Speaker 1: Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2: Hello and welcome to another episode of the Authoughts podcast.
Speaker 2: I'm Tracy Alloway.
Speaker 3: And I'm Joe Wisenthal.
Speaker 2: Joe, there are so many huge stories that you could
Speaker 2: pull out of this year, but I mean, like some
Speaker 2: actually really really big ones. So we had Liberation Day
Speaker 2: and the market crash. We had the continued weakness in
Speaker 2: the US dollar, which has been this sort of slow
Speaker 2: burned crash across the year. And we're recording this. Let's
Speaker 2: see October seventeenth, and you know, dollar down yet again.
Speaker 3: Well it is down, but however there's been a little
Speaker 3: you know, we hit hiss low in mid September.
Speaker 2: Don't make apologies for the dollar, Joe.
Speaker 3: You know, I just like keep going, all right, keep going.
Speaker 3: Then I might add something fall in the dollar. The
Speaker 3: fall in the doll is very big.
Speaker 4: So far.
Speaker 2: There's here but this huge ramp up in the price
Speaker 2: of gold, which seems to hit a new record all
Speaker 2: the time. And then we've had the continued strength slash resilience,
Speaker 2: whatever you want to call it, enthusiasm about AI in
Speaker 2: the stock market, and it really seems like there's this
Speaker 2: division at the moment between how people feel about corporate
Speaker 2: America and how people feel about sovereign America in the
Speaker 2: form of its currency.
Speaker 3: You know what I really regret doing tracing. I really regret.
Speaker 2: Did you have like a horde of gold that you
Speaker 2: got rid.
Speaker 3: Of over I took out a gold denominated mortgage. You know,
Speaker 3: I feel so stupid. I feel so stupid. Why did
Speaker 3: I do that? I could get paid in dollars and
Speaker 3: I took out a gold denominated mortgage. What was I thinking?
Speaker 4: No?
Speaker 3: I didn't, But had I done, that would have been
Speaker 3: a very bad trade.
Speaker 2: Yes, I remember those stories.
Speaker 3: From like, you know, a little bit of a tangent,
Speaker 3: remember all those stories from like the Hungarians they took
Speaker 3: out those Swiss denominated mortgage back of the two thousands.
Speaker 2: And that was very much a europe thing for a while.
Speaker 3: Yeah, that was a really funny list. We don't have
Speaker 3: to talk about that. But one thing, I was just
Speaker 3: the only reason I caveated the dollar fall, which I
Speaker 3: do think it has. It is quite a bit down
Speaker 3: from the beginning of the year. All that being said,
Speaker 3: it is striking in the last several weeks the degree
Speaker 3: to which a few of the very popular consensus ideas
Speaker 3: for this year are turning a little bit. And I
Speaker 3: say that tenure treasury is the time we're recording this
Speaker 3: October seventeenth has fallen below four percent. How many times
Speaker 3: did you hear about the steepener trade this year? How
Speaker 3: many times did you hear about fiscal dominance losing control?
Speaker 3: At the long end the dollar it stabilized a little bit.
Speaker 3: So it is a very interesting moment from markets in
Speaker 3: many respects right now.
Speaker 2: There's definitely a lot to talk about. Congrats on managing
Speaker 2: your personal FX liability.
Speaker 3: I'm doing a good job.
Speaker 2: Getting paid in dollars and paying your mortgage dollars. Well
Speaker 2: done show, All right, Well, you know, this is the
Speaker 2: kind of thing that a lot of big investors are
Speaker 2: thinking about at the moment, and we should definitely think
Speaker 2: about it too. And who is the one person that
Speaker 2: we really like to talk to when we talk about
Speaker 2: these big trends, And.
Speaker 3: Who is the one person that is always in town
Speaker 3: Because we're in Washington, DC right now, when we go
Speaker 3: to a new town, who is the other guy who
Speaker 3: always is probably going to be there at the.
