#1030 - Are Dollar Bears About to Roar? with Brent Donnelly | The Fed, U.S. Dollar, & Japanese Yen

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0:38Are the dollar bears about to roar? Hi, everyone. Welcome to the Real Vision Daily Briefing. I'm Maggie Lake. And with me today is Brent Donnelly, president of Spectra Markets and a partner in the RV Marketplace. Hi, Brent. It's great to see you. Hey, Maggie. It's good to be back. So we got a lot to catch up on because you and I haven't talked in a little bit. And we've, once again, had a lot of volatility around what's happening with the Fed, what's happening with the economy. We saw stocks rallied again today, at least early on. I haven't checked in the last few minutes, which is important because things have been changing, but generally a pretty good tone.

1:13Bond yields staying down, US dollar lower. And it's really a continuation of that move we saw in the wake of the weaker than expected non-farm payroll number and a pretty dovish Fed. But there's a lot of churn underneath that, and I think a lot of debate still. So let's start big picture. And what's your view of what's happening with the US economy and rates? Sure. So there's a lot going on, like you said. And we've been in this regime where everything lasts for about two or three months, and then things change. So we came into the start of the year with yields on the lows, I think six and a half cuts priced.

1:47And now we've gone, the pendulum has gone wild the other way. And that's been on the back of strong data, but then also on the idea that maybe the Fed could even hike because rate hikes haven't been doing enough. And I think that pendulum swing has gone a little bit too far now. So what I feel like is we've gone all the way from six and a half cuts to one and a half. But I think the modal outcome now, if you ask people, is probably higher for longer and no change this year. To me, that just seems too far, especially with the Fed, but starting with the data first. So the last little ramp in yields came from employment cost index and some prices paid on the ISMs.

2:32And to me, that's kind of backward looking. We had this little reflationary boom kind of thing that happened over the last couple of months with commodities. And then we had the Middle East. You had copper ripping, global manufacturing looked a little bit better. China has been good. But those are all things I I think that are a little bit in the rear view. And to me now, the interesting thing is we're seeing quite a bit of softness in the US data now, not recessionary by any means, but much less stonking. So the pattern has generally been that economists have just underestimated almost everything over the last couple of years.

3:10So it's been rare that you see a string of worse than expected data. And I don't know if you want to get into it right away, But the most interesting thing is what's happening in the soft data. Yeah, let's talk about that. Because I think, and I think you just laid out perfectly where some of the, it's not really confusion. It's just people seem to be zigzagging, right? You sort of get a narrative and you have data that people point to. And then you're getting these other reads that seem to say something different. And that has been the case. But people, I think, are confused about what to look like.

3:40So what are you seeing? And what do you mean by soft data? Well, also, just before I talk about that, one reason that people have been confused is that the Fed has been changing direction a lot. So we were in a hike cycle and then they basically rolled out the mission accomplished banner, I love George Bush 2003 with Waller's speech at the end of 2023. And the problem was that the mission wasn't accomplished. So they made an assumption by extrapolating the CPI and PCE data and said, okay, good, like we're done. Now we're ready to cut. And the dots started pointing to cuts. But the problem was that whether it's reflexive or not.

4:18So part of the problem with inflation rebounding was probably specifically that the Fed went dovish last year at the end of last year. But then at the same time, they just didn't wait for the fire to be put out completely. So it's like when the doctor gives you that penicillin prescription or whatever, and they say, even if you feel better after seven days, you got to take it for 10 days. And what the Fed did was they took it for seven days and things felt better and then they stopped taking it. So they took their foot off the brake and then animal spirits came back and inflation came back. So that, I think, is one of the reasons why people have been confused, is that historically, most of my career, the Fed has run with a forecasting framework.

5:01So because of long and variable lags, they can't just set policy based on whatever the data is right now, because their policy takes 12 to 18 or maybe more months to play out. So if you're just setting policy based on current data, you're always going to be lagging. And so now, because they don't really seem to believe in their forecasts anymore, after so many mistakes, like the transitory one, obviously being the main one, where they were still buying assets in 2022 when inflation was at 7 % or something. So because of that, they're not really using a forecasting method anymore. And so they went super dovish in November.

5:40Now they're going super hawkish again, saying, well, actually, no, cuts, maybe not. And so I think that's contributing to the volatility and the confusion. Whereas if you just had a Fed that was saying nothing and just spoke at the meetings, honestly, I think that would be a much better communication strategy instead of having 18 governors and board members all saying different things all the time. But anyways, that's the other here and there. The good old days. The good old days when hardly anyone spoke and the one who did, no one could understand. Yeah, when Greenspan just said blah, blah, blah, blah, blah, and he didn't really know what he said.

