Flash Update: Liquidity Will Chart the Course for Markets ft. Andreas Steno and Mikkel Rosenvold

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0:58Hello everyone and welcome to a little Macro Monday special. I've dialed up Andreas from Holiday Home and the rural areas of Denmark. Hello Andreas, how are things over there? Hey Michael. What a week it's been Andreas. I just want to start this off by introducing my little theory about what's going on here. So basically a domino effect. I don't know if you saw the pictures of Jinsu Wang, the CEO of Nvidia, signing like a rock star. And that quickly spiraled into a complete meltdown in financial markets. I don't know if that's... How have you experienced these past days, Andres? So, I mean, it seems like the consensus out there now is that the turning tide in dollar again sort of pulled the rock from under the leverage community in the hedge fund space and their positions in technology stocks and all that.

1:54I think there is some merit to that view. I also think it was sort of exaggerated by a couple of very weak prints from the U.S. economy towards the end of July, not least the non-farm payrolls report showing very soft job creation in July and all of that. So it was kind of a mix of a recession fear stemming out of the U.S. paired with that position squaring due to the turning tide in dollar yen. We've obviously covered that dollar yen story extensively over the past month. We were way ahead of the crowd on that story. And being ahead of the crowd in a situation like this is basically a matter of, if not days, then more or less minutes, right?

2:37So the point here is, Mikkel, that a story like this is something you have on your radar for a while. And then all of a sudden, it's the story that drives everything, the Stada Yen story. And here we are trying to figure out when to buy the dip. I mean, that's the thing. That's what we wanted to focus on here. What's the road ahead? How to call the bottom? I saw this great tweet. We'll get to some charts in a second, but I think this is a great one. It's a lot of loss until you sell, essentially. but Andres what we're looking at here is that this opens up a lot of opportunities on the markets of course.

3:13What are you looking at? So I think there are two things you need to watch when you're trying to call the exact timing of the bottom in the market space. The first thing is liquidity and then the second thing is the market-based inflation expectations. and when we look at the charts, you can maybe pull up a couple of them for the audience. I think the first thing to remember here is that at least if we accept the notion that this was driven by dollar yen, we obviously need to figure out where dollar yen takes us from here. And I've used this chart on the real rate spread between the US and Japan as sort of a guide for dollar yen for a while And we obviously used this a couple of weeks ago as well as a warning signal for where dollar yen could take us.

4:05And we're now trading in the mid 40s in dollar yen. It's not too far off where you should expect it to sort of ultimately land in an equilibrium state. We've seen a slight retracement higher in dollar interest rates after that complete bonkers panic on Monday, where everyone started calling for emergency cuts of 75 basis points and what have you. That was obviously never going to materialize. And now we're seeing dollar rates a little bit higher. And therefore, the equilibrium, say in dollar yen, will likely be in the range of 140 to 145 when the dust settles. So we're not too far off that equilibrium.

4:46That's step number one in terms of trying to gauge whether the sell-off is over. So step number two, and that's probably the most important step, is related to liquidity. So if you move to the next slide here, when stuff like this happens, it kind of leads to almost a deflation theory in markets. And I think the trigger for that was the decision from Bank of Japan to try and communicate that they intend on ending their QE program towards 2026. And when we see central banks, especially the Japanese central bank, trying to get rid of their asset purchase programs, we typically also see a tendency towards markets pricing in a larger risk of deflation because the money printer basically cools down.

5:42And that's essentially what you see on the chart here. We have a one-year inflation swap in the dollar market price tier. And you can see those nasty drawdowns around 2008, around the lockdown, around the equity crisis in 2016 and so forth. And typically you see a bottom in equity markets once we get a retracement higher in the priced inflation expectations in dollar markets. So when do we actually see a bottom in these inflation expectations? We've seen a slight stabilization now. And I think the ultimate signal is when dollar liquidity is added by the central banks. we'll obviously have a discussion in the coming weeks on whether Bank of Japan will have to turn around on their decision from last week but what we already see now is the first signs of liquidity additions from the Federal Reserve so if you move to the next page Griggle we have a, first of all this is obviously a very important chart when we discuss these inflation expectations what we've done here is that we've looked at indices across the globe and map them versus the traded inflation swap.

6:56So as you can see from the left-hand side of the table here, there is a positive beta between inflation expectations and equity markets, all indices on earth right now, meaning that if inflation expectations go up, markets will go up. So this fear of deflation or this fear of balance sheet contractions is what's driving everything. And the exact trigger or the exact timing to find the bottom here is the timing where the Federal Reserve allows liquidity to increase again. We've talked over and over. Yeah, here it is. The printer is coming, right? So when is that timing? And I'll actually say this.