Speaker 2: Same time, the person that we run into on the
Speaker 2: street in various outfits, Although this time you're wearing a suit,
Speaker 2: So there we go. The last time we run into randomly,
Speaker 2: you were wearing hiking gear and so were we. Anyway,
Speaker 2: we are here in DC. We have the perfect guest.
Speaker 2: As always, We are speaking once again with Hun Sunction.
Speaker 2: He is the economic Advisor and head of the Monetary
Speaker 2: and Economic Department at the Bank for International Settlements the BIS.
Speaker 2: We love talking to him and it's so great to
Speaker 2: have him here to talk about something that's really been
Speaker 2: on the minds of a lot of market participants, a
Speaker 2: lot of policymakers right now. So Hun, thank you so
Speaker 2: much for coming back on our thoughts.
Speaker 4: Thank you Tracy, thank you Joe. It's great to be back.
Speaker 2: Since Joe doubts my entire premise.
Speaker 3: For this episode, the entire premise at all.
Speaker 2: Now, let's just start with how unusual would you say
Speaker 2: this year has been? And I feel like so much
Speaker 2: has happened. We kind of have to cast our minds
Speaker 2: back to April when we did have Liberation Day and
Speaker 2: when we did see the dollar fall as the market
Speaker 2: was selling off, which was something that's not really supposed
Speaker 2: to happen. You're supposed to have investors reach for the
Speaker 2: safe haven of the green back in times of turmoil
Speaker 2: and stress. And now, you know, fast forward to October,
Speaker 2: I think we've gotten a little bit more used to
Speaker 2: that particular dynamic. But how surprised were you at that Well, it.
Speaker 4: Was a very unusual combination of events in April. So
Speaker 4: what we saw was the so called triple decline where
Speaker 4: you had stocks, bonds, and the dollar, yeah, falling in unison.
Speaker 4: And that's very unusual because in a risk off episode,
Speaker 4: you know, which April was, typically the dollar would rally.
Speaker 4: You know, there'll be a kind of safe have and flow.
Speaker 4: And you know, back then, there was of course a
Speaker 4: lot of news and you saw a lot of stories
Speaker 4: back then about you know, possibly the dollar, you know,
Speaker 4: losing its international status and so on. I think in
Speaker 4: retrospect that was, you know, quite hasty, and I think
Speaker 4: now that we have the data, we can piece together
Speaker 4: in a more kind of coherent way what was going on.
Speaker 4: And in short, I think it was a kind of
Speaker 4: hedging story where investors who had lots of exposures to
Speaker 4: the US dollar, we're trying to reduce some of those exposures.
Speaker 4: And we can get into some of the details and
Speaker 4: how you know, that kind of trade might transpire, and
Speaker 4: it just so happens that this is also the year
Speaker 4: that the BIS conducts its triannual survey of f X markets,
Speaker 4: and we've just published the results, and I think we
Speaker 4: can also shed some more light on the events in April.
Speaker 3: Let's keep it big pictures still, and then we'll drive
Speaker 3: down into specific months and weeks. What people work for
Speaker 3: the BIS, they prey must take out mortgages and Swiss
Speaker 3: Frank there living there in bars anyway, sidetrack, what are
Speaker 3: some of the big takeaways from this year service?
Speaker 4: Yeah, yeah, so I think well, actually before we go there, Joe,
Speaker 4: I mean, it's worth you know, thinking about how FX
Speaker 4: market is really a figure in the investment strategy. So
Speaker 4: you know, if you're a long term investor, let's say
Speaker 4: that you're a Euro area pension fund, what you have
Speaker 4: are obligations to your you know, local euros beneficiaries in euros,
Speaker 4: but you have a very large balance sheet and so
Speaker 4: you need to have a very broad exposure to global assets,
Speaker 4: you know, including those in non euro denominated assets. So
Speaker 4: what tends to happen is some of the euros are
Speaker 4: then converted into dollars to invest in in dollar assets.
