One More Rate Hike on Deck?

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1:30will this be the last rate hike of the cycle hi everyone welcome to the real vision daily briefing with me today is jeff snyder chief strategist at atlas financial and host of the euro dollar university channel hi des great to see you again hi maggie thanks for having me back literally looking forward to this yeah listen there's no shortage of things for investors to worry about and also kind of scratch their head because there's a lot of complicated stuff going on. So let's try to get through some of it as we head into the Fed meeting. First up, we had some regional U.S. regional banks, again, under pressure, right?

2:01PacWest down 30 percent, a couple of the ones really struggling, the overall index down. With Janet Yellen warning the debt ceiling deadline may be coming sooner than expected. And of course, we've got the Fed on tap. So if you look across the action we saw, we had stocks down, bond yields down. What are you watching? What's top of mind for you? Well, I looked at today in particular, you look at the yield curve. That's one thing to your treasury under 4 % again. But that's, I mean, that's been up and down depending upon the mood of the marketplace. A little more consistency in some of the derivative markets like three-month term SOFR, where you had massive moves today, which is consistent with what you're saying in the banking sector, massive amount of demand for hedging.

2:43Before March, you never really saw these contracts move by more than 20 basis points in a single day. But ever since March, we've had some extreme moves. And again, today, more than 20 basis point moves in contracts, really the September 2023s into 24 and 25, which is the market basically saying it doesn't really matter what the Fed does here. The results, the outcome, the probabilities are all baked into the cake. We're going to get rate cuts. They're going to come fast and furious. And as everything that continues to develop over the last six weeks. And even if we go back further than that, it continues to move in that same direction.

3:19If you ask yourself, why would the Fed turn around and cut rates? I mean, just look around. It's pretty much everywhere. Yeah, but talk to us about that. Because some people, and we have some of them come on air, say like, hey, listen, I don't think there's a recession. I think things are stronger than expected. They kind of make all the arguments. I don't see inflation going down. If it dips, I think it's going to come back at the end of the year. What do you see that makes you convinced you're going to have to cut rates? Well, the data continues to move in that direction, even though it isn't obvious right now that the U.S.

3:50is in recession or even maybe heading to a recession. That's not atypical either. You see lots of business cycles where the economy sort of just hangs in the air for a little while and then falls off a cliff. Any number of examples. I think the best one is probably 73, 74, where the economy fell into recession really with the oil shock late 73. and it kind of just did nothing for six or seven months until the middle of 74. And then all of a sudden, bam, it was like somebody just pulled the rug out from under everything. In some ways, 2008 was the same way. I mean, you think about the famous statement from the NBER.

4:24They didn't call the recession until December 2008 because they said, we looked at the data, the data didn't look too bad. And then all of a sudden Lehman Brothers and everything else. And of course, they said, yeah, well, the recession actually began at the end of 2007. So it's not atypical to see economic data look relatively good, especially in the face of what you think would be substantial headwinds. And you think you get sort of this false sense of confidence that everything looks OK, despite the fact that we've had a banking crisis, despite the fact that consumers have been businesses have been pounded by consumer prices and producer prices.

4:57Everything seems to be hanging in OK. And then it's like a hollowed out structure that all of a sudden just collapsed in and out itself. And what really tells me that's going to happen is all of these financial markets that continuously price some of the most extreme probabilities. When you see inversions at the level that we've seen now, these are these deep, sophisticated markets. It's really the monetary system itself telling you that it's hedging for some of the worst case scenarios. And by worst case, I don't mean 1978, 1979. I mean 2008. No. So that's so interesting. When you're describing that, I'm thinking of, I don't know if anyone used to see the cartoons, Wile E.

5:35Coyote or The Roadrunner, where they sort of run off the cliff in Looney Tunes. And then they'd be in the air looking at the camera for a while. And then all of a sudden, you know, they'd collapse. The market telling us this, a lot of people, we've been talking about this. It's been so confusing. And a lot of people have wondered, is it possible that it's just PTSD? like every time there's any risk, we think it's 08 again because we're just conditioned like that. Is that possible? Yeah, but we don't actually see that priced into the curves. So if you look at where the curves were, say, for example, in the last time we went through this in 2018 and 2019, you had curves, you had euro dollar futures invert in 2018 heading into 2019.

6:16That was about maybe 40, 50 basis points, which was enough to suggest something serious was going on. But today we're talking about 220 basis points. So it's the market suggesting that something really is far more extreme. And it's been it's been it's been the curves have been priced this way since last fall. And then everything that has happened since then has continued to validate that that a more extreme position that, you know, all of a sudden we're talking about bank failures again. I mean, for most people, this sort of came out of nowhere. All of a sudden, you know, we're worried about What are regional banks going to be doing?

