binance. And that has a second and third order effect. So not only did this huge exchange fail, it was such a disaster that the Binance, which is one of the more credible exchanges like Coinbase and what have you, just simply said, you know, this is beyond saving.

So it could really have a cascade effect. I know some are calling it the Lehman moment for crypto, although Albert would say there have already been five or six of those. 

TN: Right, well, and before we get too critical of FTX as an exchange, let’s look at the LME and the credibility of kind of traditional exchanges. So, I mean, it’s easy to point the finger at crypto exchanges, but the LME has done some pretty screwy stuff over the years. So I think we need to be really careful

of just saying, well, I know you didn’t say this Boris, but crypto exchanges do screw things. Other exchanges do screw things as well.

EM: might I mention, though, with the LME, they are now under the control of the Communist Party of China via HVX. Great. Who is running the show? Real competent folks at the CCP. Binance is even shiftier if you ask me, but we’ll see.

TN: Speaking of markets and crypto, Emma, can we talk a little bit about kind of markets and correlations? How are we seeing this crypto activity and how do we expect this crypto activity to kind of flow through into other markets, equities, commodities, other things? Obviously it didn’t hit equities yesterday and today, but it seemed to be hitting earlier in the week. 

EM: Yeah, just as it was all falling apart, we saw a big risk off move in equities. We saw the Nasdaq coming down, we saw some weakness in oil that may have not had anything to do with the

fundamentals in the oil market. I would venture to guess or argue that it had more to do with the FTX sell off because there were several companies, including pension funds, that had significant exposures in FTX. So that oil related selling around the time that FTX all this broke. It may not have to do with the report, this actual EA report.

TN: So I’ve got a graphic from Tracy’s newsletter earlier this week where she talks about the funds and the investors that were deleveraging in oil because of FTX. BlackRock, Ontario Pension Fund, Sequoia, Tiger Global, et cetera, et cetera.

So there were some big players impacted by this and I can’t believe that it just impacted oil. I also have a hard time believing that it was a one time, say, 48 hours event.

EM: Yeah, I would think that. Not having done any diligence for a pension fund, Ontario Pension Fund,

like for BlackRock. I mean, I don’t want to call out too many names. We all know what SoftBank is about. They were intimately involved. There’s going to be a lot of problems and a lot of spillover that we’ll just have to wait.

TN: At the end of the day, I hate to say “only”, but in terms of global fund flows, it’s only $8 billion of retail money that was lost. It’s I say “only”, but, you know, it’s not a huge amount in terms of flows, but I just don’t know how much is in these funds themselves.

AM: Yeah, you don’t know how much the funds have lost and what they’re trying to make up and like yeah, sure, 8 billion doesn’t sound a lot, but in a market that’s so illiquid with a lot of these funds blowing up right now, it can be a lot. You don’t know what they’ve leveraged off of it.

EM: And what they might be being forced to sell as a result.

TN: So we probably haven’t seen the end of that. Fair to say?

EM: We’ll see a long restructuring or not restructuring Chapter Eleven. Not a restructuring, but a liquidation. 

TN: Yeah, it’ll be liquidation.

AM: Discovery will be fun. See where all this money went to.

TN: Great, that’d be great. Okay, perfect. Anything else on markets and FTX and crypto? Are we looking at is this impacting, say, European markets or Asian markets? Since crypto has been so big in Asia, are we seeing impacts in Asian markets, like in China?

AM: I don’t think so. I think that’s really Binance’s territory at the moment. Right now, I think FTX was solely the US and Western Europe.

EM: I would think you would see an impact on Japanese investors as well, who own a lot. But just like, not the kind that puts out life insurance companies or puts you a lot of business, but more like retail investors getting screwed.

AM: retail investors have just been taking it on the chin for the last 18 months. It doesn’t stop. 30 years.

BR: Except for Warren Buffett and those who invest with him because yet again, everyone’s underwater, he’s up like 2.3%.

TN: Boris, say, can you talk us through the CPI print this week? Because it seems like CPI, the rate of rise of CPI slowed. CPI didn’t slow, but the rate of rise of CPI slowed. And so it feels like it kind of overrode the FTX worries and there was this huge cyber relief in markets for the past couple of days that we’ve kind of conquered inflation. And the Feds only going to raise by 50 in December, and then after

that we have some 25s. What’s your sense of that? Do you feel like kind of inflation is conquered? Is that base effects? Is that kind of core inflation coming down? What does that seem like to you?

BR: Yeah, I don’t think that it’s conquered. I mean, what’s interesting to me is sort of the degree to which all that matters is what the Fed may or may not do and trying to price in factional differences within the Fed. That’s how granular it’s now become. Because I think the markets were waiting for any reason, anything, to cling onto for Powell to reverse course and to after his very hawkish last meeting, where he said, ignore all of the pivot talk.

Essentially, you know, we’re going to continue to do this as effectively as long as it takes to see a sustained reduction in inflation over that’s defined. So he essentially was very angry and Albert and I were talking about this as well, that he was very angry by some of the Pivot talk from brainer than some other people yelling, was saying certain things. It looked like some of the more devastated member. And then Powell comes out and basically says, I don’t know what you’ve heard about any Pivot talk, we’re going to stay the course until we see more evidence of multi quarter reductions and declines in inflation. 

But it looked like the market really was desperate to find a reason to not believe them and to hope that anything that might persuade him to in other words, the market is looking for anything to latch onto to have a pivot, even if we don’t actually get one.

So initially it was the official position, if you were even to read the kind of the superficial financial media was they were worried if we focused on the red wave, that was what was going to get the relief rally. Then we forgot about what was happening with the midterms. And now we have this softer inflation report that as you said, to slowed the rate while most of the slowdown was because of on energy, used cars and a couple of these other, in my view, short term fluctuations which are, I mean, to the extent that CPI has already been massaged to death. 

Obviously the listeners of this podcast of course know that very well. If we measure inflation how it used to be measured from the 1970s on, we’d be in double digits. I mean, that’s just a fact. So taking even to the extent that they were able to massage it, what I saw here was the market latching onto the top line figure, hoping that this would block the Fed into doing what the markets want the Fed to do, rather than actually looking at what’s happening to the core and actually looking below the hood and the underlying trend.

That’s what I’m seeing. You also can’t have to take into account biden’s political depletion of strategic petroleum reserve. You have to take into account the unseasonably milder sort of late fall that we’ve been having, I think that’s been having an impact on natural gas prices which have this very sharp decline and now have rebounded a little bit. 

Certainly that’s coming out of Europe as well, but I’m not seeing anything fundamental that would actually allow us to conclude peak inflation and sustained reduction inflation has been achieved. So I’m not saying that when it comes to energy, I’m not seeing that when it comes to food, I’m not saying that. I mean, the housing market is not doing well. I’m not seeing any fundamental changes in the housing market. Really. This to me seems like a short term story and the market overreact, in.

TN: My view at least, this is that’s great. So I’ve got on screen Sam’s from Sam Rines newsletter, the core CPI and all CPI items, just showing a bit of turnover there. So it could be encouraging to people who like lines. Right.

But if we look at the target rate probabilities for the Fed, which is the second item on the screen, it does look like we have from a 4.5 almost to a 5.5 target rate.

So that shows there may be ongoing tightening, say maybe into Q one, if we don’t see a dramatic continued decline in the rate of rise of inflation. Is that fair to say?

BR: Yeah, I think so. I think that it seems that the growing chorus is shifting from do what continue as long as it takes to fear of overtightening, at least outside of Powell and maybe one or two other people. And Albert really, I think, is the resident expert on FOMC, inside of baseball on that and sort of thinking, et cetera. 

But once that rhetoric shifts to fear of overtightening, that tells me that they’re looking for any excuse to stop and to begin moving back. And that will just bring the inflation genie back out. Because again, these policies are being set by people who don’t fundamentally understand what inflation is and isn’t and what’s causing the inflation. So they’re looking at the wrong things still, in my opinion. 

So none of the fundamentals that I’m seeing, as I said, that would really drive a sustained reduction in inflation have changed in that direction. And once if they do decide, as you said, Tony, if they do continue to tighten into the first quarter and then decide to do a sharp 180, that’s going to just bring everything back, if not make the situation even worse. 

So they’re in a very difficult position and I think, as I said, there’s a lot of political pressure for them to move back, especially given what’s happening with these midterms, certainly on the part of Yellen and the bike administration. But I think maybe Albert can also chime in.

TN: Let’s talk about the Yellen Fed factor and also since she’s a labor economist, Albert, let’s wrap some of these layoffs that happened this week into that discussion.

AM: How coincidental that these layoffs come right after Midterms and after Yellen has done everything in her power to keep equities up so they don’t have to have layoffs until now. Well, now all the layoffs are coming. Like we’ve talked before, they’ll do this right before Christmas. 

But also on the CPI and the inflation front, there are two glaring problems that they’re staring at the moment right now. How’s y’all going to deal with the Chinese reopening in March? Because that’s going to be really announced in February. They did a little bit about real estate today. They talked a little bit about real estate supporting the real estate market. And every Chinese name that was on my screen was up by 7%.

And then you talk about oil and then we have a big diesel shortage in New England at the moment and it’s leaking down all the way into the Southeast. And those are just going to add to costs across the board. And I don’t think that they understand how bad inflation can really get. They can only suppress it for so long with SPR releases and whatnot. But it’s coming to a head and I don’t think that Paul is going to be able to release. I think he’s going to have to do another 75 again.