7:38I think there are some early signs that we're already seeing liquidity additions. So you need to follow the overnight reverse repo facility from the New York Fed on a daily basis. Yesterday, it printed at$291 billion. It's a new cycle low. And when this facility drops, you actually get an increase in the amount of dollar reserves available for the financial system. So an addition of liquidity. And therefore, we've seen two, three days in a row now of liquidity additions from the New York Fed. This is very interesting because I initially feared late last week when we saw this landslide in dollar interest rates that we would get some kind of similar scenario to the days just after the Silicon Valley Bank crashed.

8:23So if you go to the next slide, we have this kind of case study from the aftermath of the Silicon Valley Bank. The overnight reverse repo facility, the facility currently adding liquidity to the system, is driven by the spread between the yield on the facility and the yield on T-bills available to the money market funds using this facility. So when the spread between T-bills and the overnight repo facility turns negative, meaning that you can get more by parking the dollars in the Fed, you'll typically see liquidity being withdrawn by these money market funds and put into the Fed Reserve. So it's a very strong sign that they're actually not putting money in the Fed right now.

9:14My best guess is also that the New York Fed has communicated to these money market funds that they want the money out of the Fed to try and stabilize liquidity in the financial system. And therefore, given this drawdown that we've seen in the Organized Reverse Repo Facility, we are starting to see the first signs that liquidity is stabilizing and that liquidity is actually increasing in dollar markets. And that is your clue to buy the dip. Miguel, one thing I'll add to this is that you need to watch this number on the New York Fit page every day. So they release this around a quarter past 2 p.m.

9:50And they'll give you an update every day on the amount of accepted bits in the repo facility. If that number drops, it's clearly a clue for you to buy the dip. Hey, everyone. We're going to take a quick pause and hear a word from our partners. We'll be right back.

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11:08so you say the timing is now what what are the dangers of buying into the dip right now what what could change this picture so i mean if we actually saw a nasty recession upcoming um i think that would be a major uh red flag uh and we've had a couple of key releases out from the US economy since that Friday, Monday meltdown. First of all, the ISM services reported rebounded above 50. So we're basically back above contraction territory. And then also this SLU's survey, the quarterly survey conducted by the Fed system, they ask the member banks on the credit conditions, and they ask them whether conditions are improving or whether they are declining.

11:56And the overwhelming conclusion from the SLU survey out on Monday is essentially that the credit cycle is improving. The light blue line here is the demand side of the credit equation. So they're asking banks, do you see an increase in demand for credit? And the answer is yes. The supply side of the credit equation is lagging a bit behind. But as you can see, We're basically past the bottom that we saw in late 22 and into 23. And I think this is your clue in terms of where we are in the cycle. I've kind of labeled this as a mixture between late cycle and early cycle, given the dynamics that we saw on markets.

12:39But typically, when we see this turnaround to the upside in the credit demand, it's your clue that the cycle is actually accelerating into next year. and as you can see from the dark blue we're not in contraction territory on bank lending right now and we will not get to contraction territory given this survey we'll likely get an acceleration of bank credit into next year not a big one but an acceleration and this is also real life liquidity additions you can check out our past couple of shows we also described the evidence that we have that this might not be as bad as the thing One more indicator, Andreas, you just pulled it up just before we started recording.

13:20It's this one. This one. So the total return of the S &P 500 following CNBC specials of markets and turmoil. Very, very strong returns one year after markets and turmoil article. This is the show that they always come up with when we see large declines in markets, etc. And I mean, I guess it's typical mainstream media coverage that as soon as markets are down like five days in a row, then they start alerting people that they need to sell. It would have been nice to know ahead of it, right? So, I mean, it's kind of the sign that the panic is already in the price, right? So thanks to Charlie Bielello for making this chart.

14:07It's lovely. Yeah, it's great. So let's just touch a little bit on potential political response, because we are obviously very, very late in the election cycle. We're getting very close to the U.S. election. Kamala Harris has more or less taken over the U.S. administration, at least on the appearance of things. Donald Trump has already labeled this the Kamala trash, the Great Depression of 2024. I'm not quite sure that people will buy that this is a Kamala recession, but of course she's part of this she's part of this administration and at the very least she needs to come up with answers and I think that's going to be tricky for her if the economy becomes a major issue of the election I think Donald Trump is much better suited for that we have seen some videos of Kamala trying to describe inflation the role of the central bank and it's very very iffy essentially so finally perhaps Donald Trump has found some edge to attack Kamala after a couple of days and weeks of Kamala momentum, essentially.

