What’s Driving Global Liquidity? With Darius Dale

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0:26What's driving global liquidity? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Darius Dale, founder of 42 Macro. Hi, Darius. Hey, Maggie. It's great to be back with you and your audience. How are you doing? I'm doing well, thanks. I'm doing well. So it It looks like U.S. markets in a bit of a holding pattern ahead of Friday's payroll number. U.S. stocks ended the day fractionally lower. We had treasury yields down a touch, but not a whole lot going on, which is understandable. We know the economic data is going to be important, of course, but you're also closely tracking global liquidity, and you sent over some really interesting charts.

1:03So I thought we'd kick off today with you just giving us your view on what's happening with liquidity and why we need to pay attention to it. Yeah, absolutely. Thank you, Maggie. So we put together a few slides. We'll be brief and be quick, you know, open it up for some questions afterwards. But I do think it's really important to focus on this because right now we have two dynamics that are occurring in markets that are direct headwinds to global liquidity and could make the correction that we've experienced across risk assets. And obviously in defensive assets as well, primarily defensive assets, it could actually make that start to snowball in itself, akin to what we saw in September of last year around the UK guilt crisis, etc.

1:39So I think we have to be very concerned as investors that we're starting to get to some critical thresholds and some of these key leading indicators to liquidity. So without further delay, Brian, if you can just pull up chart one, we'll fly through these charts really quickly. Chart one, where we show on the left, our global liquidity proxy. And for those who are not familiar with our work on global liquidity, what the 42 macro global liquidity proxy is, is the amalgamated sum of the global central bank balance sheet, global broad money supply, and global FX reserves minus gold. We show that on a year-over-year rate of change basis in the black line in both of these charts.

2:14The blue line in the left chart is the global stock market capitalization on a year-over-year rate of change basis. Bitcoin on the right chart, as you can see, it's actually a key driver risk assets, increasingly so in recent years. And this is obviously something that Raoul focuses on. Him and I did a big deep dive on global liquidity back in June. and if folks want to check that out, you know, asset markets. If you go to slide two, Brian, you know, the reason we track global liquidity is because, you know, it explains a lot from an asset market perspective in terms of the levels of asset markets.

2:44So they're always co-integrated with global liquidity. In this chart, we just show the blue line is our global liquidity proxy on a nominal basis. Red line is S &P. Our orange line is Bitcoin. Purple line is Ethereum. Black line is the Treasury Total Return Index. And the green line is the Corporate Bond Total Return Index. And as you can see, they're always co-integrated with global liquidity, but those correlations do rise and fall. They're not always tightly correlated. But generally speaking, if you have a big move higher in global liquidity, you're going to see rising asset prices. A big move lower in global liquidity, you're going to see lower asset prices.

3:17And the reason we're sort of having this conversation now, if you throw up slide three, Brian, is because we've seen a real aggressive move higher in the U.S. dollar. I want to say it's been up every week since the end of July. And the reason that's important as it relates to global liquidity is because the dollar and FX volatility are key drivers of global liquidity on a leading to coincident basis. And so in the red line, the black line in these charts, again, are the year-over-year rate of change of our global liquidity proxy. The dark green line in the left chart shows the U.S. dollar real effective exchange rate on a year-over-year rate of change basis, almost perfectly inversely correlated to global liquidity.

3:53And then the last slide, the light green line in the right chart shows the currency volatility index. The Deutsche Bank currency vol, C-VIX is what we call it on a year-to-year rate of change basis. And you can see it has a similar relationship to global liquidity as well. So when the dollar is rising as it has been for the past few months and it's starting to see a breakout in currency volatility, not quite there yet, but we're actually moving in the wrong direction again. Now, that, in our opinion, is something that could actually make what has been a negative global liquidity impulse significantly worse, much like what we saw in 2022.

4:23The dollar, if you go to slide four, Brian, just real quick on this chart, this dollar is really strong on a real effective exchange rate basis. For those who are not familiar, real effective exchange rate is a broad trade weighted currency basket that's sort of adjusted for inflation across the various localities. And so it's sort of like a true underlying measure of strength of the U.S. dollar on a broad trade weighted basis. And what we see is that at the current level, we're about as strong as we were at the highs of 2001, which is the prior peak in this index prior to last year. This data only goes back to 1994.

4:55It's unlikely to be as strong as it was in the 80s, but it's still very strong when you consider this particular time series. If you go to slide five, another thing that's been weighing on global liquidity and obviously weighing on asset markets in recent weeks is this bounce higher interest rate volatility. So same charts we're showing here, but the red line in the left chart shows the global real 10-year yield. We track that on a PPP, purchasing power parity weighted basis, on a year-over-year basis point rate of change. We show the move index on a year-over-year basis point rate of change as well.

