Will the BOJ change course?

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1:19Will the BOJ change course? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Brent Donnelly, president of Spectra Market. Say there, Brent. Hey, Maggie. Good to be back. Yeah, it's great to have you back. And before we even get going, so our regular viewers know that your daily note, AMFX, is one of my must-reads every day. I'm always quoting you or quoting things that you mentioned in your note. And for me, it's not only super smart market analysis, but I always tell you this. It has all that extra sort of learning and it's just a pleasure and so much fun to read and drum roll starting next week, you are going to be part of the RV marketplace, which I just found out about, and I am super excited about.

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2:39So put that on your calendar as well. All right. So we were just chatting before we came on about whether anybody's like, if people are mentally checking out, it's been such a wild year. We're kind of getting into the end of it, but the BOJ is still, still linger, still out there. It's one of the last big events this year. How are you feeling about it? We should hear something right in the next, next few hours. What do you think? Are we likely to see a change in policy? Yeah. So the last time they met, we had the leak beforehand, which came about noon New York time. So we're well past that now.

3:14So it looks like there's not going to be a leak, which is nice. It's been really interesting. So the last week we had so many central bank meetings, including the Fed and the ECB. And obviously many of the central banks are turning towards cutting. And that's the dominant theme now globally from EM all the way to the Fed and ECB. We've got cuts priced in. But then you had the Norges Bank hiked. And then you are now in a position where the Bank of Japan could hike. And it's funny because they couldn't be more radically different situations, Japan and Norway. But the thing that I will say about the BOJ is just that they're so late to the party and that the increments that they're moving in are so small.

4:01So for YCC, the yield curve control program that they were doing, they were straddling the 10-year rate. And then there's some argument that that could have an impact on global bond markets because when you release the top side for yields in one country, that is going to have an impact in other countries. But when you move the policy rate in Japan, I'm kind of skeptical as to how important that really is. So I think they're going to move it probably in January, not at this meeting. Um, there's basically nothing priced for this meeting. And then April is about 40 or sorry, January or January's about 40%.

4:39And then April's kind of a hundred percent. So somewhere between now and April, they're expected to hike. But the thing is they're going from minus 0.1 to zero. So if you look at what drives the currency, what drives dollar yen, euro yen, all the crosses, And then what drives global rates? The BOJ going from minus 0.1 to zero, to me, is just such a tiny blip on the radar. And then we also have a lot of empirical data that shows that these BOJ moves aren't really that critical. In 2016, they went negative, which was a huge deal. Everyone was freaking out. And that should have been very bad for the yen.

5:20And the yen went straight up for two years after that. So the reason simply is that if you, if the main driver of dollar yen, which has always been the case since I started in 1995, has always been the path of global yields. So if global yields are going up, Japanese investors are looking for higher yields and they put their money abroad and they'll buy like in 2007, it was New Zealand and Australia. Now it's the U S or Mexico, but the Japanese as the biggest pool of savings will send their money abroad when yields are high. And when yields are low, they bring the money back and it all happens at the margin.

5:58So whether the BOJ policy rate is minus 0.1 or 0 doesn't really matter. What matters is what the Fed does, what the ECB does, what the RBA do, or what the Bankseco does. Because it's really those foreign rates that are going in clips of 25 basis points. Or in the US case, we were hiking 50 and 75 over and over. those yield moves are just so gigantic compared to what the BOJ is doing that. And the evidence shows that basically the BOJ matters on the day. And then you just go back to watching the global yields. That's so interesting. And it's a really important distinction. So one question on that, I think, is can the BOJ slowly move away from yield curve control or do they do they lose control of I mean, that's sort of been an outlier word.

6:47Now, people will say the BOJ has an enormous amount of ammunition. And they are a central bank that is still very used to intervening in markets. But still, there is also that history of when central banks say they have lines in the sand and they're only going to try to keep things in a rage that the market just keeps testing them until they blow it out. Yeah, so the thing with the BOJ now is that their cap isn't really close to where the market is anymore. So the cap, I think, is at 100. And last time I looked, the swaps were at 70 or something. So they were capping it and it was a real cap. But now it's unless yields go up significantly, which mostly they're going down now around the world, the cap is no longer really being threatened.

7:29I think the idea that the BOJ could be broken isn't really in the market's mind anymore. Just like they have a lot of credibility. But then again, you just never know. I think in a world where yields are skyrocketing, essentially anything could happen in theory. But in a world where yields are kind of stable and volatility is lower, which is the world we're in now, I think that possibility is just dramatically reduced. So then you're really talking about what are global yields doing relative to Japan and what are Japanese savers doing. And when yields are coming off globally, savers are going to bring money home and that should put upward pressure on the yen.