EM: The thing that’s just disturbing to me about that is that, like, for instance, we are going to have a serious diesel shortage coming here currently and it’s only getting worse. Powell cannot fix that problem. So let’s just shoot the consumers even more like his policies. They’re not helping. Unless you want to completely destroy the economy and have a complete disaster blow up with Deleveraging and the whole shebang.

TN: Default rate in auto loans this week. Right. I can’t remember the percentage of people who were two months behind in auto loans.

AM: Skyrocketing wastelouses start kicking into that, too. Started kicking in. But just to touch on what Emo is saying about Powell trying to kick the teeth into the consumers from his perspective, he’s trying to do the right things, but he’s just not getting any help from yelling or other members coming out there talking about pivots.

TN: What would that look like? Help from Yellen. What would that look like?

AM: Well, she can drive the dollar down to Dixie. That rallies the markets pretty easily.

EM: Well, he doesn’t want a market rally, right? She can help.

AM: Powell does not want a market rally. Brainer and yelling did want to market rally for the midterms. So this is the problem that they have. There’s a civil war within the Fed and treasury that is just making these policies look even stupider than usual. And I know Powell is going to get the brunt of it because he’s the Fed chair, but he only has two other members that are on his side. The rest of them are against them. So he doesn’t really have much of a choice. He’s going to have to do 75 in December.

TN: Well you say he’s going to have to do 75 in December.

AM: He’s going to have to do 75 because we have a CPI print coming out December 14. It’s probably not going to be as nicely massaged as this one was. And on top of that he’s running out of time because the Chinese look like they’re going to stimulate in February, March.

TN: Yeah, you’re right. I agree with the timing on China opening and Chinese stimulus in the meantime is going to be really ugly in China. Do you think that it’s possible that there’s some sort of regulatory relief especially for energy that allows, eventually allows more US. Supply, this sort of thing? Or are we too far down that path with the current administration?

AM: Me and Boris are bred from DCP, the Beltway guys, we’ll just laugh at anyone with the notion that think that anything is going to get done legislatively in the next two years.

TN: Okay, but nothing getting done legislatively is not terrible, right? At least we know the rules of the game and their content.

AM: Yeah, it’s not if there wasn’t problems but there’s glaring problems everywhere and things need to get fixed. So you need something from progress.

TN: Okay, let me throw this out to you guys. We have seen a little bit of move on CPI, whether it manipulated or not. We all kind of know it’s always in there a little bit. But what’s the timing on inflation coming back into a reasonable area? Let’s say five to six, I don’t know. Are we a year, two, three years from that, six months from now? What do you guys think? Emma, what do you think?

EM: If we’re ignoring energy and then we’re ignoring fertilizer prices and food prices, we’re looking at goods, those we may see services come down and wait the wage issue come down a little bit. Just like we’ve seen with auto delinquencies, used cars, these sort of things. You see numbers starting to roll over as demand destruction and liquidity has been pulled. 

But I think you’re going to see the opposite in energy and you’re going to see diesel shortages which pushes goods prices up. Right. If every trucker in the nation has to spend a time for every time they fill up with diesel and they can’t even fill up enough, then there’s going to be not only a shortage of goods but goods prices will less go up. 

I don’t see how we fix that situation. We only have extra finding capacity. It takes like 30 years to build a new one so I don’t see how that gets fixed. So that’s something that really looks like it would push inflation upwards. So if we add all that together, I’d say we’re going to have a problem with inflation for good at least another year if we include energy and food.

TN: OK, let me ask this. That’s a great answer. Let me ask this divorce, because I know I’m going to get an answer that doesn’t agree with what I think is there pressure to broker a Russia Ukraine piece? And if that happened, would that alleviate some of these diesel price issues?

BR: I think that there is. I know that Orban, for example, and Erdogan met and basically said to Zelensky’s, time to use this window of opportunity to start negotiating. So they liberated Kirstan today, which was.

They liberated Kirsten today, which was the one major city that the Russians were able to occupy and they were offensive earlier the year. So this is kind of a huge move with the Russians on the back foot. And these are people who are everyone is playing all sides. 

And Orban, of course, is more kind of the one European leader that’s closest to Putin major leader. But I don’t think that the US is. I know that there was some discussion from the Biden administration about don’t be so categorical about Zelensky, about saying you’re not going to negotiate with Putin. It’s irritating African countries, South America, et cetera. 

You have to start taking advantage. I don’t think there’s any pressure and will be in the near term, and especially after these midterm results, I think that the risk of any major, immediate cutoffs in military economic aid from the US to Ukraine are going to be somewhat subdued now, given the kind of the risk from right and left. So I don’t think there’s going to be any nearterm pressure on the Ukrainians right now to start looking at essentially trading land for some kind of an intermediate piece.

But as a side issue, there was some in terms of alleviating the diesel and the gas problems, especially in Europe, there was some discussion about Erdogan purchasing Russian gas at a discount and essentially creating an alternative for the Europeans through that pipeline that was being built basically through the Black Sea, et cetera. 

And there was a lot of kind of talk in the US and some European capitals like Erdogan is going to save us because he’s playing everybody and he’s going to create a new gas hub in Turkey, as he declared with the Russian gas. What he’s actually going to do, and Albert and I were talking about this too, in my opinion, is because of Turkish elections next year, he’s going to keep the discounted gas, sell it at home, domestically cheaply, in order to drum up support for his reelection next year. He’s not going to resell that to the European. 

So that life raft is not going to be sailing. So therefore, I think that unless there is some relief from the weather, I’m not seeing any, because I know that at that moment, because the weather was unseasonably warm to a large extent, you have this natural gas flood in Europe now, which has driven down natural gas price, at least in the short term.

Dutch and et cetera, the benchmark. But I don’t think that’s necessarily going to sustain. I think we could have a colder winter and Erdaman is not going to provide that relief. I know the Ukrainians are looking at alternatives themselves, but the Ukrainian economy doesn’t exist anymore, really. 

Right now, we’re basically balancing their budget through direct cash transfers at the moment. I think it’s only going to be bad news and it will reinforce what Emma has said about her predictions about the diesel shortage and about just energy in general and how that would impact inflationary changes. So I’m not seeing any major improvement. 

And also, in terms of the broader discussion on inflation, I also agree that, again, kind of what I said before to dovetail off of that, like, none of the fundamentals to reduce inflation have improved, have changed markedly. So we could be, it’s really, to me, a risk tolerance for recession on the part of the Fed. 

When will the Fed decide that if they’ve given up on a soft landing, then we’re going to have one projection in terms of when inflation is going to start coming down dramatically. If they still are insisting on the fantasy of a soft landing, then there will come a point where they might decide.

Regardless of what happens with inflation, recession is a much bigger problem. And we’re going to have to, sooner than we had hoped, begin to pivot, which is probably not something that Powell would want to do, but that’s a recession versus a soft landing versus hard landing balancing act that they’re, I think, going to have to perform over the next couple of quarters. 

And I think that’s sort of their near term focus and to kind of close that point off. Right. I mean, I think that the layoffs and I mean, the fundamentals are cooling, the economy is slowing. We’re seeing that with the layoffs, the housing market is going to get worse, in my opinion. Oh, yeah, it’s a disaster.

TN: Look at the MBS holdings at the Fed. They’ve just started to tighten them. They’ve just started. Right.

BR: But then you also have to take we talked about you said auto defaults for auto loans. What about credit card debt, consumer credit card debt? And also, what about the leverage that’s on the books of these companies? Why is the tech, which is tech at the tip of the spear? Why are we seeing all of them down 70%, 60, 70% on the year? Why are we seeing the layoffs hit tech massively? First, because they grew too much too quickly and are over level.

EM: They did refinance in 2021 when they had a chance. So they’ve got like a couple of years.

BR: I don’t know who’s advising Zuckerberg here and his colleagues. I think what we’re going to do is we’re not going to refinance, we’re going to double down on Meta, which we don’t really know what to do with and we’re going to double up on the head count dealing with Meta, on the Metaverse thing, that isn’t getting adopted the way that we would want it adopted. It’s like everything, every mistake that could possibly have been made from the financing to the head count to the rollout, and that’s happening across the tech sector, but we’re financing.

TN: Would you have done differently? I would have taken on all that too, because it was fun. I’m kidding. But I actually think that there are more rounds of layoffs in tech coming. I don’t think this is the only round. I think that in the auto sector, tony and auto and other guys. 

So I think I was in Silicon Valley in 1998 to 2001. I know that’s ancient history, but my company went through six rounds of layoffs. I didn’t know when I say my company, the company I worked for, they went through six rounds of layoffs. 

So I think all these stories about people at Meta thinking they were going to dodge it and all this stuff, I don’t think that I don’t think this is the only one. I think they’re going to have to do more in three to four months. 

I think you’re going to see more companies bandwagon on top of this to say, hey, Meta is doing it and Stripes done it and all these other guys are doing it. So let’s use this opportunity to become more productive and we’re going to see a flood of these before the end of the year. Just a flood. I think the tech sector is going to be wrecked in terms of employment.

AM: Oh, yeah, without question. Even going back to your previous point about the Ukrainians and the Russians getting some kind of peace agreement, even if they did, that would solve the diesel problem overnight.

Even if they did that today, it would take a year, maybe 18 months until all that got rolling in again if they looked at the sanctions, because they still have to go through that whole process for all the countries.

EM: Russia doesn’t send us diesel heavy crude and then we have to process it at refineries, which are running at max capacity. Hence the crack spreads being so wide, we can only convert so much crude into distillates, which diesel of which is one of which jet fuel for planes is another, but both things that cost a lot of money when the prices of the input key input goes up.

TN: Okay, great. Let’s do just a really quick round the week ahead. What are you guys looking for for next week? Albert, you go first.