6:12But so one interesting part of this cycle is generally the model is the survey data always turns before the hard data, the hard data being like the real economic data that like industrial production and jobs and all that. And so when the soft or survey data comes in weak, then you can extrapolate about six months later, the hard data is going to be weak. But this cycle that has not been the case. There's a bunch of reasons. The main one on the consumer side is that high inflation is bad for sentiment. So you saw sentiment collapse in 22 and 23, but high inflation isn't really bad for nominal growth.

6:52It's actually kind of good for nominal growth. So that creates a divergence where sentiment's in the toilet, but nominal growth is still good. And then on the business side, everyone was worried about this Bigfoot recession that everyone was kind of trying to find, but never quite found. and people were worried about rising rates as they probably should have been because logically that usually hurts the economy. So business sentiment was very bad as well. But then for whatever reason, this cycle has been different. And the reason mostly is that consumers and businesses locked in at low rates before rates went up.

7:28So those two things were kind of making this weird situation where the hard data was good, nominal growth was good, retail sales, jobs, everything was good, but sentiment was horrendous. So then horrendous sentiment kind of came back and inflation went down and sentiment got a little bit better. But now the sentiment's getting bad again. And so now, but the funny thing is everyone's saying, ah, sentiment data is BS, it doesn't work anymore. But I think that's ironic because now I think it probably will work because the inflation shock has subsided enough that sentiment shouldn't really be driven by it.

8:04And we're not worried about Fed hikes anymore. So I think it's more likely that negative sentiment is probably reflecting that demand and confidence are lower than they were, say, four to six months ago. But now everyone's ignoring it because it's like the boy who cried wolf. But in this case, I think it's actually meaningful. And then you compare that. So if it is meaningful, like if I'm right, which I may or may not be, then you look at the starting point or the entry point in yields and yields are priced for perfection basically, because you have almost essentially no cuts now. So I think there's a lot of room for yields to go lower if this sort of turn in the data proves to be correct.

8:49Now, nonfarm payrolls is hard data, and that was a little bit on the soft side. So that's one step in the right direction. CPI really is the more important figure. And if you look at what commodities and things have been doing, they've bounced back in the last few days. But overall, commodities are no longer adding to inflation pressure right now in the short run. So I think that helps too. So I think we're entering a little soft patch here. And that's why I think the dollar is probably going to trade weak from here. And I think bonds will do OK. Hey, everyone, we're going to take a quick break right now to hear a word from our partners.

9:23We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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10:31So it's interesting why, it's interesting to think about it that way, but do you worry that if the market swings around and has a sense that they start putting more easing back in the forecast, that it doesn't just once again have the effect of stimulating the economy? Or has that fiscal support or some of the other supports that were keeping it revving so high, have they dissipated? Why wouldn't we just see this cycle that every time the Fed turns, the financial markets take off and just create this repeat of reinflating the economy? Well, there's two different scenarios. So one is they turn in the face of strong data when the data is still strong.

11:17And that's what we saw in November. And to me, that lights animal spirits big time because then it essentially makes people say, oh, I guess the 2 % target is more like a 3 % target. And that's inflationary, right? So that's the Fed, whether it's a policy error or not, it's the Fed's being dovish in the face of strong nominal growth. And that is like buy anything that's not nailed down because that's a debasement trade. But if the Fed is going dovish because the data is turning, then it's more like 2019 where they tightened and it took a while. And then eventually the data turns. And to me, that's just a completely different trade because then they're responding to weakness in data.

12:00And that weakness in data usually has a momentum of its own. So if you have strong data and they're easing, that's one scenario which we've seen for the last four months. But weaker data and them easing, to me, is a different scenario. That doesn't necessarily mean that reflation just comes back because you have the combination of the easing, which is stimulative in theory. But the fact that it's reacting to weaker data means that that weak data is going to play a role as well. That's really interesting. And it's going to mean that all of these data prints are going to be really important as it kind of starts to shape this narrative.

12:35Bonds have really been setting the tone for equities. Is it also true for currency markets? Is it all about where that rate direction is? It's kind of two things. So it's a combination of the direction of yields and then the volatility. So like in 2022, we saw a very volatile bond market with rising rates. And that's a scary thing for equities. Like what equities don't want is uncertainty. But now the cone of uncertainty is a lot narrower. So even when yields go up now, I don't think it's as scary because you're not really entering into a world where the Fed is going to hike 75 basis points at the next meeting, which is where we were in 2022.