8:08And so even though I'm kind of skeptical of the importance of the BOJ, we're actually in a regime now where the yen should appreciate simply because global yields are going down. Do you have a target for the yen? Where do you think it could get to? Well, I think if tens go to 325, which I think is realistic, like that's ambitious but possible, you could get dollar yen back at 130 or 135, which is 8%, 7%, 8 % from here. Um, we've, we've topped out now a bunch of times around one 50. So it feels like a very asymmetric trade. Um, because if you're short dollar yen, you kind of have like the momentum of the fat on your side, you have the momentum of the BOJ on your side, you have the ministry of finance on your side because they've been intervening above one 50.

8:59But the big problem is that it, the carry is very expensive. So when you're long yen, you're long a currency with zero rates and you're short, whatever you're going to be short. If you're short the dollar, then you're short at 4%. So it costs a lot of money to be short dollar yen. So you need to, you know, the bar is fairly high. You need a decent move. And then that's really why it's been a widow maker this year, because every time the BOJ changes the yield curve cap, it looks like it should open the door to be short dollar yen. But then people after about two weeks of being short are like, okay, this is costing me too much money.

9:33I got to get out. And then dollar yen just rips back up to the highs. However, if U.S. yields are going down this year or in 2024, then maybe it'll finally work.

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10:56That is the big question, right? So we had Goolsby, I should mention, by the way, Japan really is kind of the making headlines on a period where we are getting quieter because there was a steel deal, right? Nippon made an offer for a U.S. steel, which is sort of interesting because we haven't seen something like that in a while. But Goolsbee came out, became the latest Fed member to kind of come out and question the market reaction. But investors seem to be ignoring absolutely any attempt to walk back the dovish messaging and reaction to the Fed meeting last week. I mean, we still see it kind of impacting the markets.

11:35So do you expect, do you think that the market's betting on the rate cuts seems accurate right now? How are you feeling about the interest rate trajectory in the US? So to me, it makes sense. So my kind of base case for a long time has been something that looks more like a soft landing. Like people say that there's no such thing as a soft landing, but there is, I mean, it's happened before it's rare and it's hard to execute, but it's possible. And if the majority of the inflation that we saw was caused by supply chains and by massive fiscal stimulus, then maybe monetary policy is a little bit of a red herring.

12:13And now inflation is just coming back down because supply chains are fine and fiscal is a little bit less crazy. The problem that the Fed has is that they've layered on so many different types of communication over the years and they never take anything back. So it's kind of similar to taxes or service charges or traffic lights. Once you put them in, you never take them out. But that doesn't mean that all those traffic lights are always going to be a good idea if population changes or whatever. So the Fed keeps adding all these new communication tools. And the point of forward guidance in the dots was essentially to reinforce quantitative easing and say, we're not going to hike for a long time, so you can believe in our QE.

13:01But now we're well past that. And the dots are saying, the dots came out showing three cuts in 2024. So on the one hand, the Fed's saying, hey, we're not talking about cuts. But they are talking about cuts because you're forced to decide when you submit your dot, are you going to put one hike or three cuts? And the median was three cuts. So they have a communication problem because no matter what they say about what they're thinking right now, the dots reveal something and the trajectory of inflation reveals something. And so the model, I think, that makes the most sense is you look at where real rates are and real rates are pretty high.

13:43Like, you know, the Fed has hiked a lot and inflation has come down a lot. And as much as I know many people will never believe this, it is possible for the Fed to cut in an environment that's not apocalyptic. Like they can cut rates a couple of times to get back to real rates of one and a half percent and the jobs market could still be 3.8%. So the really interesting thing now, though, this is not my base case, but I think like I always think of, as you know, in terms of like, what's the base case and then what are some other reasonable and realistic things. And the really interesting case now is if the data actually heats up in Q1, because a lot of times we have seen that like more in the February, the January data, which is released in February, you get really hot data and then everyone's like, whoa, what's going on here?

14:37And when you have a Fed saying one thing and the whole market's just calling BS on what the Fed has been trying to say in the last few days. And then the data gets strong, then the market's going to be in a really awkward position. So I'm keeping that on my bingo card, which is just like reacceleration in January. And everyone kind of goes, holy crap, this is like the way we got to 5 % in yields was an overshoot and maybe 3.9 is an overshoot. I think bigger picture, the inflation data is more important. And my base case is we're going back to like 2012 to 2019 was low inflation, okay growth, higher stock market, pretty good for bonds.

