#1008 - Are Risk Assets Still the Place To Be? | with Michael Howell

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0:54Our risk assets the place to be. Hi, everyone. Welcome to the Real Vision Daily Briefing. I'm Maggie Lake. With me today is Michael Howell, CEO of Cross Border Capital. Hi, Michael. It's great to have you back on the Daily Briefing. Hi, Maggie. Great to be here too. So we already have some excited people in our chat. You are a favorite among our members because you are an expert at tracking global liquidity, which has, I think, really all starting to understand what an impact that has on all different types of global markets and assets. So let's kick off. We're going to drill down, but let's kick off very big picture and talk to me about what you see happening with global liquidity right now.

1:35OK, sure. Well, I think you've got to take three perspectives. Let's think about the short term, the medium term and the long term. I think to get the long term out of the way, first of all, I mean, the outlook is pretty upbeat, mainly because we're in a situation where the fiscal arithmetic of governments, both in the US and in the West in general, just don't add up anymore. The only way that they can finance these mandatory spending promises like Medicare, Social Security, is to basically turn back to the Federal Reserve or the banks and effectively print money. We're in a world of regime change.

2:10I mean, just look at what happened during the COVID crisis. What was the response there? More spending, but it didn't come through higher taxes. It wasn't paid for that way. It was paid for by bond issuance or indirectly by monetization. And that's the way forward. So in the longer term, we're seeing a situation where monetary inflation is likely to accelerate. Now, I draw the distinction and the clear distinction between monetary inflation and high street inflation, and they're not necessarily the same thing. Monetary inflation probably leads high street inflation. But we're in a regime where fundamentally what you've got is more monetary inflation, in other words, devaluation of paper monies.

2:46And what you want is monetary hedges against that. So that's the long term. The short term is more challenging. And I'll come on to the medium term after that. But in terms of the short term, what we've got is probably an air pocket in liquidity, notably in the US, possibly more globally as well, depending on how the dollar responds. But effectively, what you've got is a situation where April, or as I understand, April 15, is when the tax season really kicks off in the US. And that is going to lead to a lot of money being drained out of money markets, ending up in what is called the TGA, the Treasury General account, on the Federal Reserve balance sheet.

3:27And that is a sucking of liquidity out of financial markets. Now, this is going on against a backdrop where the Federal Reserve's QT program is sort of gurgling along, sucking liquidity out of the system progressively. You've got the reverse repo tranche, the facility, which basically was a way of getting liquidity back quickly into the markets over the last 12 months, which is pretty much exhausted now. It's currently flatlining and actually from day to day often ticks up. So you can't rely on that anymore. So what you've got, if you look at the math of the Fed balance sheet, it's likely to dip, I think, probably quite noticeably through the month of April.

4:08And there's not really very much that the policymakers can do about that. I think that will be a concern. Governor Waller, however, has said that the FOMC is quite nonchalant about bank reserves falling below$3 trillion. They're currently about$3.5 trillion. I think that will be a disaster because that's about a 15 % drop effectively in Fed liquidity. And that could cause a serious air pocket in markets. Now, Now, for the near term, that's not a great thing. But clearly, there's an opportunity for people to want to buy risk assets to get back in again. So that answers the question we started out with.

4:43And I think you have a global liquidity versus the S &P. And if we could put that up, but I'm so interested to hear you say that because, as people are talking about in our chat right now, it was an ugly end to the market today. We started off trying to rally. We saw losses across the board for U.S. stocks, pretty steep ones, one and a half, one and a fourth across the board. The VIX was up 14%. It's still super low, but 1637. And you do feel like the markets are getting more difficult. And then, you know, we're always, we love to get these different views of the market. And that's why we love to have you on because people will say, oh, we had a lot of Fed speakers today, which is true, who sounded hawkish, sounded like they weren't in a rush to cut rates.

5:32And you could look at some economic fundamentals, but it sounds like you're saying the liquidity backdrop is negative as well and a problem. We've got liquidity draining from the system in the very short term. Correct. This is the challenge. And the question policymakers have got to try and wrestle with is, is this a risk to the regional banking sector? Now, my view, and my view certainly over the last 18 months when we've been upbeat about markets is to say that what bests the inflation target, in other words, the Fed ostensibly is after a 2 % inflation benchmark, but what bests that is stability of the financial system.