AM: I’m actually going to look at to see what the House majority and Senate majority makeup comprises of and whether the markets are going to react negatively towards it. Because if the Republicans, I know they’re going to take it, but when they get announced that they take the House, the stimulus packages all but die at that point for two years. So I’m very curious to see how the markets react to that.

EM: I’ll be continuing to watch what’s going on in Crypto to see if anything’s happening with Bitcoin ethereum, because we’ve already seen a lot of other tokens just literally, basically go to zero. So just see how that continues to play out.

TN: Great. My $20 a DOJ is still at, like, three times where I bought it at, so I’m just holding on to it just to see where it goes.

EM: And then I’ll also, obviously, as usual, be watching China and certainly the bank of Japan and just the end period.

BR: Yeah, like Albert, the makeup in Congress and also going to be looking at some of the emerging markets. I think maybe if we’re going to get more evidence out of China as to when they’re still pursuing COVID Zero, I think they’re now recording again, like, a record high number of cases from April. It’s not working yet. They’re continuing to double down and reward everybody who’s pursuing that. 

So I want to see if they’re going to continue with that and they’re going to be on track for what Albert said to reopen early next year or if it’s just going to get worse. So that’s what I’m going to be focused on.

TN: Yeah. You’ve heard of the great league forward, right? I mean, these don’t really take sound policy advice. When they get their mind on something, they just push it and push it and push it until it harms everybody they can.

EM: I often when you’re trying to when you have, like, the worst debt crisis ever and the population that’s, like, you know, put the equivalent of $50,000 down on apartments, like, millions of people have done that, and they’ve got nothing to show for it, and you want to keep them from acting out and protesting in the streets. It’s pretty convenient to have them all segregated where they’re not communicating. I wonder really what the motivation behind COVID Zero is. And so I don’t know if I buy that it’ll ever end until it’s convenient for it to end economy wise, where she feels no threat.

TN: I don’t necessarily disagree with you. I think things in China don’t necessarily end until they want them to end. Right. And if you look at exports from China to the US. They’re back up to preCOVID levels now. So in terms of that export machine in China, it’s humming, right? So there’s not feeling economic pain, at least in terms of trade. 

So if they’re comfortable feeling the domestic economic pain, then why would they stop? So I think what Albert talked about is Code Zero ending in March, and he and I’ve talked about that a couple of months ago as well. I think that’s the best case. So I think there’s a best case that they end it and they stimulate in March, but it’s quite possible it continues going on because there may be social reasons, there may be other reasons to not open up. 

So I don’t think, as westerners, we can look at the Chinese government necessarily and understand the perspective they have on policy and the reasons they have for policy. There is so much inside of Jungkonghai and all of the different things that happen that we just can’t look at it rationally and say they should do A, then B, then c, and very few Americans can look at that and understand why and how it’s happening. You may be exactly right.

EM: Yeah. It’s not a logical I mean, it’s more like if I’m she or if I’m trying to do this, it’s not really like what westerners typically associate as logical things to do economically. It’s more like it’s possible.

TN: Yeah. Anything’s possible. Guys, thank you so much. I really appreciate the time you took to talk through this. Have a great weekend. And have a great weekend. Thank you so much.

Categories
Week Ahead

Growing out of stagflation, Fed operating impact & Brazil Risk: The Week Ahead – 7 Nov 2022

Learn more about CI Futures here: http://completeintel.com/futures

In this episode, we are joined by two special guests – Mary Kissel and Travis Kimmel – as well as our regular co-host Albert Marko. Mary is the EVP and senior policy advisor at Stephens. She was the senior-most aide to Secretary of State Mike Pompeo and was on the editorial board for Wall Street Journal. Travis Kimmel is a technology entrepreneur, market philosopher, and spicy tweeter.

First, we dig into the approach to getting out of the  current stagflationary model. The Bank of England, the ECB, the Fed, and the BOJ are starting a managed decline. And the real question is, is that really necessary? Mary Kissel walks us through how the Fed may actually be making things worse.

We all know the Fed raised by 75bps and is expected to continue with at least 50bps in December. Raising rates has decimated tech names and made operations significantly more challenging. Travis Kimmel discusses the impact of the whiplash in interest rates on operators, on the people who run companies, and how they run those companies in this type of environment.

And then finally, with Albert, we talk about Brazil. We saw a big election result in Brazil this week with Lula declared the winner. Many Brazilians are not happy.

Also, note that Brazil is one of the largest emerging economies and a huge trade partner for China. Lula has already made comments in support of Russia in the war with Ukraine. What does this mean? Is Brazil a risk for US power in the western hemisphere, given China’s inroads in Venezuela, etc?

Key themes
1. Can we grow out of this stagflationary muddle?
2. Impact of Fed rates whiplash on operators
3. How big of a risk is Brazil?

This is the 40th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:
Tony: https://twitter.com/TonyNashNerd
Mary: https://twitter.com/marykissel
Albert: https://twitter.com/amlivemon
Travis: https://twitter.com/coloradotravis

Transcript

Tony Nash: Hi, and welcome to the week ahead. I’m Tony Nash, and I’m joined this week by Mary Kissel, Travis Kimmel and Albert Marko. You all know Albert well. 

Mary Kissel is the EVP and senior policy advisor at Stevens. She was the senior-most aide to Secretary of State, Mike Pompeo. She was editorial board for Wall Street Journal. Mary is extremely well known. She doesn’t need an introduction.

Travis Kimmel is a technology entrepreneur, market philosopher and a spicy tweeter. So really glad to have you both today. I really appreciate it.

Before we get started, I’m going to take 30 seconds on CI Futures, our core subscription product. CI Futures is a machine learning platform where we forecast market and economic variables.

We forecast currencies, commodities, equity indices. Every week markets closed, we automatically download that data, have trillions of calculations, have new forecasts up for you Monday morning we show you our error. You understand the risk associated with using our data. I don’t know if anybody else in the market who shows you their forecast error. We also forecast about 2000 economic variables for the top 50 economies globally and that is reforecast every month.

Let’s move on. Thanks guys. Thanks very much.

So this week we’re going to move on to some key themes. First, there’s a really interesting concept that Mary brought up. Can we grow out of this Stagflationary muddle? And I really look forward to getting into that a little deeper. 

We’re going to also with Travis talk about the impact of the whiplash in interest rates on operators, on the people who run companies and how they run those companies in this type of environment.

And then finally with Albert we’re going to talk about Brazil. We’ve had a big political change in Brazil and it seems more meaningful than we’re being kind of told. So I want to dig a little bit into that.

Mary, first let’s dig into kind of the approach to getting out of this Stagflationary model. So the UK, the Bank of England, the ECB, the Fed, the BOJ, they all seem to be, as you said, starting a managed decline. And the real question is, is that really necessary? 

And I’ve got on the screen the balance sheets for the ECB, BOJ and BoE and the Fed of course.

And then we also have a graphic for the CPI versus the money supply. Looking at CPI change and what that is related to the money supply.

Do we in fact need to manage this? Decline I think is a real question and I guess who is growing out of this? I think it’s possible that China grows out of it. I think that’s the only card they have right now. But I’m really curious to hear

your thoughts on this.

Mary Kissel: Well, it’s great to be with you Tony, Albert, Travis, thanks for inviting me today.

Of course growing is the best option. It doesn’t necessarily mean that it’s the most politically salable option. But obviously it’s preferable to inflating away your debt and effectively ruining the savings of seniors and putting an enormous burden, particularly on the poorest and in our various economies. Do they developed or developing economies? 

I hate to talk politics because I think it’s always easier for the street to say, “well, you know, we’ve got these neat models and economic forecasts and if you just pulled this lever or that lever, we could achieve X amount of growth.” But the reality is that you have to take politics into account and it’s just very difficult to take the kind of measures that we need to take to grow. And I think you saw that you mentioned the UK and your introduction. You saw that most clearly recently in the UK, where former Prime Minister Liz Truss and her chancellor Kwasi Khortang came out with really what was the only plan outside of Greece?

Greece is the only country that is focusing on growth. They’re looking to hit investment grade next year. But beyond that, the UK was the only country that had really put forth that formula that we know works, which is it’s not just about tax cuts and reducing that burden, it was about stimulating the supply side, opening up Britain’s energy reserves, fracking, going back to the North Sea, encouraging investment.

I mean, if you look at the UK and their economic statistics, it’s pretty shocking. I mean, the two decades prior to the Pandemic, they had growth less than 2% real wages were stagnant for 15 years. Their investment was terrible, even lagging behind their OECD peers. And yet you’ve had twelve years of Conservative governance there and they haven’t really turned the corner. Why? Because politically it’s just simply easier to tax and spend. And once you get on that track, it’s really hard to get off of it. So maybe I’m talking too long, you just one more time.

TN: No, this is a great point. But in talking about managed growth and you brought up politics, I feel like there’s this kind of fate accompli in most Western governments around. Well, we’re really on the downside of our opportunity and we’re a declining country, so we’re just going to manage ourselves that way. And when I think about things like the semiconductor investments and other things coming into the US.

I live in Texas, I don’t know what it’s like in other parts of the country, but it is really booming here. We have a lot of tech companies coming in, we have a lot of investment coming in. It’s a good investment climate. I mean, for anybody in New York or California, it’s terrible here, a lot of rattlesnakes and scorpions. But in terms of the economy, really great. 

And so I want to talk about that a little bit in terms of kind of the fake company around. Well, we’re kind of past our prime. Is that kind of a baby boomer thing? I mean, millennials are as big as baby boomers. So is there this demographic assumption baked into that? 

