Is There a Risk of Another Flare-up in Banking? w/ Geo Chen

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2:07Is there a risk of another flare up in banking? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Gio Chen, author of Fidenza Macro Blog. Hi, Gio. It's great to see you. Hey, Maggie. Good to see you, too. So we're all coming off a long holiday weekend here, bank holiday in the UK. And, of course, those who were paying any attention and not kicking off the summer season here know there was a deal, which was a relief. But we still see this sort of edginess in markets. U.S. equities ending mix, yields a bit lower as investors wait for Congress to now sort of pass and stamp this, some last-minute bickering.

2:49But there is the assumption that it will get through. How do you see this playing out? I know there are, you know, just before we can even get some relief in that they actually agreed to something, I know there's a lot of concerns about what happens once the deal is actually done. What happens next? How do you see this playing out? Yeah, I'm pretty excited to get past the passing of the debt ceiling because I do think that what's going to happen on the other side of this is going to be really interesting. You know, as many listeners and viewers know, what's going to happen is that we're going to get the Treasury refilling its Treasury General account.

3:34And this has been one of the most telegraphed, talked about refilling of the Treasury General account I've ever seen. and you know what's interesting is that I think that the market especially bond market has already gone a long way to price this in because the bond market sees this massive 700 billion of additional supply coming in over the next four months and they've they front run it to a certain extent, I think there's been a buyer's strike where the market wants to get a premium in yield ahead of this issuance. And that's why we've seen bonds sell off. We've seen shorter dated sophers sell off.

4:24And we've even seen another hike get priced in for over the next two months. And I don't think this is really driven by fundamentals that much. I do think part of it is being driven by anticipation of this massive issuance. Yeah, that's an important point. So a lot of people think that, oh, the Fed's been looking at some of the data and we don't see things slowing down as much as they want, or there are some signs of inflation still running at elevated levels, and that's why we're going to get the rate hike. You think it has maybe more to do with this issue of supply, or is it both? Yeah, I think if I had to guess, one third of it would be those fundamental issues of inflation being too high.

5:18A couple of data points coming in a little bit higher than expected. But I think the majority of this move has been due to expectations of that supply. And this is because I noticed that the buy side liquidity in fixed income has been really poor. So when we've had these hawkish comments or slightly hotter than expected data, we've had outsized moves in the bond markets. And that's been going on for the last two or three weeks. And it just seems a little strange to me. And the only explanation that I can come up with is that the bond market is front running this issuance. And this is a phenomenon that I've seen in the past, like, for example, in FX, when the market knows that there's a big flow coming, like a well-publicized dividend payment or rebalancing.

6:21You know, the liquidity on that side will just dry up. So if it's a self-low, the buy side, the liquidity will just dry up. And you'll see the market just get pulled lower into the event. Yeah. Yeah. I think it's really important. We've been talking about it for a while, both on the daily briefing, which is why we do this for you guys, but also on the platform. They've really been digging in. If you've been listening to Andreas's weekly steno signals, Gio, I know you've been writing about it. A lot of you who really closely watch these macro events have been signaling this. And it's not the kind of thing that you are hearing about, I would say, on mainstream, or if you're an average investor, if you just open the newspaper, it's not always easy to see those signals.

7:04But this is important. First of all, talk to me about the amount of supply. This is a lot of supply coming onto the market. Normally, this wouldn't happen, but they weren't able to do it while we've been haggling over this. are there enough buyers are yields high enough now to attract the amount of buyers that will be needed to absorb all of this all of these bonds yeah i i do think that yields are now high enough for the market to absorb these bonds and that's because where yields are especially on the short end right now i in my opinion are are pretty mispriced um i just don't think that there is

7:50enough cuts being priced in over the course of next year to factor in the possibility of a recession and or banking crisis coming up. So when we're looking at liquidity, you sent over some charts, right? I think we can pull one up. So what do you think is going to happen? People, we talk about liquidity, so I think it's hard for people to understand exactly what that I mean, why are you looking at this chart? What's going to happen with that first chart? Yeah, so we were looking at the Treasury General account earlier. And then if you go to slide two, you can see the chart of net liquidity. And this is the Fed balance sheet minus the Treasury General account minus the reverse repo.

8:35And it's just a picture of overall net liquidity in the dollar. There we go. Yeah, now we're looking at it. Okay, so that's net liquidity. And so we're going to get$200 billion of issuance in June, net issuance, and$500 billion in Q3. So that's$700 billion of additional issuance. So that's going to send net liquidity all the way back down to March lows, which was where we were before the banking crisis, Silicon Valley Bank and all that. So not only have we had a serious backup in yields, the prices of liquidity, but now we're just going to get a big drain in supply. And I just don't see how the banking sector is going to be able to take this very well.