6:10If you start to see the fixed income markets or the banking system starting to wobble, the Federal Reserve comes in very quickly. What they need to do is to maintain the integrity of the financial system. And that is their major a goal, it will override inflation concerns, certainly in the short term. And if there are problems in the regional banks, again, just look back to what happened in March of last year, when that was really, if you like, the starting gun for a lot of liquidity coming back into markets, when you saw the SVB crisis. If that echoes again, we get another follow-on from that.

6:46New York Community Bank clearly has been a concern over recent weeks and months. If you get further problems, then I think the monetary authorities are going to come back. I'm sure they're standing on the sidelines waiting. So we've been thinking and having people on saying that the hire for longer, and that would match up with the Fed messaging, maybe we're not going to cut, maybe we're going to leave rates higher, maybe we get a retest. And I'm curious what you think about what is going to happen with the 10-year. but are you suggesting that also this falling liquidity will further pressure financial banks?

7:22So it's not just that they have the interest rates high and you've got money markets competing for the funds but also that the draining liquidity, the falling liquidity short-term for the reasons you just mentioned is also further pressure that could strain regional banks? Correct, absolutely. That's the main thing. I mean, I come at this from a liquidity standpoint. So for me, liquidity is by far and away the most important thing. Rates don't matter so much. And I come back to the analogy that what we're living in is a world of massive debt. There's huge amounts of debt worldwide,$350 trillion.

7:58The point about debt, unlike equity, is that debt needs to be refinanced. So you've always got to find the role. So if you've got a five-year average maturity with$350 trillion of outstanding debt, the math says you've got to roll$70 trillion every year. And you need balance sheet capacity, in other words, liquidity to do that. Now, if you think of the simple analogy of a home mortgage, if you need to refinance your home mortgage, it doesn't matter so much what the interest rate is for the role. It's whether you actually get the role from a lender. If you don't get the role, you're homeless. If you're a corporate that wants to roll their debt and you don't get the role, you default.

8:34Now, as it happens, debt's never paid back. It's always roll. And that's the key thing. So you need liquidity. Liquidity is paramount. And every financial crisis, if you look back over the last two decades, has always been a refinancing crisis, and it's hard. And that's what we've got to worry about. Now, interest rates are clearly out there as a factor to think about, but they're much more, in my terms, thinking about the forward guidance that the Fed is issuing to markets. And I think that if you look at this higher for longer argument, which I certainly buy into, the fact is that the momentum of the US economy is sufficiently strong now, I think, to pretty much rule out rate cuts this year on economic grounds.

9:14Whether you'll get them on political grounds is a completely different question. And Jay Powell keeps saying we're at a peak and he hints we're going to cut. So I suspect that's playing into the election. It's not addressing the economy. The economy looks pretty robust. Look at the latest ISM. All these indicators are pointing upwards. Look at shipping activity. Asia-Pacific trade is zooming at the moment. You just got to look at the throughput of Singapore ports, Chinese ports. Look at what's happening to L.A., Long Beach. All these things are telling you that Asia-Pacific trade is picking up.

9:48So the U.S. economy, I think, is on a roll. It's beginning to accelerate. That is not the backdrop for rate cuts. Hey, everyone. We're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing. Kraken Pro is the powerful crypto platform for experienced traders who demand the best. With advanced charts, real-time market analytics, and lightning-fast trade execution, Kraken Pro empowers you to trade your way. Customize your setup and make every pixel count by rearranging and stacking trading modules in a way that makes sense to you.

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11:51So it's the economy that he's looking at. It's political, but it also is financial stability, right? That is the other third thing that we've got to watch for that's going to dictate Fed policy. Yeah, but the overriding factor, I think, is the financial stability question, is that what they can't afford to do is to let too much liquidity drain out of the system, because that will pose a problem for the regional banks for sure. We saw it last year. We know that the regional banks, many of the smaller ones, are suffering from a lack of liquidity. They haven't got the sufficient liquid assets. And you need to get that into the system.

12:30The big banks, JPM, on a roll, they are looking fine. Just look at the share price of JPM. It's doing wonderfully well. But the regional banks are under a cloud. Is it possible that it doesn't matter if there's financial strain in the regionals? I mean, is there a demarcation line between the too big to fail? And then the rest of them, do they just get eaten up by those that are doing well? Well, I think the long term story has got to be yes, because if you look at the US banking industry, it's way too fragmented compared with other regions worldwide. So there needs to be a consolidation. I'm sure the authorities are trying to foster that in the medium term.