15:11So, Andreas, yeah. Miguel, one thing I'd like to ask you, just before we went on air recording here, Kamala picked her VP or potential VP, right? Tim Walsh is his name, right? So, I mean, what's your take on him and especially his connection to China? because that's kind of been the news since this. Yeah. Yeah. So to be honest, I was a little bit surprised. You always make the geography analysis that she would pick Josh Shapiro out of Pennsylvania, et cetera. Minnesota is pretty much a given state for the Democrats, but he is very well-liked. He's a well-known name. He's not as well-known as Mark Kelly out of Arizona, the astronaut, but he will get there.

15:57I mean, Tim Walsh is a sign that this is going to be a leftist administration. He is a tax-inspent Democrat, even though on some issues he's appeared a little more central. I think we are seeing some openings from the Biden administration towards a more amicable relation to China. And perhaps they, at the very least, they're trying to open or trying to consolidate the coalition against China. You could also say by allowing some of the U.S. partner countries, the Netherlands, Japan, South Korea, to export into China. And so we are seeing movements on that. The policy of Kamala and Tim Walz is still going to be based on the decoupling from China, but it's very possible.

16:46But one theory I have here, and it might be completely wrong. I think the U.S. administration, the Kamala Harris team are looking for Kamala to do sort of a Brandenburger tour moment. You know, Barack Obama tried to arrange a speech in front of the Brandenburger gate in Berlin ahead of the 2008 election. Kamala Harris is the sitting vice president. So she has the opportunity to join Joe Biden on a trip. It could either be to the Middle East or it could be to China. That could have some very, very strong – it could set Kamala Harris in a world leader perspective. If she can get something done on China, on the Middle East, on Ukraine even, that would be very, very strong for this election.

17:27That's one card that Donald Trump cannot play right now. They can bring Kamala in and start building up her image. So very, very interested in that. We have to say the Kamala momentum is real. She's taken over the lead in many polls. It's still very, very tight, especially because she most likely has to win by one or two percentage points. But she has consolidated a lot of the third party votes into the Democratic tally right now. So things are looking tough for Trump. But let's see, there's still a long way to go. I mean, just a little bit what happened over the past one to two months. We still have two months or three months to go.

18:02So, yeah, very exciting times ahead. But Miguel, I'll add one thing on this. As far as I can see, Tim Walz, he's lived in China. He ran a business taking students to China on trips. He was married on the anniversary of Chichuwin Square. So he's not China hawkish, let me put it like that. And in relation to this discussion on when to buy the dip and where to find value right now, I've personally bought into TyEx, the Taiwanese equity future. On this story, first of all, a slightly more conciliatory stance towards China on the liquidity rebounding, and because it's full standard deviations cheap in our models.

18:51But this is potentially very interesting news for Taiwan. And you can argue that, is it a good idea that you bring in the China dove for the Taiwanese equity market? Well, at least the risk of a major standoff between the US and China probably abates from here. Hey, everyone. We're going to take another quick break and hear a word from our partners, and then we'll be right back.

19:17It probably opened up more or widened channels of communication, and that's a very, very good thing. It could be the first steps toward a sort of a detour over a Kamala presidency. still very early days on that but of course it's going to be a huge importance for markets as well so I think that was pretty much what we had Andreas, a little extra episode here we still have an exciting week to go this is what I prepared last week for us to look at this week it's been everything but this but we are still looking ahead of course at some important export numbers from China especially and services PMI out of the US to add fuel to the fire or perhaps calm things down a little bit.

20:00Any last remarks, Andreas? Yeah, so maybe, Miguel, I can sum up on how to call the bottom. Yeah, good idea. You need to look at one-year traded inflation swaps. If they rebound, that's your clue that the market is getting less scared of deflation. You need to watch where dollar yen settles. I think it will settle between 140 and 145 based on where real rates are now. and then you need to watch the overnight reverse repo facility from the Federal Reserve. If that facility keeps dropping, it's your clue that liquidity is increasing and don't buy into this panic that the Federal Reserve will emergency cut.

20:38If they'll make an emergency decision, they'll make an emergency decision on liquidity. And if they announce something on their webpage on liquidity in relation to this, it's also your clue to buy. Absolutely. We're welcome, Andres. Thanks a lot for joining. It's getting dark where you are. I can see we cannot see you anymore. So I think it's time to round this off. We'll be back on Monday with another edition of Macro Monday. See you all today.

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