Speaker 4: But of course what you want to do is to
Speaker 4: make sure that you hedge that currency risk. And this
Speaker 4: is where this instrument called an FX swap really comes
Speaker 4: into its own, and it's an operation where essentially the
Speaker 4: Euro Area investor pledges some euros and then borrows dollars
Speaker 4: and then with those dollars then go into dollar denominated assets.
Speaker 4: And as you do that, you also promise to unwind
Speaker 4: that transaction at a known exchange rate that affixed in
Speaker 4: a moment in the future. So essentially, once you've gone
Speaker 4: through that transaction, your currency risk is hedged. Now exactly
Speaker 4: how much of your foreign portfolio you hedge in this
Speaker 4: way that varies over time, I mean it depends, for example,
Speaker 4: on you know, how high the hedging costs are. Because
Speaker 4: you're typically doing this fairly short term and you're rolling
Speaker 4: over these hedges. What's important is the short term dollar
Speaker 4: interest rate, because you know, you're borrowing dollars in order
Speaker 4: to invest in dollar assets. So when the short term
Speaker 4: interest rate is very high, that's typically a time when
Speaker 4: hedging costs are very high. And so what had happened
Speaker 4: over the last few years was that these so called
Speaker 4: hedge ratios. You know, the proportion of your assets that
Speaker 4: you actually hedge had been really you know, trending down.
Speaker 4: And you know to the extent that some investors you know,
Speaker 4: didn't hedge at all, And why would you if the
Speaker 4: dollar is surging and the hedging cost is so large.
Speaker 4: And so when the turbulence broke earlier in the year,
Speaker 4: a lot of investors were basically caught with very large
Speaker 4: dollar exposures, you know, having not hedged. And I think
Speaker 4: one piece of evidence that you know this was that
Speaker 4: the events of April was very much an expost hedging story,
Speaker 4: you know, hedging after the fact was that, you know,
Speaker 4: we saw a lot of the telltale signs of swaps
Speaker 4: being taken out and dollars being sold happening in the market.
Speaker 4: So what would happen is, you know, if an investor
Speaker 4: is holding dollar assets, you know, without a hedge, but
Speaker 4: you're concerned about the dollar falling, then what you would
Speaker 4: do is you would put on a hedge X post.
Speaker 4: You would put on a hedge after the event. And
Speaker 4: you could do that, for example, by actually then engaging
Speaker 4: in an FX swap right there, but then selling the
Speaker 4: dollars that you've acquired so rather than investing those dollars
Speaker 4: into dollar assets, you simply sell it in the spot market.
Speaker 4: What that kind of dynamics would would imply is that
Speaker 4: there would be you know, lots of downward pressure in
Speaker 4: those situations where institutional investors are trying to you know,
Speaker 4: raise their head ratios. But expost So back to the triannual,
Speaker 4: what do we see there that to you know, puts
Speaker 4: additional light on this episode. By the way, on the triangle,
Speaker 4: you know this, it's just so happens that the sampling
Speaker 4: period was April this year, amazing, so you know, it
Speaker 4: may be slightly distorted by the events of you know,
Speaker 4: the April episode. On the other hand, the silver lining
Speaker 4: is that we have some great data on really the
Speaker 4: you know, the events of the of the April episode.
Speaker 4: But the headline numbers are really quite you know, quite notable.
Speaker 4: It's nine point six trillion dollars daily flow. This is
Speaker 4: like something like almost thirty percent higher than the previous
Speaker 4: survey in twenty two. The dollar is still very much
Speaker 4: the dominant currency. It's ninety percent of all of the
Speaker 4: transactions have the dollar on one side. It's even higher
Speaker 4: than what we saw in twenty two so you know,
Speaker 4: in spite of the survey being affected perhaps by these
Speaker 4: you know, stress events in April, you know, we think
Speaker 4: we've got a very very very good sort of take.