15:22Secular stagnation was what they called it at that time. And if you imagine something like that, but a little bit less bad than that, because that was pretty bad in terms of like growth and inflation were very low. So if you imagine, there's been some flow through from wage growth to inflation psychology and things like that. But then in the end, technology and demographics are mostly what drives inflation. And then you had a supply shock and the supply shock's over. So my base case is we just kind of grind back down and we get some rate cuts. But the really exciting thing would be is if things just take off in Q1, I mean, people will lose their minds.

16:02Yeah. And it would be the pattern we've seen, right? Because everyone anticipates the weakness, the recession, the pivot, and that we heard everybody saying that it's a pivot party. Everybody's welcome. That was the headline. I forgot who said it, but last week that everyone grabbed onto. And then you get this violent move again in bonds, if that's the case. I think what's interesting is so many of you that have been coming on Real Vision, and it makes sense because a lot of you will hold a shorter term tactical framework as well as your larger macro framework because you're always kind of retesting your thesis or looking for the probabilities that may have switched.

16:45Quite a few of you are nervous about this sort of whiplash, this potential for things to still run hotter. And then the market kind of had to rethink the timing anyway of the rate cuts. And maybe that's where the question mark is. It's not whether they'll eventually cut next week, but how quickly they do that. Right. I mean, that's the thing is the bar to hike is just so high now that I don't think that is our hike. No, no to hike. So I don't think that's really like, that's barely even in the playbook anymore. Um, like even if the, even if the data picks up, they're already in restrictive territory, they will probably still won't hike.

17:25Um, and the bar to cut is extremely low. So that's kind of the starting point. But then now, because pricing has moved so much, even if they didn't do anything, that's a big rejection of the pricing. And that could take 10-year yields back to 440 or something like that. So that's an interesting scenario to watch for. But like I said, my base case is just that we're going back down to basically target inflation simply because the shocks are over. And yeah, it takes a long time for that stuff to get out of the system, but it's working its way out. By the way, Paul in the chat said he has purchased one of your 24 trader handbooks and almanacs, and he is really finding it nice and useful and enjoys it.

18:13Thank you for that comment, Paul. So, you know, it's funny in terms of sentiment as well, Brian, because so many people got killed on the bond trade that reversed. you know, as to what we were just talking about, sort of anticipating that change, yields moving lower and then snapping back quite violently when it seemed like the economy is stronger. And even Powell talked about that, that everyone got the US economy wrong in this year, right? I mean, they were just surprised by how strong it stayed in the face of all the rate cuts and that lag between the fiscal and monetary was problematic. Sentiment-wise, it seems like people are kind of like thinking we came too far too fast.

18:53Christopher in the chat saying the market's finally acting tired today. Negative advance decline line. Even as the NYSE, even as the S &P printed a new high for the year, he kind of thinks a slap is coming, even though from a higher level. Christopher, thank you for your contributions. Always giving us some good feel for the market. By the way, Christopher's piece with Roger is hitting the platform. I don't know if it's on yet. I have to go look for it. Um, but, uh, Christopher is a long time trader and had a really fun conversation with Roger her. So everybody check that out, give it a thumbs up piling on the comments.

19:27Let's show some love. Um, but anyway, how do you feeling Brent about sentiment is everyone just sort of scarred from that volatility last year and, and thinking that maybe things ran up too far too fast. So yeah, I have to split it into a few things. So in macro people are tired. returns were okay, but not amazing this year. A lot of people got hurt in March on Silvergate. We've had a lot of themes this year in macro, like going from recession to hire for longer banking crisis, China reopening, yay, China reopening, boo. There were so many themes this year. And generally in macro, the way people make money is identifying themes early and riding them.

20:10So there was no riding to be had this year. It was all mean and reversion and the things that worked well this year were like carry and seasonality and positioning. Those are the three factors that kind of worked in macro, but like having your macro thesis and writing it didn't work. So, and that's what most people do. So in macro people are tired and they're very light, um, in equities, I would agree with Chris that there's nobody's left that's bearish. I mean that every single indicator in terms of like the, the percentage of like the tech, tech mega tech ownership at 99 % in Goldman's prime data all the way across the board to like CNN's greed and fears at max greed or whatever.