MK: Well, look, I mean, democracies get the leadership that they elect, period. And so, you know, I may not like what’s happening in Britain. I may think that they’re on the road to looking like France in terms of their, you know, permanently high double digit unemployment and lousy investment and lousy growth, lousy prospects for their young people. If they’re voting for that, that’s what they’re going to get. 

I think that from an investment community. When I’m talking to Stephen’s clients, they’re saying, all right, well, where is there the opportunity for a political process to move us in the other direction? And that’s really just the United States over the next couple of years. I mean, that’s kind of it. Not going to happen in Japan, it’s definitely not happening in Australia, it’s not going to happen in continental Europe.

But the danger here is that the population, particularly the young people, get so mad that they realize that they have no opportunities left, that you see popular protests and you see a push to political extremes. So, look, protests are still going on in France. You’ve got protests starting to erupt in Britain. I wouldn’t be surprised if you saw that in more places across the continent as this energy inflation starts to hurt and as voters realize that this formula of price caps on energy, which isn’t going to solve any of the underlying supply problems of taxing and spending.

So it’s just a huge burden if you want to kind of start a business and get something going. No real move towards less red tape or the ability to kind of start a business and innovate. People are going to get upset at that. Again, I don’t think Populism is dead on the continent, and I think that the US, as these countries kind of go down, I think the US looks more and more attractive.

Albert Marko: No, I mean, Mary is absolutely correct. I’ve always been a proponent of looking at politics in terms of investing, just because things have been shifting so much, being in the United States, emerging markets, which is the rest of the world at the moment, like Mary said. Yeah, I mean, Populism

is absolutely not dead. With layoffs looming in the United States, we’re probably going to see more protests here in the United States gearing up to 2024.

But just like Mary said, I don’t see anywhere else in the world right now that you can actually invest in except for the United States. And I think it’s a little bit by design, by Yellen in them to force money to come out of those countries and into the United States. Although it’s a good thing for the United States in the short term, it’s destructive long term for the global markets.

MK: Sorry, just one more point. In order to get political change and to get back to that growth idea, you have to have real differences between the left and the right in democracies. And I think a lesson that came out of a place like, say, France, where Macron just sat himself in the middle, he destroyed the choice. 

And you know, the Conservatives have done the same thing in the UK. They’ve sat themselves in the middle. They took a lot of the center left platform. So what are you going to do if you’re sitting in Manchester, right? Like, who do you like? Labor light in Rishi Sunak or do you just vote for labor? I mean, it doesn’t really matter, does it? You’re going to get the same outcome, right?

TN: So we’re going to do a little bit of what Tom Keen talked about regular. We’re going to kind of rip up the script here and I’m going to ask about you talk about inflation, talk about the leadership in places like Europe. And is it at all possible I know this is kind of a silly question, but is it all possible that in places like the UK or continental Europe that it’s possible to start fracking? That we start getting some of that upstream activity to ease the burden of energy crisis?

MK: No, you’re going to need a war.

TN: Okay? So the dirty upstream stuff, according to Europe, is other people’s problem. They just want cheap energy.

MK: Look, it took Putin slaughtering thousands of people in Ukraine for them to realize that, hey, maybe Russia isn’t a secure supplier and yet they’re still not welcoming fracking. They’re still not coming to the United States and saying, hey, how do we open up more LNG? What are you guys doing?

Right? I mean, this is unbelievable. What is it going to take?

TN: Something like Larry Tankers sitting off of Europe right now, waiting to unload because there’s not enough capacity?

AM: What it’s going to take is exactly what you said, political people, to the point where it just starts dripping over governments. And right now there’s been a push for Blinken to push leftist governments throughout the world right now that it’s just like the status quo everywhere. They’re not going to open up the franking. We’re not going to touch any kind of environmental issues over in Europe right now.

MK: Look at Rishi Sunak doing a U-turn and going to the COP conference. I mean, this has to be the most ridiculous grouping I’ve ever heard of. I mean, at a time when you’ve got like ten plus inflation and people can barely pay their bills or buy eggs or the rest of it, or fill up their car, they’re going to talk about climate change. Are you kidding me?

TN: China’s tripling down on coal.

MK: Yeah, I’m also clean climate too. I don’t care what kind of energy we use, as long as the market’s figuring it out and we’re letting innovation happen, period.

AM: Well, they’re going to start blaming Brexit. Even the Tories are going to be like, oh, maybe we should stay into the EU.

MK: Could Britain go back to the EU?

AM: Maybe? Yeah, they could.

Travis Kimmel: I think the thing that’s really challenging here is we just need coherent and stable frameworks for a lot of the stuff, whether it’s energy policy, monetary policy, like if you think about what the purpose of markets are, to take a really simple example, take a CSA. What is that? It’s a futures market. It’s done in a really small scale. You got a farmer who’s basically short forward produce, right, and you’re buying futures and then you’re taking delivery of whatever lettuce and cabbage and. 

If you think about that as it’s a very simple example of what a market is designed to do, it’s designed to allow operators to derisk their business. A large futures market is no different. I mean, I work in tech. We’re sort of like extreme beta, right? And what we just went through here is we went through this period where everyone was looking at a massive boom as a result of policy. And so we all started hiring and there was the time we’re all trying to hire the same time. Staff up handles the influx of business and then in the middle of that staffing motion, your reverse course. So now you have these companies that are… You heard Stripe come out, they’re cutting 14% and just owning it. Like we missed-staff for the environment. 

There was almost no way to navigate that properly for operators. And so what you have is you have this destructive policy impulse that is sort of like ruining the whole reason we have markets in the first place.

The reason we have markets is to allow for derisking. And speculators come in there and they provide liquidity and it’s awesome. Markets are awesome. But we’re removing the value that markets once had for operators. And if you’re out here in the economy running a business, it’s extremely hard to navigate that.

TN: Yeah, Travis, that’s a great segue. And let me put up your tweet that you put up earlier this week. Talking about Powell saying some of you losing your job is like little rays of sunlight to me and I think that’s great.

And talking about how do operators work in areas in times of rates whiplash like this, I think bringing it back to risk is, is it? Right. And I run a tech firm. You run a tech firm and it’s not about high rates or low rates. It’s about the magnitude of change for planning. Right. So we can plan for a high rates environment if we know that’s going to happen.

We can plan for a low rates environment if we know that’s going to happen. But that stability is what economies like the US are built on. Right? Yes.

You mentioned one word, “coherence.” And I’m afraid that that’s a little bit too much to ask from policymakers right now, especially when we have the push pull going on with the Fed and the Treasury right now, right?

TK: Yeah. I think we’ve been overdriving this thing for years now. Basically, you saw this in, think about the events that we tried to respond to policy with. You have basically volmageddon. They were like, oh, and they used policy to address that. So your policy takes two freaking years to come through. I mean, how can you respond to a pandemic via policy? I know people get really upset about the SPVs where they short up private credit, but I would say that was probably the smartest thing they did.

So this pandemic and it was like, oh, it’s a few hundred million, right? And so they shore up private credit. Like we’ll backstop that. Arguably, that is the original intent of central banking, is that motion. Of course, you’re supposed to do a higher interest rate and all that badge itself, but whatever.

So that tiny motion was sort of interesting and maybe well played, but flooring rates, making money free and then just jamming liquidity into the economy at the same time, and we’re basically, they generated this boom that we’re now on the back of.

Now we’re reversing that super hard. I just don’t think you can respond to this kind of stuff with monetary or fiscal policy. I don’t think you can respond to emergent events. It’s not an emergency thing. What these are designed to do is to tune structural weirdness like you could tune a demographic change because demographics aren’t going to change that much in a short period of time. And so you can apply a policy to that and wait for the policy to translate through. I think what I would have liked to see when they realized their error here is just set rates at whatever, 3%, leave the balance sheet slowly until you’re back to where you want to be. And don’t do much. All these extreme action where the Fed comes in, they’re like, we get an event we don’t like, whether it’s the coronavirus or inflation or whatever. And they’re like, we’re on it. We’re going to respond swift and hard. That’s the mistake. You can’t do that. So we’re now going to get this…

What I expect to see here is eventually they will solve inflation. But that solution is by the time it translates through, it’s going to have its own momentum and it’s going to be very destructive.

TN: Oh, yeah. I think the real irony is you have publicly traded companies that are expected to give market kind of insight twelve months out to the penny on the share level, right. But then you have Powell standing in front of the world saying, we’re not really sure what we’re going to do next month. It may be whatever, and it’s data dependent. It’s like, really? Like, how many people do you have, analysts do you have? And you don’t know what you’re going to do in 30 days? That’s crazy. Right?

MK: I think Travis is raising such a good point. And the underlying theme here is that is to do something right and to juice the markets on the monetary and the fiscal side. That’s why I put in a plug. If you haven’t read it. James Grant’s book on the 1921 crash, like The Forgotten Depression, such a great book because essentially it’s like do nothing in the market. It will take pain, but then we’ll come back up.

TK: I love you mention that example. It looks like we are generating that exact same, it looks like we’re

generating a depression. Not like the depression that everyone remembers, but that little, very short, swift, extremely difficult period of time. It’s like a couple years in 1920. We’re teeing up the same thing here. It’s really weird.

MK: People make it worse. I don’t know, Travis.

TK: Look, I’m not going to fail that.

MK: I think you could be in the 30s because they’re not going to do nothing, right? They’re going to cap energy prices. They’re going to do more programs to help people.

TK: You have to let the market achieve homeostasis. And the bond market is like, it’s the spine of the economy, and we just keep whipping it back and forth. So everything else is going to be high data.