5:26And what we find is that interest rate ball, although not as tight, is a key driver of global liquidity and more so on a leading basis. What we find is that when you see these big spikes in yields, you typically see big declines in global liquidity on a lack basis. And what we find is that the move index or bond market volatility is inversely correlated to the global liquidity on a coincident basis. So, you know, a lot of what we've seen over the summertime in terms of the spike that we've seen in interest rates, I mean, just look at the last month, the real 10-year tips yield is up about 50 basis points.

5:57You know, that's something that's really causing, you know, real damage to this sort of liquidity features in asset markets in recent weeks. And just if you look at slide six, Brian, the move index is actually structurally elevated as well. So, what we show that blue dotted line just shows where the current value of the move index is. And, you know, you're in the 80th, 90th percentile for this time series going all the way back to 1988. And it's been elevated for a while, but we're now moving in the wrong direction again in terms of, you know, kind of the liquidity feature in asset markets. And the reason we bring this up, we'll just wrap it up in terms of the last couple of slides, is the global liquidity impulse has been negative for each of the past six months.

6:34And if you go back to the discussion we had with Rau back in June, we sort of took the other side of the view, Rau's view, which was that we thought global liquidity was inflecting, had inflected lower and would likely continue to be negative on an impulse basis, on a go-forward basis. And what we're seeing is that positive surge that we saw in global liquidity in the first, the latter part of acute poor and the first part of this year has really inflected. And we tracked our global liquidity impulse on a three-month, on a trailing three-month momentum basis. And what we find is that we're losing about$1.8 to$2 trillion of global liquidity over the last three months.

7:08And that's something that could deepen in the coming months if we continue to see dollar strength and bond market volatility, which in our view would be further exacerbated by this sort of U.S. exceptionalism dynamic that we wrote about in our lead-off morning note this morning. And then, so that's sort of it. We can wrap it up there in terms of questions. I think that's really important. I'm going to pause and say two things here. And Brian, I'm going to ask you to pull up our platform if we can. So it's great for us to start with that, with Darius, because I think that he's giving you a peek inside the framework that a lot of analysts build, right?

7:44They're not throwing darts or they're not just guessing where they think things are going to go, like sort of shooting from the hip, right? There's a lot of analysis that goes into it. If you feel like you don't understand everything Darius just said, if you're earlier on the journey or coming into this from YouTube or you're listening on YouTube and understand it, on our platform, the comment section under the video lives all the time. So you can ask questions about the charts he talked about or what it means again or for further clarification. Brian's showing it right now. That's open all the time.

8:20It doesn't close. tag me, tag Brian. We look at those all the time. So the next time we do an AMA or the next time Raoul and Darius come on and dig into this, we look at all those comments, we look at all those questions and we feed them into the shows we do, the questions Raoul takes, the academy things we do in our education center. So don't be put off if some of this seems like it's a little, it's something you haven't heard. I know some of you are diving into it and you know about it already. But if you don't, I don't want you to say like, oh, this isn't for me. We're here to break it down.

8:56That's what we do. And nobody does a better job of that than Darius by showing you what goes behind it and showing you some of the charts because it's a lot of work. So I just wanted to say that right off the bat. So Darius, with that, this global liquidity piece that you've been talking about, Raul's been talking about, is something that it doesn't really sort of pop up when you go flick on the financial news channel or something. But it's very important. It seems to be playing a really big role. It sounds like you're concerned that all of the sort of whipping around that we've seen in interest rate, in treasury yields, in currencies is sucking, am I understanding this right, sucking liquidity out of the system.

9:37And that's bad for stock markets. That's bad for things like Bitcoin. It's sort of creating a risk-off environment. Is that what that's telling you? Yeah, that's the key takeaway. And why it's doing that is because the world needs dollars to satisfy their existing stock of dollar obligations. So if the price of dollars is going up and the supply of dollars is being reduced at the margins because of currency volatility, because of interest rate, real interest rate rises and interest rate volatility, then it's making it harder for the global capital system that we currently built and kind of stuck with for a while to continue chugging along at the same pace.

10:13And so obviously the implications are you're going to have headwinds in asset markets. You're going to have headwinds in the economy. And that's very different than the sort of transitory Goldilocks vibe that we've been living in really since, you know, going back to Q4. You know, we sort of pivoted to that back in January. 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. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus500 Futures, you can trade crypto without the hassle of opening a wallet.

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11:39While we're talking about this currency situation in the dollar, and that chart on the dollar is crazy, but before we take a look at that again, Andreas dropped his latest steno signals on our platform today, and he also highlighted currency risk. Let's have a listen to that, and then we'll talk on the other side. so there's a risk of what i call the dollar intervention doom loop occurring out of asia so when the dollar is strong versus local asian currencies local authorities can sell dollar assets and buy local fx to try and mitigate the pressure from the strong dollar but the issue is if they start selling their dollar treasury holdings.