9:26It's still fragile. They're still borrowing from the Fed in order to cover their health to maturity portfolios. deposits are still flowing out of the banking system into the reverse repo facility. So I just think that there's a high probability that we're going to get another flare-up. And if you go to slide three,

9:52you'll see that every time that real yields have gone back up to this point, which is 1.6 % in the 10-year real treasury yields, something bad has happened. there's been some volatility. And right now, where equities are today, there's very little volatility priced. So I do think that there is going to be some kind of volatility event, most likely in the banking sector, that's going to shock the system and potentially force the Fed to come back in and support it, just like they did in March. so let's walk through the different implications of that and so and i know it sounds like it's really scary i know i know guys like you you see these vol events as opportunities as well so i don't want to lose that in all of this like being prepared is the most important thing if you know what to have on your radar and look for it when it starts to happen it can be dangerous but if you protect yourself and then you have the ability to have some powder dry to look for opportunities i I know that's enticing, but let's talk about what the event in and of itself first.

11:01Within the banking sector, are we talking about just continued loss in regional banks? Is it one of these slow motion ones where we can see them ring fence it, or is it going to be more serious this time? Do you see it moving up the food chain or happening more rapidly in a way that would cause dislocation? Yeah, to tell the truth, I don't know. I don't know if it's going to be one bank or a series of banks. What concerns me is if it's a super regional in the U.S., a bank, a large bank that has 300 billion of deposits or more, that would be more deposits than the FDIC has as an insurance fund.

11:46or if it's in the European banking sector, which would be extremely dangerous because these banks have half a trillion or more in deposits and they are systematically important because most European countries only have just like one to three really big banks. And there isn't really a mechanism for each individual country to come in and save it very easily. Yeah, that would be a difficult situation to say the least. So let's put that off to the side for a second. Let's talk about equity markets. So we've seen this really interesting as bonds are fretting about the debt ceiling and now the knock-on effects once we get through it because it sort of lingers.

12:41It has consequences that we ran up this close to it as you've just laid out for us, the NASDAQ's been on fire, right? Driven by gains, AI-related stocks, NVIDIA, the poster child for it. By the way, programming note, everyone, Beth Kindig is going to be back on Three Ideas tomorrow, Wednesday, the 31st at 1 p.m. to give us an update on those January trades, which NVIDIA was the top one. So she's going to give us an update on how she feels about those trades now and give us three new ones. So be sure to check that out. But Gio, when you look at this happening in equity markets, are they just going to continue to operate on their own fundamentals like this, all the enthusiasm around AI?

13:23Or is it setting us up for trouble if we were to see a vol event like you're talking about, a breakdown in the banking sector again? Yeah. Equity markets, I don't think that they are going to come out unscathed if we get some kind of flare up in the banking system um i do think that they will be a little bit more resilient than than expected so um you know i i think the ai sector uh big tech it's it's real like it's it's it's a real this is real growth and and this is what we saw in nvidia's earnings um so it's not you know completely a fad it's not completely a bubble I think at some point in the future, it may become that, but we're not at that point yet.

14:15And if you look at other equity markets around the world and other sectors, the Russell, S &P, equal weighted, they've been going kind of sideways. So, and I think this is a reflection of liquidity going sideways. But once liquidity goes back down, then I do think that it's going to spill over into the broader equity market, most likely including the NASDAQ, suffering a bit of a pullback. But overall, I do think that I would like to be set up to buy that pullback because I just don't think that liquidity, even when it goes down over the next few months, I don't think it's going to stay down. Mm-hmm.

15:05Yeah, everyone's waiting for that pullback, right? But it is worth noting, and you're right, if we see, it just depends on what the nature of that the issue is or the banking issue is, because when there's turmoil, sometimes people have to sell their winners too. So it's difficult to always think any stock or any asset is unscathed, even one that's performing really well. And Trillian X, to your point about European banks, Trillian X in the chat, I'm pointing out that Andrea showed last week that a European bank walk has started as well. So Andrea is watching those European banks as you are, Gio, with a lot of concern.

15:46So if we're looking at that, let's finish. And we have a question, let's go around the asset world. And we have a question from Ed saying, what happens to the U.S. dollar if not enough, and markets, but we just covered equities, U.S. dollar if not enough treasury buyers show up for an auction? How does this impact currencies? Yeah, well, if the last three weeks has been any indication, the rise in yields has led to a higher dollar. So if you see a couple of weak auctions, then you do get a jump in yields. And I do think that we will see a jump in the dollar. But interestingly enough, like the past few auctions have not been so bad.

16:34They've been pretty decent. So I do think that we are starting to attract buyers down here in the treasury curve. And I actually think that in treasuries and sofas, the risk is down to the upside because because we're going to, you know, if we do get some kind of banking flare up, if we do get a pullback of equities, that's going to be positive for treasuries as well as for gold. So this sounds like, so we just, I think, you give us a great overview of very near term once we get past, which is going to be the next month or so, how, you know, we have to deal with this and the implications that might have in terms of all of supply and the pressure it's going to put on banking.