AM: Yeah, but why are they whipping it?  It’s because the political influences within the central banking system, whether they’re Treasury and the Fed. Right now, nobody is talking about the real civil war happening between conservative Powell and some of his members at the Fed, and Lail Brainard and Yellen, who are liberal that are trying to help Democrats by pumping these markets. They crush the bond market only to pump it up two points, like within minutes to pump the Nasdaq, and then the market starts running with it, and then they parade out all these liberal members of the Fed to counteract Powell’s speech yesterday.

So it’s like we can hope for stability, but until they depoliticize the Fed to the point where it’s actually acting properly, I think it’s just a pipe dream.

TN: Do you think Powell is overplaying because of the kind of politics inside the Fed?

AM: Oh, absolutely, because if you look at the Fed minutes in the FOMC releases, those are going to continue to be muted because it’s a cooperative process. Right. They have all the members talked about vote on issues and whatnot, and then Powell has to come out there and counteract that and say, listen, things aren’t working out like the minutes are reflecting, so I’m telling you we’re going to go 75 basis points next meeting. And then again today, they bring out another Fed member to say, oh, no, it might be 50, it might be 50, and then the market shoots up 100 points. This is absurd. Right? That’s an untradable market. It’s untradable market. Right? Yeah.

TN: Since we’re talking about policy fumbles, and Mary recommended a book. I don’t know if you’ve read, Ammonie Schlay’s The Forgotten Man, fantastic book about the 1930s, talking about policy error after policy error after policy error. FDR is proclaimed as this hero who got us out of the Great Depression, and he absolutely screwed up time and time and time again, and took what could have been a two-year recession and turn it into a twelve-year recession. Right? Yeah.

And so are we entering that again? That’s the real question. And it’s really easy for people to say, oh, we’re in the 30s again. I mean, I hear that so many times, it’s just tiring. Right. But we have to look at why the 30s happened. We have to look at why 1921 was so quick and then understanding what the implications for policy and the economy are.

Travis, what you brought up in terms of quick, sharp actions for specific events is exactly what we need. I think rate rises are stupid. Playing these stupid rate rise games, it freaks everyone out. It creates volatility, uncertainty, and nobody can plan. And then you get between now I think we talked about this two weeks ago, Albert, between now and the end of the year, we’re going to see so many layoffs in tech companies and they’re all going to get them just in time for Christmas, because that’s what happens all the time. Right?

TK: The thing that Albert highlights here is really interesting. It’s like, from a decision making perspective, we have the speed wobbles. You’re riding a bike and you get that thing, it’s like, you know you’re going down, you can’t pull out. We just have that right now. We’re whipping this thing back and forth. We’re being hyper reactive. And until we get to a place where we can just sort of chill for a while. Does anybody think that’s on the horizon? It doesn’t look like it. No.

AM: Not as long as politics and inflation are taking hold and there’s elections to be won. That just can’t happen.

MK: I think investors, they go back to basics. They say, OK, where do we have a stable rule of law Where do we have any kind of predictability in the political process? Or even, you know, as I said, the US like the opportunity to have a more attractive business environment. 

And where do we have resources? You know, human resource, mineral resources, you know, and so that’s essentially the Gulf in the United States.

TN: Don’t talk to Texas too much, Mary, please. Okay, perfect. Guys, thanks for that.

Let’s move on to Brazil. Brazil’s obviously a really big story this week, and Albert, we saw Lula declared the winner. This was very much a 50-50 election. Of course there were irregularities. There were irregularities in every election. We’ve seen five days of protest now. I’ve got a tweet up from Steve Hanke talking about tens of thousands of Brazilians out who are Bolsonaro supporters.

But what’s really interesting to me about this is not really who wins, but Brazil is a huge supplier of things like energy, frozen chicken, soybeans, these sorts of things to China. And so this type of disruption can hurt that type of trade. We’ve also had Lula already make supportive comments of Russia shortly after the results were announced. So, Albert, what does this mean? What do we need to be looking out for?

AM: Commodities, really. Soybeans, soybeans, corn, ethanol and everything tied into that. Now you’re looking at Brazil, which you’d mentioned is a big supplier to China for soybeans. And then he goes on and declares that Putin is right in Ukraine. It just smells so bad right now for the United States and the longterm interest in the region.

Like I mentioned before, these push for leftist governments, it’s just not wise. I mean, it’s shortsighted.

Long term, these leftist governments are really susceptible to Beijing and Russia at the moment. So, you know, you’re out there and Lula comes out and immediately declares, like, the World Economic Forum is correct, and we’re going to take on deforestation, which is obviously going to obviously going to depress the soybean crowd because it takes years.

How the soybean crops work is like, you clear land, and you got to let them sit there for two years, and then you start rotating in and out. So there will be a steady supply of soybeans that the Chinese eat up pretty much, I think, like 60% or 70% of their crop every year. So what are we looking at? Higher food prices across the board, everywhere in the United States is specifically a problem.

TN: So I’m interested in that regional political angle you mentioned. So if we look at Brazil, we look at Venezuela, we look at Colombia, the government’s coming into kind of our region, and the influence that China has on, say, Venezuela with the debt that’s owed to China Development Bank and then with Brazil on the trade side and so on, is that a regional political risk for the US?

AM: It’s an incredible risk. I mean, you’re looking at the Argentinians about to sell a naval base to the Chinese. So now they have Atlantic access. Bolivia was a problem with the lithium mines to the Chinese. Peru was starting to set up naval bases for the Chinese. I mean, it’s like, how do we overlook this? This is right in our backyard, and we’re sitting there overlooking leftist governments taking control and then flipping against us the very next minute. I don’t understand what Blinken and Jake Sullivan are looking at here. What plan do they have for US interests long term when these governments routinely act against us? Venezuela decided to go start talks with Colombia again. US friendly nation in any sense of the word. So it just boggles my mind at the moment.

TN: So, Mary, you’ve sat in the seat. What would you be thinking at this point?

MK: Well, the key to all of this is Cuba because none of these regimes, many of them, would not be in power were it not for the Cuban security services, which is not really talked about, but, you know, Maduro good examples, publicly available information. His private security officers are all Cubans. So I think Biden had a fantastic opportunity early in his term. All these Cuban people came out under the streets. We should have turned on the Internet and allowed them to determine their own fate.

But instead, where did that go? Nobody seems to care. I think Latin America today for the administration, is more about domestic political ends, and it is about thinking strategically about wait a second. Okay, we’ve got some pretty decently large markets, as Travis  pointed out, right?

In Brazil, in Argentina, and Mexico is going way far away from us. That’s another huge story nobody’s talking about. Canada. Right? There’s a lot of opportunity within the hemisphere to create market openings and growth for all of us, but they’re not thinking about it. They really don’t care. It’s about talking about democracy in Brazil so they can talk about the state of democracy in the United States.

AM: Yeah, it’s just because Colombia was such a great US ally and the government was solidly behind the United States and a focal point for Latin American aspirations, and then you go and push for a leftist government that’s favorable to Maduro. I don’t understand what goes through their heads at the moment.

TN: Great. Okay, thanks for that, guys. Just one last question for all of you. Kind of don’t have to necessarily come in individually, but we’ve had all these economic announcements this week. We’ve got the elections, the midterms, US midterms next week. What are you guys looking for in the week ahead Generally? I guess, Albert, you have some specific ideas, but for Travis and Mary, what do you guys expect in the week ahead?

AM: For the midterms, it’s pretty much set in stone as the Republicans are going to take control of the elite the House most likely to Senate by two seats. So you know how the market reacts. Whether we start dumping is really going to probably depend on CPI.  So that’s actually what I’m going to really watch, the CPI so we can solidify the 75 basis point rate hike in December.

TN: Okay, great. Travis, any thoughts.

TK: In the political sphere, I’m just kind of looking for individuals that make sense. I’m not really, I don’t really have team allegiances. I just want somebody who’s talking sense.

I think the CPI will be interesting. In terms of intraweek stuff, I try not to think of markets that way. I try to think of a little more defensively and where I want to end up. So if I had a position on, I want to be able to ignore it for a month or two while I just focus on doing my job. I’m a pretty defensive player here. Especially with all the whip.

MK: I think even if Albert is right, and I think he is, that Republicans take control of one or more houses, the regulatory state is going to grind on. So I’m really not looking so much at the federal level. I’m looking at governor’s races where like a Republican Lee Zeldin as Governor of New York could open up fracking in New York.

TN: Is that a real possibility, do you think?

MK: I think it could be, absolutely. Remember Cuomo shut it down himself, so why couldn’t Zeldin open it up?

TN: No, but do you think Zeldin being elected is a real possibility, do you think?

MK: Oh yeah. Really? Remember Giuliani, the pollsters went out and they were like, hey, you’re going to vote for Rudy? And everyone on the Upper West Side said, no, I’d never vote for that guy. Right. And then they looked at the crime in the mess, and then they went into the polling moves and they went yeah, exactly. Right.

TN: So it could be New York, could be Michigan, some of these other places that have had some polarizing governors kind of move more to the right or to the middle.

TK: Do you think that policy at a state level is sufficient to justify capex for energy companies?

MK: No. I mean, really, only the Feds can make a meaningful difference at the margin. I talk a lot to clients about the regulatory state, because we don’t talk about it a lot. But that really is what depresses investment.

Categories
Week Ahead

China risks, tech earnings, and crude stockpiling: The Week Ahead – 31 Oct 2022

Learn more about CI Futures

In this episode, we’re joined by Isaac Stone Fish, who is the CEO of Strategy Risks. He’s the author of a book called America Second, and he lived in China for seven years.