6:51How many of them are going to be taken over by the FVIC over months ahead? That's consistent with a market's pricing a 2008-style scenario and the level of inversion that we're seeing. So I think in the marketplace, it's a little more nuanced where this time really does appear to be somewhat, I don't want to say legitimate, but at least the probabilities are more like 2008. That's, I mean, not necessarily repeat because nothing ever repeats, but the same level of concern and the same level of downside potential, certainly in the real economy, even if things turn out to be different, that's what's priced into these markets.

7:30it's well first of all that's that's a very sobering sobering idea because you know we I think a lot of people are holding their sort of holding out hopes that we could I don't want to say soft landing because that's been overused and I think we've kind of ruled that out but a lot of people were hoping we could get away with something more mild that we wouldn't see anything really break, although they've been confused about why markets are like that. So what's causing this extreme dislocation or the fear, the desire to hedge and the fear that something big is going to happen? What's driving that?

8:08What would cause that? Well, a lot of it, too, is that there's really not a whole lot of answers, at least in the public, right? I mean, you think about nobody said anything about the banking system before March. And all of a sudden, now we're talking about banks, which is, I mean, that's already in the same territory vicinity of the 2008 era. And then you have, you know, what's really driving the curves is that we have the combination of an already weak economy. I know, again, as you said, Maggie, soft landing, that was sort of an overused term. But even that was suggestive, okay, we have some existing, pre-existing economic weakness heading into this year before we even get to the worst parts of the banking crisis, credit crunch potential, and everything else.

8:49So you have a weak, questionable economy, and then all of a sudden you throw a banking crisis and credit crunch at it. And those two things together, that's where you get into the 2008 Great Recession territory. Because what made the Great Recession, quote unquote, great was the combination of the credit crisis, the banking crisis, along with economy that was really not in great shape at any point to begin with. I mean, the middle 2000s recovery wasn't all that awesome. And it really started to fall off 2006-2007 with a housing bubble. So it's the combination of economic weakness as well as the fact that economic weakness is everywhere.

9:28It's not just the U.S. There's really no place to hide. Europe is not doing very well. China's reopening is faltering. So China's not going to be a source of strength. And much of Asia follows along with China. So it's global concerns about a globally weak economy that can't really afford any more substantial shocks. And oh, by the way, here's a banking shock, which is among the worst kinds of shocks that there can possibly be. 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.

10:04Yeah, and yet people are falling over themselves to say that this is not a weight. This is contained. You're going to see the Fed. Just like in 2008, right? Yeah. Well, I think that's the worry. But it sort of sounds sensible when they're saying it, that their balance sheets are different. It's kind of coming from a different place, a combination of mismanaged banks. Yes, Fed rates are high. That's causing some trouble. But the underlying banks themselves are healthy this time around, not like others. Is that just BS? Some of it is. I think there is, as usual, there's a kernel of truth to it. But in 2008, the banks that were under pressure were the large money dealers.

10:46That was the Lehman Brothers, the AIGs, the Bear Stearns, J.P. Morgan, Citibank, all the big, big global dealer banks. They're not the ones that are under pressure this time. So that's definitely a key difference. I mean, when J.P. Morgan, Jamie Dimon comes on TV and says, you know, from where I sit, everything looks great. I think he's right. From J.P. Morgan's perspective, they're not in any way, shape, or form under the same amount of pressure that other parts of the system have been. That's kind of what me and other people have been warning about, is that the crisis isn't an exact copy of 2008 because history never repeats exactly the first time.

11:23So we're not worried about another Lehman Brothers or Bear Stearns, although Credit Suisse is sort of the exception to prove the rule here. But it's mostly some smaller banks, regional banks this time around, as well as maybe some pressures from non-bank sources, even national economies, that's somewhat different and maybe in some ways more alarming. Because while we spent the last 15 years focusing on making sure the big banks are fine, did we ever really look and examine at all the rest of the parts of the system that actually did experience problems back in 2008? And they either know we basically ignored all that stuff and said, well, if we don't have another Lehman Brothers, everything will be OK.

12:04I think that's the fatal conceit in a lot of this is that, yeah, J.P. Morgan, there won't be another Lehman Brothers this time around. But that doesn't mean that everything works out just fine. No, especially when you realize just a small slice of that. We've been getting a good picture of how important regional banks are to the functioning of the U.S. economy on a state by state level. I mean, that's not easy to switch that, even if they are gobbled up by the larger ones. Is this all a result of the aggressive rate hikes by the Fed? Is that actually the source of the problem, or is that just a symptom of some of what's going on?