13:18And the interesting thing too, is that another reason why I think yields probably top out now is that Powell had a chance to kind of put the hike possibility or the hike side of the distribution on the table. And he was like really skillfully managed to not do it. Like when people were like, what are the conditions under which you would hike? He would respond something like, well, let me tell you about some conditions under which we would cut. And he basically just batted it away in a pretty good way. I think he must've rehearsed. He must've done some role playing before that meeting. So I think that reaction function also shows you that the bar is just at this point with the pricing here for, for pricing to get even more hawkish, the bar is just incredibly high.

14:04Whereas to go from one and a half cuts to four, three cuts or four cuts, that bar is incredibly low. So you get a weak CPI coming up. And I mean, that trade is very asymmetric, I think, because it's just so much easier to price in a couple more cuts. Whereas crossing that zero bound of going from cuts to hikes, that just requires like almost some kind of like, it has to almost look like an emergency for them to do that. Yeah, that's so interesting. So the dollar has been, as we mentioned, coming under some selling pressure in the last few sessions. Does it feel, where's sentiment now? Does it feel like there's more room to the downside now that people kind of see this potential shift?

14:50Or do traders want to see more data? How does this look like it's setting up? Yeah, we're kind of in this purgatory right now because the market, so we have a measure of dollar sentiment and dollar positioning, and it was the most long, both momentum and positioning were the most extreme long since October, 2022. That was April 15th. So that's about three weeks ago, we got to like max record long dollars and the market just doesn't move. Like positioning just doesn't change that fast. So now you have a situation where CTAs are still max long dollars. Specs are kind of like, eh, they've reduced maybe from 100 % to 50%.

15:33But people are still kind of praying for this long dollar trade to work. And there hasn't been enough negative data. So what I'm describing is kind of like, I see weakness, and I'm forecasting that it continues or gets a little bit worse. But it hasn't been bad enough for people to say like, okay, the perhaps hitting the fan, I got to be short dollars. So we're kind of in this weird in between where I believe like the macro narrative has changed from everything's amazing in the US to maybe slightly amazing, but not as amazing as it was. But the narrative hasn't turned enough to actually impact positioning.

16:12So to me, that's kindling for a big dollar down move. But to get that dollar down move, you're going to need to ratify this sort of string of weaker data with some actual weak, ideally inflation data, because in the end, it's the inflation data that matters the most. And even though I said, okay, the Fed was dovish and this and that, in the end, it doesn't even matter that much what they say, because they've been so beholden to the three-month annualized data, which again, like I said, I think is a mistake because you end up chasing your tail doing that, but that's what they're doing. So to me, it comes down mostly to the CPI data.

16:52And then, of course, the inputs into that, some of which are transparent market prices, like the price of oil, which to me has not traded well through the Middle East stuff. Even though that stuff calmed down, oil traded horrible, even when that was a pretty scary situation in Iran and Israel actually attacking on each other's soil. Yeah. Yeah, a lot of people were a little bit surprised by that. But again, just showing so many cross currents in these markets, and the commodity markets are included in that. I want to talk a little bit about the yen because there's been a lot going on. I know that you've been talking about it and writing about it, but where are we now with that?

17:34It hit multi-decade lows. Talk of BOJ intervention. You yourself said, yeah, they're intervening, but not with the sort of conviction maybe that you would expect if they really wanted to make an impact. What's happening with the yen right now? Right. So there's a lot of pieces to this. The main one being the dollar. So generally, dollar yen is almost always or always throughout my career, starting in the 90s. It's a yields trade. So if yields are going up, most likely dollar yen is going to be going up simply because you can own dollars and be short yen and make the carry. And that's an attractive trade.

18:12And especially when volatility is low, that's always going to be attractive. So ultimately, the Ministry of Finance, by intervening, can't really change the direction of Dalian. But what they can do is they can halt the rate that it's moving or the speed with which it's moving. And so in April 2022, they intervened and then they got lucky and yields went down and Dalian went down and that was it. And so generally, that's how FX intervention works is like even when you saw Brazil intervening at other times or whatever country intervening, usually they're not trying to reverse the trend. What they're trying to do is avoid disorderly depreciation of their currency.

18:54And then they just have to hope that FX fundamentals turn at some point. But it got interesting over the last couple of weeks because just to give like a really quick background, I don't want to bore people with the history, but I think it's important to know that Japan throughout history, throughout most of the last, since 1990 and the Nikkei bubble burst, has had a problem with their currency being much too strong. So I think that's an important context when people are saying, oh, the currency is collapsing and it's weak. I mean, essentially, this is what they wanted. Delrayan was at 75 and Abe introduced his platform called Abenomics.