12:26They also increase the yield on US treasuries along the way, meaning that the yield spread between the dollar and the local currency will basically widen even further. And then we basically have a doom loop and they need to intervene further. So more dollar assets, yield spreads widen, and there you go. So that doom loop is a clear risk. And that's just one of five things influencing the treasury yields curve. That's what Andreas was really focused on. But as we're discussing, it has a lot of implications. To watch that entire presentation, by the way, head over to our website. If you're only following us on YouTube, make the leap, jump on one of the trials we have.

13:07You can find it all at realvision.com. So Darius, we hear doom loop. This is a pretty ominous thought, but talk to us a little bit about that dollar situation, because this is, I think this is really important and it seems to connect exactly to what you're talking about with global liquidity. Yeah, absolutely. So if you can just go chart three back up while I explain this, and I think doom loop is a fantastic phrase, by the way, because it perfectly describes what is actually happening on the ground. And so when folks, particularly in the crypto space, think about liquidity, they think about it from the perspective of, okay, central banks, this central bank stat, are they pumping?

13:45Are Are they removing liquidity in terms of making the Bitcoin price go up or down? There's private sector agents that create liquidity as well in the sense of commercial banks, non-bank market participants as well, particularly in net international investment surplus economies like Europe and Japan. It's very hard to create incremental credit and extend and allocate credit to borrowers, existing borrowers, newer borrowers, when you have currency volatility, when you have interest rate volatility as we are currently experiencing now. And so that sort of private sector liquidity creation vehicle in terms of the global liquidity matrix, which is why we include broad money supply in that matrix, is actually being curtailed at the margins.

14:26And the reason that's important as it relates to the doom loop is because we have this sort of the world is structurally short dollars. We know that there's about 13 to 15 trillion dollars in dollar denominated debt. If you look at dollar-denominated loans, it's about two-thirds are denominated in dollars. Bonds, international bonds are about two-thirds denominated in dollars. And about half of all that is created by entities that have no organic access to dollars. It's like Japanese banks or European hedge funds or Brazilian pension funds, something like that. So the world is sort of stuck in this doom loop scenario as long as the dollar continues to rise.

15:04And when you think about what's causing the dollar to rise, and Brian, you can throw up slide nine here on the screen, what's causing the dollar to rise is very fundamental. You know, the U.S., and so what we're showing here is our global liquidity monitor, where we're tracking various metrics across growth, inflation, and policy across the various localities to understand, you know, what are the key deltas, the levels, and trends on all these indicators to understand what's likely to occur from the perspective of policy, from the perspective of those, you know, sort of commercial banks. And what we find is that the U.S.

15:37is outperforming substantially. When you look at places like Europe, places like China, it's not quite outperforming Japan. But, you know, one of the things that's been causing that dollar persistent dollar strength is this U.S. exceptionalism by not just in terms of the economy, but also in terms of terminal rate pricing, floor rate pricing, et cetera. So I don't really see how we get out of this without some sort of intervention from the perspective of central banks who have the ability to kind of. That was my next question, Darius. You read my mind. Could we see intervention? It's been a long time.

16:10People forget, but there was a period where central banks were – I mean, we see it happening in Japan. We see, to a certain extent, in China, they're in the markets. But there was a time, especially pre-Euro, when currency intervention was commonplace by central banks. Could we see intervention? Could the U.S. intervene to weaken the dollar to prevent this sort of doom loop from spiraling out of control? I think if we saw currency or - Coordinated. Coordinated intervention. So that was the Plaza Accord back in, I want to say, 86, when we saw coordinated intervention in the currency market. The dollar was much stronger on a DXY basis back then, I want to say, in the high 160s, whereas now the dollar is kind of just above 100.

16:54So I think we're a long ways away, both in terms of the price levels of the dollar, but also in terms of the volatility in the interest rate market and in the currency market to see coordinated intervention. The kind of intervention I think is more likely to happen in this scenario is economic intervention on the other side of what happens when you pull this liquidity rug from out underneath these major economies. You might start to actually see something that looks like a real true sovereign debt crisis in more core sovereign debt markets. Obviously, the GILT is a fairly core market, but it's still not really big or meaningful relative to the existing stock of a global sovereign debt.

17:28If we start to see something creep into, I don't know, the JGB market or the Boone market or the U.K.-U.S. Treasury market, because all these markets are highly correlated, That's where you might start to see central banks find the next alphabet soup of acronyms to kind of address it, much like what we saw with the BTFP back in March. Exactly. Don't expect them to call it quantitative easing, though, because we know how everybody feels about that. The same thing in a different dress, maybe. So a lot of great questions coming in here. You folks are amazing. We're going to try to get through a lot of them.