13:05In the short term, I'm talking about the next few months. I think if there was a regional banking problem, but you tell me, you're more an expert than me on this. In the US, if there was a regional banking problem, would that feature in the election? I'm sure it would. It wouldn't be the sort of thing Janet would want to oversee. Yeah. Well, the other issue that we have now is how regional are regional banking crises now that everyone has a bank app on their phone? I mean, that is the sort of shot across the bow with SVB that we don't know the answer to. And, OK, that maybe was small enough while their creditors ran, everyone else sat tight.

13:45But what if it's a bigger one? Or what if it's closer to home? Or what if it's in conjunction with something else? Do you run the risk of a run, even though they are, in terms of their importance of the system, small and something that can be ring-fenced? I think this is something the Fed is looking at really hard and they don't know the answer to that because this is a new world we're living in. So your point is spot on about this, you know, being something that is maybe politically a problem, but also just a problem for the financial sector. So we have so many questions, but I want to make sure we get through medium term because we touched on long-term and just thread them all together before we answer what are some really good questions here.

14:23So we've got this short-term, sounds like problem or a rough spot, global liquidity is being drained. That could be pressure on markets. What happens medium-term? And we talked about the US and some of the factors. What about China here? What about the rest of the world in terms of liquidity? Do you expect it to then turn back up or is that unclear or murky in the medium term? No, I think it's pretty clear. I think what we're in is a liquidity cycle that's expanding. We called the bottom on that cycle in October of 2022, just after the British guilt crisis. It was reinforced by the SVB failure.

15:02More liquidity came in, but that was pretty much the bottom. And if this is a normal cycle, which I think in many ways it is, what we're likely to see is a peak in that cycle around late 2025. So we've got a lot of months to go yet in terms of the cycle. Now, one of the things we've been expressing in our research notes is that, look, look at how markets respond to that, particularly to the S &P, and what you see in a normal bull market for the S &P. At this stage of the cycle, after about 15, 16 months of a bull market, you've already seen two-thirds of the ultimate gains in the bull market. So in other words, there may be a third to go.

15:39Now, a third is maybe worth having, but you've got to remember out there, There's been an awful lot of bears that have missed the first bit. So there may be, you know, there's going to be disappointment. But the fact is that the risk return balance in the market is changing. That's clear. It's going to be tougher in the next 15 months to make money, but you'll still make money. So I think that any air pocket is worth exploiting. And if there's an air pocket in Q2, which forces the market lower, buy back into it. Because everything seems to be falling in place now for a normal investment cycle.

16:11Look at the performance of sectors in the US market. It's absolutely been true to form. Technology has led. Cyclicers are outperforming. What we're starting to see now is, or we should be seeing, is performance coming out of commodities, tick that box, out of energy stocks, and out of banks, particularly the big banks, when all those things seem to be moving. So it looks like a very normal cycle. Also, what economists have been derailed by is the inverted yield curve. But my argument is that the inverted yield curve is, if you like, a phony figure, because what's happened is the 10-year yield has been depressed by this huge amount of bill issuance that's been put through by the Treasury over recent quarters in terms of their funding regime.

16:55So that's actually artificially depressed the yield curve. If you do an adjustment to the yield curve to make good that anomaly, what you find is the yield curve never inverted. In fact, the actual, the true yield curve never inverted. And it's actually been steepening since February of last year. Now, if you say that the yield curve is normally a one-year-ahead lead indicator, that concurs exactly with the upturn in the economy we're currently seeing. So everything, to my mind, is fitting into place. And the only thing that I would say looks different is the bond markets were a little bit stronger last year than I ever thought.

17:30But I think that's because of the scarcity argument, because there's been so much bill issuance that people were forced into the coupon end of the market because there weren't many available. Now that's being addressed. Yields are going up. So do you think they could get to five, five and a half? Does that seem reasonable based on what we're seeing? Well, I think five and a half may be pushing it. I think our targets for a long time have been five and a quarter. In other words, that they're going to pretty much match what the short end is currently. The problem that you've got, the reason that yields are being forced up is really because bond yields have two moving parts.

18:07One is rate expectations. As I've said, if you look at the momentum of the US economy, you look at we do a now casting on a daily basis of what the momentum is in US economic growth, that points to an acceleration of the economy. And if you look at market expectations for what terminal Fed funds rates are, what you can see is that that normally matches that GDP nowcast. In other words, they move pretty much instead. But there's been a noticeable divergence. In other words, terminal policy rates look too depressed relative to the strength of the economy. In other words, economically, you've got to rule out rate cuts.