19:34And one of the prime targets of that, there were three arrows in the quiver, and one of the arrows was to weaken the currency. So to say that they've lost credibility and the yen is collapsing and they're out of control is just completely wrong. They have tons of credibility. In fact, the MOF was buying dollar yen at 80, and now they're selling it at 155. So not that central banks or ministries of finance are motivated by P &L, but they have a lot of credibility. They've devalued their currency in a pretty controlled way. and now they're saying enough is enough. And I think the thing that people forget is that, so the main issue with Japan is that monetary policy is very loose.

20:18So they're fighting that. The Ministry of Finance is essentially fighting the BOJ in a way, which makes it difficult, and that's the trilemma, if anyone wants to Google the trilemma. But then at the same time, they do have other things they can do. For example, they can change tax policy to make it more beneficial for Japanese to repatriate yen, which is something they've floated. And in the end, unless you think US yields are going back above 5%, I think it's not a good bet to be short yen, because what the Ministry of Finance does is they truncate one part of the distribution for a while, and then eventually they give up.

20:55But generally, I think speculators will give up before the Ministry of Finance. And just one last thing, I don't know if we can put up a graphic for a second, But I'm a big into behavioral things like magazine covers and people freaking out and making crazy price targets and stuff. I think because my experience in the dot-com bubble was every time someone makes a price target that's insane, that's usually the high for the stock. And in the last 10 days or so, there's been so many of these sort of behavioral things with the yen, people saying it's going to 200. We got an Asian currency crisis. we're rerunning the 1998 Asian financial crisis and things like that.

21:37And it's like when the chyron on CNBC says markets in turmoil or whatever. It's a behavioral clue that the emotion and the sentiment are at an extreme. And I think we hit that in the end. So I'm more biased to be short dollar yen at this point. But in the end, it's a dollar trade. And if you're doing that, you need US yields to go down. Have you been getting a lot of inquiries about that? Because we've had We've had several different people come on recently, and they're very bullish, Japan. When you ask them where they see opportunity, that's what they're looking at. Well, it's kind of two different things because a lot of people, when they buy Japan, they do a currency hedged because of the correlation tends to be if things are going well in the world and in Japan, then the yen weakens because of the carry trade and Nikkei goes up.

22:26So Japanese stocks have been super popular for sure. I think when we're in the period of US exceptionalism and there was an acronym TINA, which was there is no alternative. And it was like, all you can do is own mag seven and tech stocks because everything else is crap was kind of the thesis for a while. And the first country that that kind of was the exception to that was Japan, because Buffett made a huge purchase of Japanese stocks. And the way he actually did it was genius because he issued bonds in Japan at the super, super low yields in order to finance the purchases of the equities. And the equities have gone up, the ends weakened, and the rates have gone up.

23:07So everything, all three legs of the trade have been pretty smart. And I think that started kind of like a surge of interest. And there's been a lot of interest in Japan just because it's cheap and it's a momentum trade as well. But you don't have to be bullish the currency to be bullish the stock market there. In fact, usually they move in opposite directions. 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.

23:42Part of the reason I think people were talking about whether there's an Asian currency crisis and concern about it because we had the dollar strong against so many currencies, and including the Chinese yuan, right? There was concern that there would maybe be something that looked disorderly or there would be a devaluation of the yuan. Is that something that you think is on the card? So the Japanese are approaching it that way. What are the Chinese doing in regard to their currency? So that's right. They tend to move together a little bit because obviously the dollar is the dominant driver of both.

24:17and I had referred to September 2022 when the MOF came in. And at that time, China was actually even more worried about their currency and the dollar than Japan was. And they intervened at 7.38 in dollar China and they won as well because yields went down. And so Japan and China both won. So there are a lot of parallels. The one big difference now, or there's kind of two, but one big difference is that dollar China is not at the highs now. it's at 720 and the high is 738. So it's a little bit off the highs. But the other thing is that it's a really confusing argument because if you just looked at pure macro and China's an exporter, obviously then in that framework, they would want the weakest possible currency.

25:03But the thing is, they have many other goals. And one of those goals is stability. And another goal is to resuscitate the consumer after the real estate shock. So if you devalue your currency, you're creating instability and you're also punishing the consumer. So to me, and then the last thing, actually, the third thing you can look at is just what are they doing? Because it's a managed currency. It's not free floating. So they set a fixing and then onshore has to trade within 2 % of the fixing. So the offshore can move around that, but the basis can only get so wide. So generally, it's kind of like a managed float.