12:39I think that's one way in which people are rationalizing why this isn't a big deal. Because they think if the Fed broke it, then the Fed can fix it. And if the market is saying that rate cuts are coming, then you think, well, as soon as the Fed starts cutting rates, our problems are over. I actually think the problem stems from 2020 and 2021, where a lot of these banks, especially, I mean, Silicon Valley, First Republic, were sort of emblematic of that whole period, this distortion of the government throwing all sorts of resources at the economy, just hoping something sticks in order to alleviate any potential downside in the pandemic and lockdown periods.

13:18And a lot of the banks mistaking that to be permanent money printing or permanent prosperity. Silicon Valley Bank specifically was absolutely acting as if that was the case. They built their entire business on this massive surge of deposits as if it was going to continue forever. And so a lot of regional banks have been sort of struggling with the fact that it was a one-time distortion and that as the distortion, as the monetary and financial system searches for a more stable equilibrium in the aftermath of that redistribution and distortion, there's a lot of downside to that sort of, you know, reversion to the mean, where the mean in this case doesn't mean what everybody thought it was to begin with.

14:01So I think that what's happening is, for example, commercial real estate. Commercial real estate, everybody went crazy over real estate in 2020 and 2021, but the economic fundamentals never supported that. So there's a lot of trouble in commercial real estate that's only now being uncovered as the economy gets weaker, as liquidity in the system gets much, much more difficult, which means that now we're seeing all of these mistakes being uncovered by the conditions that are showing up everywhere. So that's a really important point. And if that's the case, can the Fed, is it within their ability to correct the problem with lower rates?

14:43Will that ease some of this transition to mean reversion, or is that not going to do it? I think that's the problem. The fatal mistake was already made years ago. And so it's sort of been sitting there rotting away, just waiting for the time in which the rot would become too much. So you don't fix the commercial real estate vacancy problem or lack of payments or defaults with lower rates. That's not going to get it done. The economic fundamentals just never supported that level of intrusion into that space to begin with. I think there are other problems too. I suspect that a lot of commercial real estate loans that were packaged into CLOs have found their way into the collateral streams, which is one maybe possible explanation for why we've seen such extreme collateral shortages over the last six weeks too.

15:30So if commercial real estate really is the problem that many people suspect, rate cuts aren't gonna do anything. In fact, what the markets are saying is that the commercial real estate problem is going to provoke the rate cuts, not that the rate cuts are going to come to fix the commercial real estate problem. CLOs, Collateralized Loan Obligations, how would they explain a little bit about making it into the collateral stream? To me, that sounds like jumping into a dangerous place that could cause bigger problems. Can you explain that a little bit? Why is that something that you're watching? Well, because securitized structures, we started structuring illiquid loans so that they could be packaged as liquid collateral to be used in collateralized transactions, whether repo or derivatives, whatever the case may be.

16:16It was a good idea way back in the 70s and 80s when it really started. It took off in the late 80s. But there's a downside to that, too, because you could be packaging loans that on the surface seem like they're worth putting together in a pool. You can slice and dice them up as you need to. You can create the specific financial parameters for each structure as they roll off an assembly line. But as we saw in 2008, and again, I hesitate to make the comparison, subprime mortgage structures, mortgage bonds and things like that, CDOs that were packaged together with certain illiquid loans that we didn't really understand how they behaved under stress conditions.

16:55What you end up with is a bunch of ostensibly illiquid, unknowable products put together in a pool that are then – at one point, they're valued in a way that they probably should never be valued. And then the liquidity characteristics of those products of the CLOs or whatever the case may be, whatever security structure it is, they tend to behave very differently than how they're modeled when they're put together because they're modeled under a certain set of tolerances. And history has shown that it's quite easy to violate those tolerances. So in the case where anybody has been using CLOs as collateral, either directly in funding transactions or as a three-legged transaction with transforming, putting up CLO collateral in exchange for, say, a U.S.

17:44Treasury and then using the U.S. Treasury securities transformation, It allows these risky assets to essentially impact and affect the collateral, the systemic position of collateral all across the entire monetary system. Right. They snake into the system and it's very hard to. So is there a way to measure that or no, to the extent that's going on? Because this is exactly what happened. But in the mortgage space, in the subprime mortgage space, and nobody knew who had counterparty risk. Nobody knew where these things were, what books they were on, who was holding them. It was incredible. But we all thought that would never happen again.

18:26It sounds like you're saying there's the possibility that this could be the case again, except now it's commercial real estate at the heart of it. Derivatives products that are based off commercial real estate loans. Yeah, it's exactly – I mean what really – the biggest problem was that as people didn't really understand the downside or how these structures behaved in an adverse scenario, what happened was they just said, I'm not going to value it at all. I'm not going to buy these things. It just got completely shut out, which meant that all of these esoteric structures were impossible to value.