We talk about how are foreign companies dealing with the political changes in China? Or what should they be paying attention to? We’ve seen changes in Xi’s team that, to be honest, weren’t all that unexpected, but seems unexpected anyway. It’s certainly a hard turn to the CCP’s commie roots. This tweet really underscores how desperate Xi is to set an old school tone.

Markets have seemed a little spooked this week, so we saw orders from Beijing to prop up the CNY and Chinese equities, which didn’t work all that well. But with all the political and market backdrop, what does all of this mean for US and other foreign businesses? Are foreign employees at risk? Do we expect direct investment to slow down?

On the risk side, we look at tech earnings, which are super bad. Hiring is a huge issue and tech firms seem to have been hiring based on their valuation not based on their revenues. When will we see headcount reduction announcements? One of Meta’s investors was saying they should cut 20%. Albert shares his views on this.

And we’re also looking at crude oil inventories and refined product inventories. They’re way below averages. We saw another draw on global inventories this week. As OPEC supply is contracting ~1.2m bpd. Russian crude sanctions start soon. And US exported 5.12m bpd last week, making it the 3rd largest crude exporter. We know global inventories are low, but when will it start to bite? Tracy shares to us what’s going in.

Key themes

1. China risk for Western companies
2. Tech earnings & China
3. Crude inventories & Asia stockpiling

This is the 39th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.

Follow The Week Ahead panel on Twitter:

Tony: https://twitter.com/TonyNashNerd
Isaac: https://twitter.com/isaacstonefish
Albert: https://twitter.com/amlivemon
Tracy: https://twitter.com/chigrl

Time Stamp:

0:00 Start
1:00 Key themes for this Week Ahead
2:52 What the news about China means to Western businesses
6:38 What has changed around the concept of Communist Party membership over the last ten or 15 years?
8:20 Anybody who’s overseeing a business in China has to understand modern Chinese history
9:31 Risks for foreign staff in China
12:34 Congress does not want US companies to do business with China
14:14 Danger of a rush to the exits in twelve months
17:58 Tech earnings are super bad – how bad will layoffs be?
21:10 Is it possible to cut 20% of Meta’s workforce?
22:44 China and US competition in India and other countries
24:52 Crude inventories – when will this start to bite?
28:31 Japan is stockpiling crude – is it because of geopolitical concerns?
29:47 China stimulus – will they do it in February?
31:55 What happens to the crude demand of Covid Zero ends?
34:27 Will oil prices raise by 30% before 2022 ends?

Transcript

Tony Nash: Hi, everybody, and welcome to the Week Ahead. I’m Tony Nash. Today we’re joined by Isaac Stone Fish. Isaac is the CEO of Strategy Risks. He’s the author of a book called America Second, and he lived in China for seven years as the New York Times in New York Times bureau. So we’re really lucky to have Isaac with us. We have Albert Marko, of course. And Tracy Shuchart. We’re very fortunate to have them again today with us.

So, Isaac, welcome and we’re really happy to have you.

Our theme today that we’re going to talk through first is how are foreign companies dealing with the political changes in China? Or what should they be paying attention to? 

On the risk side, we’re looking at tech earnings and the impact that tech earnings will have on other earnings and headcount reductions and other things over the next few months. And we’re also looking at crude oil inventories and refined product inventories. They’re way below averages. 

And we want to hear from Tracy as to what’s going on. 

Please take a look at our product, CI Futures. It’s a forecast subscription product. It’s $99 a month. We cover a few thousand assets over a twelve month horizon. Economics, currencies, commodities, equity indices. So please take a look at that. The URL is on the screen. Thanks a lot for that.

So, Isaac, welcome. Would you give us a quick overview of what Strategy Risks does?

Issac Stone Fish: Strategy Risks works with corporations and investors to help them manage and reduce their China risk. And with increased tensions between the United States and China, and growing awareness of the liabilities in both China and the United States of working with the People’s Liberation Army or the United Front or the Ministry of State Security or the Chinese Communist Party more broadly, it’s been a good couple of months for us.

And so excited to be joining you and chatting with you on these issues.

TN: You must be working 24 hours a day. I have no idea how you stay, how you get any rest right now with all the stuff that’s going on in China. 

ISF: Under drugs right here.

TN: Isaac, I’m curious, with all of the political changes announced this week, of course, that’s been way analyzed, a lot of different perspectives on things. I would warn people as they read through that analysis, just be careful of kind of some anti China bias, but we have to kind of read things for what they are too.

We saw changes in Xi’s team that, to be honest, weren’t all that unexpected. People have talked about this for months, but the fact that he actually carried through with it, I think made people feel like it was a little bit unexpected. 

But it’s certainly a hard turn to the CCP’s communist roots. I’m showing a Tweet right now looking at Xi taking his team to pilgrimage where the long march ended during the Communist revolution. And so he’s just the optics around the hard turn to the party’s communist roots are front and center.

So Isaac, markets were spooked this week. Of course, we saw orders from Beijing to prop up CNY and prop up Chinese equities. Obviously didn’t work very well. But with that backdrop, what does all this mean for US and other foreign businesses? I know it means a million things, but if you had some top level takeaways, what are the things that you’re seeing that it means for, say, US and other foreign businesses in China?

ISF: Have a really good understanding of leftist ideology. If you decide that you want to stay, which oftentimes we discourage, and if you decide that you don’t want to reduce your exposure, which we always discourage. Have a really good understanding of how Communism works, and read the tea leaves. Spend a lot of time on analysis. Understand that every Chinese company or every company in China that has at least three party members has to have a party cell. And for a long time people overlook that law.

But companies like Alibaba have tens of thousands of party members. So understanding that you’re partnering with the Chinese Communist Party and things that you used to be able to get away with, you can’t anymore. I think the other high level take away is with increased media, consumer and congressional scrutiny on China. 

What happens in China doesn’t stay in China. So the work that you do with a major Chinese charity which does say party building exercises in Chinese orphanages, aka Brainwashing Chinese Children on Party ideology, we can get that information here. Congressional staffers can read that, journalists can pick that up, and you’re going to have to start dealing with the liability of that from a PR perspective. The final highlevel takeaway, the more Xi marches to the left, the more draconian things get. And the more saber rattling we see with Taiwan, the more likely it is that the US and China go to war over Taiwan.

Right now, I would say that’s still not the base case. War is very avoidable. It probably won’t happen. But it’s a very concrete risk and investors and I would argue especially boards of major corporations, need to be discussing this risk. And perhaps the best thing to do with the risk is to say, okay, we know this, we’re not going to change. 

But I think if there is a war, companies are going to have to face some pretty serious shareholder lawsuits because it’s a viewable risk and you didn’t do anything about it.

TN: Right. So let me ask you, take two questions. First is, in 2010 or ’11, I spoke at the Central Party School in Beijing, and the person who drove. I was giving an economic update. I was working with the Economist at the time, and it was so surreal for me. The person who drove me to that event was a venture capitalist. And so I think the view that many people have of Communist Party members is, oh, you know, they’re these soft guys, they’re capitalists like us too, you know, that sort of thing. What has changed around the concept of Communist Party membership over the last ten or 15 years?

ISF: Think of the perception. So when Rupert Murdoch in early 2000s was going into business in China, he would downplay the importance of the Communist Party and say things like, oh, they’re just like us, there’s really no difference. And some people just join the party for opportunistic reasons, and some people do it because they believe, but they’re fairly soft spoken and gentle. And then there’s the very hard security element of the party. 

And I think people are realizing that for every venture capitalist, there’s also the PLA secret agent or the MSS agent or the public security agent in that these people are increasingly important in the Chinese system. 

And the other piece of it is that it used to be seen from a Western context, both PR and regulatory, relatively benign to be working with party members in the Communist Party. But after the genocide in Xinjiang, after Xi’s increasing authoritarianism, people are not getting the pass that they had before when you and I were out there.

TN: Right. And so I think it’s really critical. Anybody who’s overseeing a business in China has to understand modern Chinese history. You have to start from the great famine, really. I mean, start from the revolution, but really the great famine through the Cultural Revolution, through the 70s, through Deng Xiaoping, through… That era is really critical to understand what’s happening today. Right. Because that’s when Xi Jinping grew up and that’s when his ideologies were formed. Is that safe to say?

ISF: Good is safe to say. I think the other thing that we have to understand is we do have to be incredibly humble about our ability to understand what’s going on at the top of the party. We have very little idea. People are going to keep speculating about that crazy video with former Chairman Hujing Tao. We probably won’t know what happened there for decades, I would guess.

And I think when we talk about war with Taiwan, we talk about what’s going to happen between the US and China, we have a lot of insight into how Biden thinks and almost none into how Xi Jinping thinks. We just need to bake that into our predictions.

TN: Yeah, that’s absolutely right. And I cautioned on that earlier this week about the Hoojin Tao exit. It could be health, you don’t know. Right? It could be intrigue. You don’t know. So none of us know. 

So let me also ask you, when you talk about you had a tweet about potential China-Taiwan war earlier this week, and you talked about Chinese staff for American companies or Western companies, sorry, and you talked about Western staff in China. So can we talk about some of those risks, like the real people risks for multinational companies who hire Chinese employees. And none of this is intended to be Xenophobic.

This is intended to be purely practical in understanding really what the risks are. And also with those foreign staff in China. Can you help us understand some of those risks?

Tracy Shuchart: Yeah, I was going to ask something along that line, if I can just tag on my question to that one. We saw a bunch of people who are Americans pulling their staff from Chinese chip companies right, lately. So I was wondering if you saw that, see that trend continuing and bleeding into other sectors besides just the tech sector.