18:44Politically, as I say, that may be a different question. But economically, the Fed should not be cutting at the moment. Now, that's point number one. Point number two is the term premium. That's a wonkish concept, but that's your, if you like, cushion for taking on interest rate risk over the term of the bond. And what that's affected by significantly is the amount of new issuance that's coming into the market. If there's a lot of new issuance coming on, you'd expect that term premium to be positive. And looking out on the calendar, there's a lot of issuance coming. The Treasury have switched back away from Bill Finance towards more coupon issuance.

19:21And that's got to be pushing coupon yields up. We're starting from a place where, you know, in Ireland, they have the saying that if you want to travel to Dublin, let's not start from here. And this is pretty much the case with the bond market. You don't want to start with a term premier that's currently negative because we know historically it mean reverts. And there's a lot of upward pressure, I think, on yields coming through. I love that. I also I'm still, by the way, you know, you got to find the role, the idea that you're always rolling over that debt, and you've got to find that. And that is such an, I think, great explanation why liquidity matters so much for those who are wondering why everyone's so keen to track it and so keen to chase after you for your thoughts.

20:02We didn't talk about China, by the way, but you did ask that question. We did. So I want to get to that. I just want to wrap this up about this medium term. Ralph is saying, so in other words, he's saying buy the dip, but I just want to be clear on this because you're also saying that the easy gain in assets is gone. You might have an opportunity to buy the dip, but it sounds like you're couching that a little bit. What's the determination? Do you just have to be nimble and watch for the turn? Does it matter how strong the economy is and the Fed response? How do you square those two things? I think that's a key point.

20:35I mean, strong economies don't have strong financial markets. That's a fact. So if you're looking at a very rapid acceleration in the U.S. economy, then I think you've got to rule out big market gains. What we'd like to see, the best environment for any investor is a tepid economy that the Fed is trying to get going. And if we've got that situation, then you're going to make a lot of money out of financial markets. I'm not sure we've got that right now. I think we've got an economy that is accelerating and a Federal Reserve that may want to ease, maybe it shouldn't. So I think we're in that sort of halfway house where you can make decent gains, but nothing like we've seen in the last 18 months.

21:16Those were the easy gains. There's a lot of skepticism, but liquidity was definitely coming into the markets. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

21:33Right. I think that's a really important distinction to make, so everyone was clear on your thoughts on that. So Peter asking, what's going to be the biggest driver of liquidity for this year cycle? And where is this coming from? So this is, I think, a good point to get into China. So you can answer that question, but how is China factoring into this? Yeah, OK. Well, let's address China. But let me sort of caveat that by saying, if you look at liquidity or global liquidity, basically, we think that it broadly has two big moving parts. One is what the central banks are doing. In other words, what the Fed is injecting or the BOJ or the People's Bank of China, these factors are clearly important.

22:12The other is basically how much collateral can be levered up. In other words, what we think of as the collateral multiplier, which is really what the private sector does. Now, what that is conditioned by to a very large extent is bond market volatility. So if you've got bonds which are highly volatile, then you've got a situation where the collateral multiplier will shrink and liquidity will be dented. So you don't want misbehaving bond markets. Now, to go back to something which is a key metric, which is the move index, which we've been long saying is a much more important metric for equity investors than the VIX.

22:49So the move is the equivalent, it's bond volatility across the curve. And when I was more involved in bond markets, it used to be the case that 150 on the move index, it's currently under 100 for reference, but 150 was end of the world thing. That's when the Treasury or the Fed lost control of the bond markets. It was when you switched the lights out. We got to 200 in March of last year, a year ago. That was how bad the situation was. The move has come down a lot since, and that certainly helped global liquidity pick up. If you get bond volatility, that's clearly a negative. I suspect we're going to be seeing bond volatility remaining around these levels, in my view, because I think the yields are going up, but I don't think it's a fast move.

23:37So from that perspective, it's a good thing. So that really comes back then to the central banks. What are the central banks doing? Well, we've mentioned the Fed. The Fed, I think, wants to ease. I think the basic backdrop is that financial stability is paramount, and they'll want liquidity to go in to markets through this year. There may be an air pocket in Q2, but we can look through that. And then longer term, the fact is that the Fed balance sheet has to expand, or if you like, directly or indirectly, the indirectly may be via the banks themselves. So what you're actually getting is a situation where there's monetization of government debt.