17:16I'm curious as we sort of broaden out and look now toward the second half of the year, I'm going to ask you your thoughts in a moment. But Ryle and Jeff Snyder just did an interview where they also shared a lot of the concerns you have, and they laid out the reasons that they think something somewhere is going to break. But very interestingly, part of their conversation touched on what they feel like are false narratives circulating around. Let's have a listen, and then we'll talk on the other side. real legitimate sustained inflation the 70s style that most people are talking about that's a monetary phenomenon and the monetary system itself has said that isn't happening and so most people try to try to uh like the uh central banks and mainstream keynesian economists to try to bring it into the to the scope of the phillips curve and say well it's it's the uh trade-off between unemployment right if we have a tight labor market then that leads to consumer prices or at least the higher wages that then companies have to charge higher consumer prices and you lead to this wage price spiral.

18:17So that is what's gotten most people's attention as far as, you know, what are the future risks? They think it's macroeconomic when that's not how inflation actually works. It gets out of control when there's too much money in the system. And the system is telling us, as you know, Raul, there is no money in the system for this to happen. So the wage price spiral, which has become a pervasive narrative, is not something the market is considering because there isn't the money to keep it going. Instead, we had a supply shock, right? We had the massive imbalance between supply or really demand that was artificially accelerated because of government programs for various reasons.

19:00and the inability of the global system to keep up with that demand, which small e economics, very simple economics teaches us that the only way for those two factors to reconcile is through higher prices, which is exactly what we got. But that's not inflation and that's not sustainable because that's an artificial redistribution of both money as well as economic activity in the most harmful and unproductive ways. And when you have harmful and unproductive redistribution, eventually that's going to come back to bite you, which is where we are today. We have the markets that are telling us that that day of reckoning is coming closer and closer and closer when we have to pay for an unproductive several years where everything got out of whack.

19:44All right. That was just a little snippet of that explaining why they think the inflation narrative is wrong. By the way, I know a lot of our viewers disagree with that. It's a divided camp, right, as they touched on. So feel free to watch and go drop your comments. We're going to touch on it a lot more in coming interviews, but it's really a must-watch interview for those of you who haven't had the chance to yet. The full interview is on our platform. They really lay out the signals they're watching and why they also think there are big risks ahead, as well as, of course, opportunities, as we just talked about.

20:18But they really sort of tick off a bunch of things. Super interesting. Those of you who know Jeff know he watches the Eurodollar market rate, the global supply of dollars circulating around the world. Super, super interesting with him and Raul. And it was really Raul, the first time we've heard Raul kind of respond to some of the things that Jeff thinks about. So a great one. So a ton of people are responding to it. If you are not a member, scan the QR code so you can participate and sort of have yourself ready, inform your own opinion about some of the things that may be coming at us. So, Gio, when you're looking at the second half of the year, and I think that chat title, something somewhere is going to break, right?

21:01As you're looking at the second half of the year, what are you going to be focused on? What has you concerned? Is it centered in the banking system or is that just going to be where the sort of spark for the powder keg is? Yeah, I think that the banking system could be the spark of the powder keg. But even if we don't get a banking system flare up again, we are seeing a drastic drain of liquidity over the next four months. Because if you add up the$700 billion from the TGA, and then you just have QT going on for$80 billion a month, that's a trillion over the next four months. So if you look at this chart of bank reserves, we're at 3.2 right now.

21:49And there's this theoretical floor, which the Fed estimated to be 8 % of non-world GDP. So that puts it at 2.1 trillion. And that's the floor of where the Fed believes that bank reserves really shouldn't go down below. And if it does, then, you know, we could have potential flare ups in the financial plumbing. Last time we probed the floor, that was back in 2019. and we saw this mini crisis where the repo rate spiked and that forced the Fed to come in and have to buy T-bills and expand the balance sheet. So whether or not we get a banking crisis, I think we are going to find out this year that there is a limit to how far the Fed can tighten liquidity and reduce its balance sheet.

22:48So that's going to be a really interesting event because I'm not sure everyone in the market is believing that this could come so soon. But if I told you that four months from now, the balance sheet is going to stop getting reduced, I mean, that would be massively bullish for equities, for gold and for Bitcoin. Here's the opportunity, people. Okay, let's put up the gold chart first. So explain why that is. Yeah, you know, we saw this back in 2019 when gold started this gold market. Tech stocks had a great year. And I do think that we are going to see, you know, a bit of a mirror image the second half of 2019 when liquidity bottomed out.