18:03So, gosh, they're so good. Okay, let's start with the DXY. Do you think that Brian and Mario are killing me this week, and Nick, they're just naming people after celebrities because you're coming in a serial number still. So this question goes to Seth Rogen. Do you think DXY could go back and possibly break above 113 from back to October of last year? Yeah, yeah, definitely will. No, I mean, it's unlikely to if we continue to have this sort of expeditious rise, because I do see I see a scenario where the Fed is going to have to step in and intervene in asset markets. If we continue to rise like we do for the next few months, like we have over the previous two months, over the next few months, if we could have a much more grinding move higher in the dollar and a grinding move higher in real interest rates, like what we've not necessarily like what we've seen.

18:53But if it slows down but continues, that's how you get the dollar back to those levels, because ultimately there will be no reason for the policymakers to intervene. So I think it's a reasonable expectation. It just depends on the path it takes to get there. Tom Hanks is asking, can the Fed – they have to have some fun. I love it. I know. I'm all for it. Can the Fed – I mean, I love that some of these – you can let us know how you feel about your celebrity. your celebrity handle while we suffer through this. Can the Fed reverse the liquidity drain, which is forcing the dollar up? Yeah, it can.

19:31Is it going to? No. I mean, you look at the most recent kind of compendium inflation statistics. We are now in a official tug of war between immaculate disinflation as a market narrative and sticky inflation as a market narrative. That, in our opinion, was very much evident in the August CPI data and the August PPI data. We saw headline CPI and PPI pop on a three-month annualized basis to levels we haven't seen in a couple of quarters. We also saw some stasis or lack of further deceleration in some of the underlying measures of inflation like trim mean CPI, trim mean PCE deflator, and also the super core PCE deflator, which obviously Jay Powell was cited a few times as kind of this kind of main underlying inflation gauge that the Fed is intricately focused on.

20:17And we're not really We're no longer seeing movement in those indicators anymore on a three-month annualized way to change basis. And that's a problem because they're all stuck at levels that are 100, 150 basis points north of the Fed's 2 % price stability target. And if we start to trend sideways, this Fed is just going to be on the sidelines for an extended period of time unless we have some carnage in financial markets that can get them. I was just going to say, unless something breaks. This is how we started the conversation with the rapid or the tightening that was more aggressive. And then we stopped talking about it because we had all of this other growth and all these other developments.

20:56But we seem like we're back to that again. And there are a couple of questions related to that. One of them, what do you make of the recent decline in oil prices? Yeah, no, that's the best possible thing you could be seeing on your screens as an investor right now. Obviously, there's a lot of folks who are long energy and probably about the highs in energy that are learning a lesson from Mrs. Market right now. But the reality is that's awesome. I mean, energy is up about 10 % over the last three months. Prior to this decline, it was up like 20 to 30. So that's something that's obviously contributing to the inflationary impulse that we're still seeing.

21:32But again, that inflation impulse is not just energy. It's not just the sort of more volatile components of CPI. We are actually starting to see stasis again in these underlying measures of inflation that have nothing to do with energy and food. And so we need to see energy prices go down if you want to remain bullish as an investor. You need to see food prices go down. You need to see Europe closing the gap as it relates to U.S. exceptionalism and some of the economic delays that Europe's been in, because that's been one of those things that's caused this unabated rise in the U.S. dollar. We're going to take another quick break to hear a word from our partners.

22:05We'll be right back with more of the day's top analysis on the Real Vision daily briefing.

22:14Yeah, and that's exactly what Oliver is asking about. Do you see a recession in the EU? And if so, will that push the U.S. dollar even higher relative to the euro? Well, every major economy in Europe, where you go, Eurozone, Germany, France, Spain, Italy, has negative year-over-year industrial production growth. Sorry, negative year-over-year real retail sales growth. And every economy, with the exception of Spain, has negative year-over-year industrial production growth. I don't see how you can argue that they're not in some form of a mild recession with those statistics coming at you. Now, this is not a recession that's sort of like cascading and building upon itself like recessions typically do.

22:48Right now, they're just kind of experiencing a mild contraction in economic output. If we start to see the eurozone unemployment rate rise in a material degree, it has not really risen yet. But once we start to see that, that's when you can make the case that this European recession ordeal could be pretty nasty. And eventually, that'll be positive because it'll take inflation down in Europe and get the ECB kind of backing off from a rate perspective. if that'll take the terminal rate structure in European rates down to a level that's a lot more palatable for market participants. But again, this is a multi-step process.