ISF: I very much do, and I think there’s two ways to think about this. One is the economic and regulatory so increasing difficulty doing business in China, desire for localization of staff, Biden regulations that restrict the ability of Americans to work at certain Chinese chip companies. And then you have the potential for war. 

And the idea is that if the US and China go to war, American staff in China and also Chinese staff for certain American companies could be seen as enemy combatants. And we saw this with Afghanistan, we saw this with Ukraine. There’s orders of magnitude, more staff for Western companies in China than in these places. I mean, it’s not even comparable, the numbers. 

And I think from an ethical perspective, I get really worried that people don’t talk about war because then war could just be on us. And the United States has a terrible history of interning Japanese during World War II and harassing Germans during World War I. I think with the dynamic with Chinese people here, we need to have a concrete conversation about it so that we can defend the rights of Chinese and Chinese Americans in America if we go to war. 

And from a corporate perspective and from a risk perspective, companies need to have exit plans for their staff in China because they’re going to be dealing with major, major ethical and insurance risk issues if this happens. And they can’t just take the foreign staff out to Hong Kong anymore. Because that’s not like a free zone anymore. And you hear stories of people being smuggled out now, and I think we’re going to hear a lot more of those, and that’s going to be more and more common.

TN: So, Isaac, what are we missing when you see the discussion about China right now and with American businesses, what are we missing? What’s not being discussed that you’re like, Gosh, I can’t believe people don’t see this.

ISF: Congress does not want American companies to do business in China. And with the UFLPA, the Uighur Forced Labor Prevention Act, we talked to a lot of corporates about that, and they don’t seem to understand how to comply with the law. And that’s the point. It’s a law that’s meant to deter behavior as opposed to shape behavior. 

So it’s okay, we can’t invest in Xinjiang, but this company that we work with, has a branch of Xinjiang. Well, don’t work with that company. And I think the American political calculus of this too. 

People don’t really get Pelosi’s trip, I think didn’t really bake into corporate behavior in the way that it should have because people think this is a Republican issue. They hear Marco Rubio, they hear Ted Cruz, they hear some of the awful remarks that Trump made, and they don’t realize that Nancy Pelosi and Chuck Schumer sound almost exactly like Rubio and Cruz on these issues. They think it’s a Republican issue. It’s not a Republican issue. There are holdouts on the progressive left, there are holdouts on the libertarian right. But the US is pretty united about this from a government perspective.

It’s just not from a business perspective. And that’s fine. You can have that discordance. But businesses need to understand main street and Congress feel very differently about these issues than they do.

TN: Yeah. So one last question on this. Unless Albert, Tracy, you guys were going to come in, but do you think we’ll see publicly traded American companies disposing of their China units with say a Hong Kong IPO? 

I mean, I know this is an old idea, but better than nationalization, at least they can get some value of it. And I think of like a GM or something like that, right? It’s a huge business for them. So they could potentially either have that nationalized or they could make it public on the Hong Kong stock exchange or something. 

So do you think we’ll see more of this? Young Brands is the one that everyone knows about from ten years ago or whatever, but do you think we’ll see more of this? And if people don’t do it now, is there a danger of a rush to the exits in say twelve months?

ISF: I think that’s an excellent point. Ping on, which is a major shareholder of HSBC, suggested HSBC break up into two different banks, one headquartered in Hong Kong to focus on China market and one of the rest of the world. 

And companies like Boeing, which has an airplane business that I think it’s something like 14% to 18%, goes to China, specifically the Chinese Communist Party and then has a very important government contracting business which is increasingly at odds with its relationship with the Chinese Communist Party and need to start considering these issues. 

I think you’re right also on the timing, these things take a lot of time and companies are very private with them for obvious reasons. So if they’re considering them now and we’re going to see announcements on it and it doesn’t require that much scrutiny from Cyphius or the Beijing’s regulatory Agency or other Beijing other Chinese agencies, I can see these things happening.

I think if companies are starting to think about it now, it’s probably too late. I think years process. But in the same way that nobody wants to talk about war, nobody wants to talk about spinning off their China assets.

TN: Right. But you either do it now or it gets nationalized. Or you do it for $0.10 on the dollar in a year or two years.

ISF: I think you’re exactly right. And Tony, we should write something on this, and I think this is a good time to talk about this issue.

Albert Marko: Okay. There are other issues. Capital flight out of China, even if you decide to list in Hong Kong, is like, where’s the money going to come from? It’s not going to come from the west. Even the Chinese are starting to take their money out into Singapore and Macau  and anywhere else they can get it out of at the moment.

But I agree with Isaac on 90% of what he’s saying. I don’t think that war, Taiwan is even a remote possibility in the next ten years, to be honest with you.  The pilot bureau, Xi is inspired politburo. It looks scary. There’s no question about that. And the Western companies need to take a look at that because it reminds me of the Nazis from the 1930s.

Now, I’m not talking about what the Nazi crimes were, but just the mobilization of the country and the nationalization of corporations and then starting to boost the economy internally. It’s most likely going to start happening, and they will nationalize companies that they see are instrumental for their vision going forward.

TN: Yes. I mean, honestly, I don’t know why anybody related to SAIC Shanghai automotive. Why would that not become the property of SAIC? If they’re really taking this nationalist bent, that’s a real risk, right? I think so. Any of these guys really need to pay attention and really start to evaluate what is their path going forward? What is their path for Chinese staff? What is their path for foreign staff there? What is their path for IP that’s shared between those units? These are real head scratcher questions. 

Okay, Isaac, thank you so much for that. This is so insightful. I’d love to spend 2 hours with you on this, but we’ve got to talk about tech earnings.

So, Albert, tech earnings are super bad, right? Super bad.

AM: Super bad is an understatement.

TN: Yeah. Horrific. It’s a tech wreck, all that stuff. So we can talk about what missed and kind of we all know what’s missed. That’s been analyzed over the last 24 hours or say a few days or whatever. But I guess what I’m most interested in tech is staffing. 

So the vacancies in the US. Workforce has been a big issue for the Fed. Okay. And I’m showing right now on the screen that the Meta’s stock price from $350 all the way down to I think it was $97 yesterday, just over one year. It’s incredible, right? 

So a lot of these tech firms have been over hiring. They’ve been putting out job wrecks for things that they where they just want to target one person and they don’t really want to target the job and all this stuff. They’ve almost been hiring based on their valuation rather than their revenues. So in terms of those productivity metrics, do you think we’ll start to see headcount reduction in tech? Or they’ve been saying, hey, we’re just going to slow down our hiring.

So do you think they’re going to stick to only slowing down their hiring? Or do you think we’re going to see this kind of tech halt and kind of shrink the tech workforce?

AM: Oh, absolutely. You got to shrink the tech workforce. But that’s not going to come till after midterms. I mean, nobody wants to be in the line of sight of Biden’s firing squad over firing 10 thousand people just before midterms happen. But afterwards you will. Probably after Christmas, you’ll actually start seeing quite the number of job layoffs in the tech industry.

TN: Every time I’ve worked with a tech related firm, the pink slips come literally the week before Christmas.

AM: Yeah, you know what I mean? I don’t think that people understand how bad these tech earnings are. Right. We can note Facebook and Amazon and whatnot, but they had tailwinds of inflation of an extra 10% because CPI, they say 8%. It’s really like 20%. So they had an extra 10% baked into their earnings that people don’t really catch. Right? And even with that, they’re down 30, 40%. 

Amazon lost 25% in two days. Amazon. These are just astronomical. Which is a solid company. I love Amazon. I don’t have any… Company. Yeah, it is a solid company. And I like Amazon, I like the tech, I like the delivery service. And everything they do is correct. But I mean, realistically, they were, them and along with another dozen tech names were so over inflated for the last two years because the market just kept pumping up to just the high heavens that this was just I mean, it was an easy call that tech had to come down.

And on top of that, tech is based on zero rates. We’re not going to see zero rates for years.

TN: Right, that’s fair. Okay, so, you know, one of the hedge funds, I can’t remember who, was pushing Meta or Facebook now, I guess, again, to cut 20% of their workforce. Do you think something like that is possible?

AM: And it sounds like a lot, but given what’s happened with their valuations, do you think a 20% cut is possible? Do you think more or less is possible? And 20% is a lot. Usually when you have over 12%, you start looking at a company as going into bankruptcy. That’s one of the signs that you look at. So 20% is way too much. I don’t think that’s going to happen. Maybe seven to 10% staggered over the next few years.

TN: Okay, that’s fair. But I mean, they hire a huge number of people. What that would do to wages in tech would be immediate, right? $300,000, 22-year-old dev, that would be gone.

AM: Well, yeah, that cuts into the state’s budgets also because they take those tax revenue and whatnot. The other thing that we should talk about is China’s mix with the tech industry. I mean, now that the US congress, like Isaac was saying, is actively trying to prevent companies to go over there, I don’t know where tech earnings are going to come from. I just don’t see it. They’re taking away massive market share. They’re taking away supply chains and semiconductors and everything. I don’t see any silver lining in tech for the next two, three years.

I think they need to run size their organizations and really focus. Plus there’s more competition in the ad market, so you’re not going to see ad rates necessarily rise from here for some time.

So, yeah, I think there’s a lot of headwinds. I actually have to get Isaac’s opinion on this one is no one is talking about the tech industry in China competition with American companies in countries like India. Right? Because you have Chin Data and a couple of other countries that are massive and makes generate a ton of cash out of there.

And nobody’s talking about the competition level in India between the two. And I don’t know if you’ve heard anything, Isaac, but like, that’s something that I wanted to start looking into.