19:02And so if you have a small problem in one part of the mortgage space, for example, back in 2008, now you can't value any mortgages. You can't value any mortgage problems because nobody understands really the characteristics. There's no actual liquid market for them. And as soon as the liquid market dries up, then all of the financial characteristics go haywire. You can't price them. Then they become non-negotiable as collateral, which means everybody has to scramble for different kinds of collateral. And it just becomes this snowballing effect where the system is unable to tolerate any sort of adjustment in something so fundamental in the monetary system.

19:38So this is so important, folks, that we're talking about this because it sounds like, Jeff, this may be the fear that the market's pricing in when we see these inversions and we see this need for hedging, even though no one entity is identifying it. That seems like that's what's circulating, the possibility of this happening. Yeah, and just to be clear, I don't know this for sure. I'm trying to put together different pieces from what we see in the marketplace. Because as you know, Maggie, we don't have any direct insight or a direct window into what's going on in the monetary system. So we sort of have to get some – we have to look at the curves, for example, and what are they telling us?

20:22What's going on in some of the collateral parts of the market? You know, treasury bills. What's been going on in treasury bills? Extreme levels of demand even runs. And so you sort of – you put these things together. And while we don't know for sure that CLOs are a major problem here or that's what's really bothering the market, it doesn't seem entirely unreasonable. And more than that, we can't really rule it out. And if really looking at the way things stand right now, it seems to me that's far more likely than it is unlikely. So if we're looking for one part or one big part of the overall fear factor or fear equation, for lack of a better term, that's probably right at the top of it, at least according to my opinion.

21:03Is there any way to, and we'll take that, We'll take you just – this is the conversation we're having. We're asking you where you're – what you're worried about, where you see possible signs of strain or stress. Not that you have a crystal ball and know it's going to happen, but this is an important conversation. Is there any metric to measure these CLOs or measure collateral? You can look at collateral spreads or credit spreads on certain – there are CLO credit spreads. And they don't look too bad, but you don't know how representative those are. Because, you know, you go back to 2008, you look at some of the prices, some of the pricing mechanism for some of the mortgage products.

21:47You know, we didn't really get a whole lot of advance warning really up until the summer of 2007 where they started to really crack. And some of these CLOs, I mean, they're not really traded in any open fashion. We have some benchmark indices and things like that, but it could be that parts of the system that are truly opaque, there's problems going on there that trigger the cascading effect where it just becomes more of a systemic issue. And it may just be that there's a small hidden problem somewhere, and the markets are saying, I can see this snowballing out of control where it becomes a much, much bigger issue.

22:24And so I'm going to hedge to the max today, especially with everything that continues to go on in the same way that it has over the last several weeks. Yeah, that makes a lot of sense. This is why, you know, for those who are not, it's the famous quote we always say, right, when Warren Buffett called derivatives weapons of mass destruction. Not saying they didn't have their utility, but what his comment was, was that they are opaque and you can't see things happening in them until they eat you alive, I think. And it just keeps playing out over and over again. We noticed there's so much. It's incredible.

22:57Yeah, sorry, Maggie. There's so much hubris attached with them because they're basically made to be quantified by mathematical models. You talk about CLOs, that's what they're basically for. It's like we have this arrogance that we can accurately map all the risks and all of the potential problems that are in these instruments when time and time again, even going back to, you know, John Merriweather and LCCM. Yes, that's exactly what I was going to say. It's exactly the issue with long-term capital management. If you want to go back in history and check it out, this is what happened, right? Yep.

23:29We thought we had all the risks covered, VAR, all of the mathematical formulas that are out there. And we think that we know what the tolerance is for these individual products. And therefore, we know what the tolerance is of using these products inside an opaque system is. And then only to be surprised at how fragile everything is rather than knowable and predictable. And as it becomes more unpredictable, what happens is the math gets even more just ridiculous and to the point that the whole thing just starts to break down. We're going to take another quick break to hear a word from our partners.

24:01We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

24:10The questions are going crazy, and I'm sorry I haven't gotten to them yet. It is just so important what Jeff just said. And this is the entire reason that Raul started Real Vision is to try to flag things that the professionals are talking about that maybe they see that everyone else is left in the dark about. And so this is what we do. I'm going to get to as many as I can. Don't worry. A little bird told me that Jeff's going to be back having conversations with Raul in a couple weeks. So we'll make sure to let you all know about that. And I'm going to – I was going to run a clip from Andreas.

24:40I'm not going to do that so we can get to questions. But Andreas has his steno signals on liquidity. That just dropped on the site today. So go check it out. If you are not a member, scan the QR code so that you can access it. He's got some really good stuff, too, that really dovetails with what we're talking about. But let's get to those questions. We have a bunch of people asking this question. Where did it go? Oh, can the dollar and gold go up simultaneously? Because a few people asked it. We'll start with that. We have a euro dollar liquidity question, too. But can the dollar and gold go up simultaneously?