23:44And, you know, here with gold, we see that it's tagged the 100-day moving average pretty well. You know, last time we were down here, it had a really nice rally up on the March banking crisis. So if we do think that this 100-day moving average is going to hold gold, and if we think that we are maybe a month that we're going to get some kind of banking flare up again within a month or two, then this is a great place to go long gold, both tactically and for the long term. So interesting. And you mentioned Bitcoin. I'm assuming maybe you're looking at tech stocks, too, because these are the places, the Nasdaq, where when there's liquidity flowing into the system, this is what happens.

24:32These assets rise, right? That's right. That's right. And so far, I think for the past few weeks, Bitcoin hasn't managed to trade alongside tech stocks because I do think that what's happening in AI is an idiosyncratic story. But if we see liquidity going back up again, I think both are going to rise in tandem. So Peter has a question, basic question. He says, does a reduction in liquidity adversely affect bank stocks? Yeah, it definitely does because it drains bank reserves. It drains deposits out of the system. And, you know, basically provides banks with fewer deposits to lend out. So let's see.

25:28We got a couple more questions. Let me get to that page because they're good ones. John was asking, I'm going to jump around a little bit. John was asking, who do you think the buyers are of the new T-bills? That's a hard question, but do you have any thoughts on that? Who would be buying that issuance? Yeah, I think institutions.

25:49The yields right now are pretty attractive. I mean, they're 5 % raising from 5 % to mid fives. I think it's pretty attractive for institutions and for people who want to hedge and lock in that rate if a recession does come along or if a banking crisis comes along. I mean, these are really attractive levels to buying T-bills, especially longer-dated ones, one year outwards. So a question from G, will QT be suspended once the Fed has to pivot? I'm going to guess, G, you're wondering. I'm going to add something. He's not asking this. Maybe you were, maybe you weren't. So if we get a pivot, how do you see it playing out?

26:40Because if it's spurred by something that's breaking, does the pivot go immediately to ease? Are we sticking around at that level where they pause for a while? And then in that situation, if they're just pausing, would the first move maybe be stopping QT before they would go to ease? How do you see the Fed responding? Because it is not something they're telegraphing right now. Now, they are trying to stick by that hawkish forecast, talking about a skip instead of a pause. I think it was Neil Kashkari that said that or higher for longer. I mean, they are hanging on that wording still. Yeah, I think it could go down several ways.

27:23So we could follow the playbook of March where they keep rates high. They don't stop QT, but they have to expand the balance sheet in order to save the banking system in the form of loans. So I think at a minimum that that would happen again if we do see a banking throw up. Now, if it's a really serious one, then they might have to stop QT. They might have to cut rates. I don't know. It really just depends on where inflation is at that time, how serious and systematic the next banking clear-up is. I do think that there is a high bar for them to cut rates. That's not their preferred path, nor is it their preferred path to stop QT.

28:14But whether it's their preferred path or not, or whether it's something they're forced into, is a completely different story. and from a lot of what you were saying and listening to Jeff and Rao, a lot of people feel like their hand will be forced. Gio, what are you going to, so you're looking, it sounds like you're kind of really eyeing those opportunities, gold, perhaps tech stocks, perhaps Bitcoin. I don't know if you're interested in all of them, but you see those assets potentially rising. What would be your trigger? How are you thinking about timing? When are you going to know it's the right time to get in?

28:46Yeah, so I think with gold, that does really well in the volatility event, as we saw in March, and then after the volatility event, when the Fed dollar sheet is riding. So I think this is a pretty opportune time to be getting into gold, as well as getting some allocation to treasuries, short dated. I do think that we need to see how the whole liquidity drain and bike banking crisis, if it does happen, how it plays out. And be patient on Bitcoin and tech stocks. So what are you thinking happens to inflation? Do you see inflation just kind of collapsing based on economic weakness and banking problems and all the rest?

29:40Yeah, I wouldn't say collapsing per se, but I do think that we are on a slow and steady trend lower in inflation. There are, you know, what we have is a contraction in CRE and bank lending. And so that's going to weigh upon inflation. We have the China reopening has turned into a slowdown. So that's going to help contribute to lower inflation. I think we're already seeing it in the gusts of inflation data, CPI core services came in pretty low last month, even though the core was still at 0.4. So I do think that we're seeing the components of CPI come down in a way that's pretty encouraging as well.

30:29Now, the CPI shelter is also coming down, and I think that's already baked in the cake and likely to trend lower for the next six months. And what about oil? So you like gold, but what about oil? Yeah, oil is pricing in a global slowdown. And, you know, we're seeing all these rallies just get sold. And even though there are a lot of great arguments for oil to go up because of supply being dampened in the U.S. and elsewhere, I just think that if we are in a global cyclical slowdown, it's not really an asset that I want to be long yet. I'd rather get long later on when we're seeing green shoots in the cyclical story.