ISF: I think that’s an excellent point, is it doesn’t get nearly enough attention. And the market for the rest of the world for most of these companies is larger than the market for the US and China combined. There are a lot of contested spaces, especially in countries like India, Brazil, Indonesia. 

And I think the lens through which we should see it is the political battle between the US and China because both countries are really pushing all of these third countries to be more sympathetic towards their way of view because so many of these tech companies can be hobbled by regulations. We see that with Huawei. We see that a lot in India where there’s a lot of distrust for Chinese tech companies, a lot of restrictions on the ability of Chinese tech companies to operate.

And so it’s protectionist, but it’s good political warfare for both sides to be making these arguments in countries around the world. And it is good business for these companies to be spending heavily on government affairs in all of these companies, in all of these countries and figuring out how they position their relationship with the government, whether it be the Chinese government or the US.

AM: Yeah, and that’s something I actually criticized the Biden administration that they’ve been so hard on India about using Russian tech and Russian oil. It’s like, come on, you guys got to be a little bit pragmatic here. You know what I mean? They’re stuck between a rock and a hard place with China and Pakistan.

TN: True.

ISF: I think that’s a great I mean, they buy huge amount of weapons from Russia, and they buy those in large part to defend against China.

TN: Yeah, very good. Okay, great. Thanks for that, Albert.

Now, Tracy, let’s move on to crude inventories. I’ve got a Tweet up where you talk about there was another draw this week.

And we saw a draw on global inventories. As we have inventory drawdowns, we have OPEC supply contracting by what, about 1.2 million barrels per day, something like that. Russian crude sanctions starting. We also have with the SPR, it was interesting to see the US became the third largest exporter of crude, I think last week or something, with over 5 million barrels per day because of the SPR draw. 

So we know global industries are low, but when does that start to bite? I feel like the easy answer is well, after the SPR stops, right? What more to the story is there?

TS: I mean, I think it really depends on where you are. I mean, we’re already seeing the SPR. Those draws are kind of dwindling down, right? We’ve gone from about seven, 8 million barrels per week to 3.5 million. Even though that’s still a lot. That’s been part of the reason why we’re exporting, because we kind of, first, we were drawing down sour crude because that’s really what US refiners need. But at some point, that’s almost gone, so we had to start releasing sweet crude, and we can’t do anything with those barrels. And so they are making their way to China, they are making their way overseas.

And that’s why our exports have increased over the last few months there. In particular, we’re kind of seeing an uneven balance where we’re seeing global inventories are drawing, still drawing, right? US inventories are drawing, by all intents and purposes. I mean, we had, what, a 2.8 million build, but we also had a 3.5 million SPR release and an adjustment factor of 15.8 million barrels. Technically, we are drawing. And really, if you include the SPR, we had a draw of 5.9 million barrels total crude plus products this week.

But we are seeing what’s interesting is we are seeing Japan. Their stocks are actually going up because they’re stockpiling mad right now. So they’re buying everything from everybody. It’s stockpiling, and they were giving subsidies for companies to buy that in their SPR. So Japan kind of had a different kind of way of looking at things and the rest worlds just dumping. But they’re literally stockpiling.

China did stockpile for a while, but really their SPR is down, obviously, from the 2020 highs. They’re not stockpiling as much. But with China, I know that there are many problems going on there, but if they increase those import quotas for the Teapots, then we’re going to start seeing them by a lot.

TN: By Teapots, you mean the small refinery?

TS: Is just correct, because they’re talking about possibly raising those import quotas. But we won’t really find that out until December, and that’ll be for into 2023.

TN: Okay, so just a question on both, well, in Japan, first of all. With the yen at these dramatic lows, they’re stockpiling and it’s hugely expensive for them. It’s not just kind of incidental decision, this is a really intentional decision for them to stockpile. So are they partly, do you know, are they partly stockpiling

on geopolitical concerns?

TS: Yes, absolutely. I believe so. And all around, because we really saw them that sort of started to kick off in March after Ukraine invasions. Same with LNG, right? They’ve always been huge importers of LNG, the world’s largest, but they’re importing even more because they’re kind of seeing what’s happening in Europe right now and they don’t want that to happen to them.

AM: I think it’s a little bit more than that. Also, I think that they see that we’re probably even got cues from the US that Japan is going to be a manufacturing hub to try to pick up the slack from China. So I think they’re preparing for that in 2023, 2024. And on top of that, the price of oil right now, that’s still discounting China not stimulating because once China stimulates, the demand is just going to skyrocket.

TN: Okay, all three of you guys want to ask about that China stimulus. So you guys all know China Beige Book, and they’ve been saying everyone’s really foolish for thinking China is going to stimulate, and they’ve been saying that for something like six months. Right? And I hear a lot of people say, oh, they’ll stimulate after the Party Congress. I said that too, and we still haven’t seen that. Do we think that we’re going to see stimulus in China, say, before Chinese New Year, which is what, February?

ISF: I would say absolutely not. I think the real stimulus for the Chinese economy, too, will be less a government led infusion of capital and more a relaxation of COVID concerns. 

And I think that’s going to be a lot more likely after Spring Festival than after the March Congress because, A, you have the appointment of the premiere, you have some important events there, but you also don’t have to worry about mass contagion with hundreds of millions of people wanting to travel.

So I think the base case for the opening of the economy and then potentially economic inflation is after the Congress, after Spring Festival. And who knows, it’s very hard to predict, but that would be my best guess for that.

TN: I think that’s really solid. What do you think about that?

AM: Yeah, I think COVID Zero policies are going to be still in place until March. There’s no question about that. I think stimulus happens around the same time that they think that inflation is under control. I think that’s pretty much their driver at the moment, because if they stimulate price of copper and oil and everything in the country is going to go to the moon and they know this. So I think it really depends on inflation. What the US can do to tame it.

TN: So when do you think they’ll think that inflation is under control?

AM: I think close around March after the US. And also the end of quantitative tightening and whatnot. So it’ll probably be a coordinated effort.

TN: Okay, so Tracy, if they just let go of the lockdowns, what does that do to crude demand?

TS: Well, definitely we obviously start to see that rise because they’re locking down millions of people at a time, you know what I’m saying? An entire city, and not for a couple of days. We’ve seen some cities lock down as long as two months. 

So I think as soon as they start relaxing that we’re definitely going to see demand come flooding into the market. 

And again, China hasn’t really been stockpiling this whole time during this, which they have a little bit from their lows, if you look at their SPR, but not a lot. Not as much as everybody thinks they are. Everybody thinks they are because oil prices are lower and they like lower oil prices. But really, comparatively speaking to how they purchased in the past, the SPR hasn’t been as much as most people think. 

AM: Okay, do you think that they could be? First of all, I don’t trust the data of China. I don’t have anything.

TS: Well, what we can see from satellite systems, right? We have no idea what their underground storage looks like or anything of that nature. But what we can tell and what we can track, what’s actually going into the country. 

AM: Do you think that they can hide that in tankers on the sea for a while?

TS: Yeah, absolutely. I mean, they’ve been known to do that before. Absolutely. They’ve used Myanmar,

AM: Singapore also, I believe.

TS: Well, Singapore is a little bit harder to hide just because it’s so huge and so many people are tracking vessels there. So they kind of like to kind of stay away from there when they’re kind of trying to hide stuff.

But definitely, I mean, they’ve, you know, hidden purchases from Venezuela through Singapore, through other ports in that area. From what you can see from the best guess. From the best guess, what you can see, what you can tell what satellite services have picked up, like Kepler or whatever.

TN: OK, let me kind of close up with this question. So I just filled up with gas in the US last night and I posted this price in Texas is $2.95. So I’m sure you’re all jealous. I said, will this be 30% higher by the end of the year? Because post election, SPR releases stop, other things? Do you expect gasoline to rise, say, as much as 30% before the end of the year since SPR release and other things are stopping? Or do you think we’re kind of in this zone that we’re going to be in for a little while?

TS: Well, I think that generally this is kind of lower demand season anyway, right? I mean, usually typically we don’t see prices really start to rise again until about mid December, just seasonally speaking, right before the holidays. Christmas in particular, and everybody goes on vacation, et cetera, et cetera.

But I think, I don’t know. 30% might be a lot for this year, but definitely for next year we’re going to have some problems because they took that last 10-15 million barrels and they pushed that out for December, so we’ll still have some releases then.

So I think they did that it was actually 14 million barrels that are left and so they did push those out until December. So they’re kind of going to triple it out in order to kind of control prices.

TN: Okay, so the selection bias for people telling me that I was right is wrong.

TS: I think it’ll probably depend on where you are in the country, you know, depending on the state. Yeah, absolutely. I mean, if you’re in the Northeast, you’re going to have a huge problem, right, because they have the same issues going on that Europe. They don’t have any pipelines, they don’t have any storage, and they don’t have any refining capacity.

So this winter, especially with the diesel shortage, you’ll probably see the highest gasoline prices, obviously in California and then the Northeast will be the next higher.

TN: And I just want to say to everybody, I’m not promoting the gasoline price as a reason to move to Texas. I mean, it’s all scorpions and rattlesnakes and really terrible bagels here, so please don’t move here. It’s just an incidental benefit of living in a place that’s a pretty rough place to survive.

So anyway, guys, thank you so much. Isaac, really invaluable. I don’t think we’re going to gotten this perspective from anybody else on earth, so I really appreciate the time that you spent with us.

Albert. Tracy. Thank you, guys. I always appreciate your point of view. So thanks very much. Have a great weekend. Thank you.