20:53Um, but then at this time of year, who's going to sell, like nobody's really going to be around to sell. So I would just defer to the seasonality until the new year. And then again, I think the thing that would really turn things quickly would be any kind of whiff of strength, especially when people have the Pavlovian, uh, what, or PTSD or whatever you want to call it from like multiple re-accelerations that always, it always looked like it was turning. And really there's, there's no like strong evidence that the, that things are bad in the U S it, this is one thing that I think has been interesting this year is if you look at the workhorse data that like, you know, if you looked at a textbook from 1997 and it said, what are the economic data points that you watch and you look now, they're still the same basic data points.

21:42It's initial claims, non-farm payrolls, GDP, retail sales, industrial production. The main workhorse numbers are all pretty good still. Unemployment's 3.7. Claims is at the lows. Basically, everything's pretty good. Atlanta Fed's 2.6 or something. But then the blessing and the curse of being alive in 2023 as an economist is that there's just so much access to so many data points and so many different ways of slicing and dicing existing data points that someone will always be able to find a some weak data series that like in terms of credit card delinquencies or whatever, like things that are legit.

22:26But if you have a thousand streams of data, you can't expect 1 ,000 out of 1 ,000 to be strong. But then the other thing is people will also slice and dice the jobs data to fund the negative. They'll look at the household survey, which is a really bad survey that's just non-farm payrolls, but three times more volatile, all noise, no signal. So I think that's been one of the things that's happened this year is there's been enough whiffs of weakness around that there's always been a credible way of saying some economic weakness is coming. But to me, it just seems easier to wait for the main data points to turn and they just haven't turned still.

23:05So that could be really interesting going into if you go into January with basically market max long stocks, max long crypto or close, and then pretty long bonds. I feel like bonds is one of the hardest ones to judge positioning because there's just a lot of real money in, in bonds. Like, you know, people are actually buying bonds cause they want the return. You know, my mom's putting her bank balances into bonds cause or into GICs or whatever, cause she wants the return. So it's not like, it's not as speculative to me. A lot of it is just more like 5 % or 4 % yields are going to attract money.

23:42Um, but going into the new year, I think that everything will be pretty sensitive to, to any strength in the data, but then on the other side of the ledger. And this is why I think it's just a lot more important to watch the data than to listen to the fed is that if the data weakens, the market's just going to run with it. And, and, you know, two rate cuts in Q1 will turn into four. And then if you get anything closely resembling a recession, then you get the strip where you can start pricing fifties and 75s, which means you can price basically anything into the curve. So I feel like there's, there's a lot of elasticity both ways.

24:20And to me, that means follow the data and the Fed, like what they're saying, like, okay, the dots are there, but if the economy is strong, then the dots aren't going to be ratified. They're not going to cut. Yeah, they'll just change it. We know that, right? That's why they reissue them all the time, which is funny. But I guess the point is to try to give us a peek into where they are at that moment. But I know what you mean. And great, great point about all the information out there. I mean, you see the wars on Twitter, right? I mean, people have their narrative or their leanings and they can find stuff to support that if they want.

24:58So you're right. You want to try to like step back and, and really kind of look at it all. Yeah, go ahead. Yeah, it's tricky. Ralph has a question. Does Brent see an over, over action, I think maybe overreaction to the downside indexing and a possible reversal? Yeah. So the tricky thing with the dollar is that the window for where it performs poorly is so narrow that it's so hard to make money being short dollars these days. What you really need for the dollar to go down in a meaningful way is some kind of rebound in Germany and China, like a global manufacturing cycle, which some people are predicting a little bit of a turn up in the global manufacturing cycle, because otherwise it's just like the issue that you keep running into specifically with Euro is that, okay, say people want to be short dollars because the dots were three cuts.

25:58And so you just go short dollars against whatever. And the dollar index, the Dixie is like 57 % Euro. And if you include Swiss in Sweden, it's like 70 % Euro basically. So people buy euros and it goes up and then they sit there and they go, okay, so why am I long euros again? Like PMIs are at 42, uh, everything they export to China is not selling. Um, like the ECB is going to probably be the first one to cut. So it's really hard to find good trades on the other side. except for carry. So people buy Mexico and Brazil just simply for the carry. But if you're looking at relative economic performance is ideally what you want, where the US is kind of slowing into the secular stagnation that I was describing that we experienced from 12 to 19.

26:47But then other countries are doing okay, like Australia is exporting to China, China is doing all right. And with China in a balance sheet recession and Europe, like, I don't know, on the edge of recession and their inflation is going down a lot faster. It just always feels like dollar down is like a rental and never something you want to own other than in carry. So I'm much more tactical. I feel like generally people are way more sympathetic to dollar down just because of where it is. The dollar has gone up a lot because of the deficits, which may or may not ever be relevant. Sometimes they are, sometimes they aren't.