Speaker 4: One of the things that we noticed this year is,
Speaker 4: of course, you know, as well as the FFX swaps,
Speaker 4: which is by far the largest segment of the of
Speaker 4: the transactions, we also see a lot of a big
Speaker 4: increase in the spot transactions and also outright forwards. So
Speaker 4: let me just explain that for your listeners. You know,
Speaker 4: when you engage in US in an effect swap, you know,
Speaker 4: the investor with borrow dollars by pledging euros, and then
Speaker 4: there's also a promise to reverse that. Now that promise
Speaker 4: is called a forward, and of course you can get that,
Speaker 4: you know, without going through the swap. You can just
Speaker 4: go to a deal and say, look, you know, just
Speaker 4: sell me a outright forward so called, and then I
Speaker 4: would actually then have a dollar obligation.
Speaker 3: A swap is like a spark trade plusure forward exactly.
Speaker 4: Okay, it's that combination. And what we see is as
Speaker 4: well as the swaps, we see the two components, the
Speaker 4: spot and the forward being very very large this year.
Speaker 4: And we think that the events of April must have
Speaker 4: had a you know, had an impact because you know,
Speaker 4: as well as getting a swap and selling the dollars
Speaker 4: in the spot market, you can also just ask a
Speaker 4: dealer for a forward contract, but then of course the
Speaker 4: dealer has to hedge, so you know there's going to
Speaker 4: be a spot sale anyway, and so that combination would
Speaker 4: actually lead you to a situation where both the spot
Speaker 4: and the forward transactions go up a lot. And that's
Speaker 4: exactly what we see.
Speaker 3: Interesting.
Speaker 4: So this is another piece of the evidence that this
Speaker 4: was very much exposed hedging. And let me mention just
Speaker 4: two other things on this. We put out a bulletin
Speaker 4: earlier in the summer we you know, lay out all
Speaker 4: the other pieces of evidence that we could gather. But
Speaker 4: it's also notable that if you look at the actual
Speaker 4: portfolio flow numbers, the international portfolio flow numbers, there was
Speaker 4: no real selling in April, so you know, there was
Speaker 4: a very very small outflow, but on the scale of things,
Speaker 4: it was really tiny. There was certainly no you know,
Speaker 4: concerted portfolio outflows you know from the US. So that's
Speaker 4: really the i think, perhaps the most you know, compelling
Speaker 4: evidence that the so called sell America trade was not,
Speaker 4: you know, was not the story behind the eight episode.
Speaker 2: Why should we care, either qualitatively or quantitatively if this
Speaker 2: was a hedge America story and not a sell America's
Speaker 2: story outright.
Speaker 4: Over the long term, it is possible that you know,
Speaker 4: long term investors would then reassess their global exposures. And
Speaker 4: you see and you hear a lot of anecdotal evidence
Speaker 4: that you know, these conversations are going on, but so
Speaker 4: far that hasn't really you know, translated into actions. But
Speaker 4: I think what you know does flow very you know
Speaker 4: clearly from you know, from the actions in the spring,
Speaker 4: is that when we look at the various pieces of
Speaker 4: the global financial system, every part depends on other parts,
Speaker 4: and there is this network effect where provided that everyone
Speaker 4: else is doing what they're doing around the US dollar,
Speaker 4: then it's also in my interest. So actually, you know,
Speaker 4: be part of that ecosystem. So if you have this
Speaker 4: kind of need network effect, it's very difficult to have
Speaker 4: this whole sale shift away.
Speaker 3: One of the things that I think is unusual, and
Speaker 3: I probably said this in a few other episodes, but
Speaker 3: what I think is striking about this environment is that
Speaker 3: if you look at the US it can come up
Speaker 3: with a long list of reasons to be concerned, which
Speaker 3: we don't need to come down recapitulate now. On the
Speaker 3: other hand, the most affitable, impressive, cutting edge companies in
Speaker 3: the world that everyone would love to have exposure to
Speaker 3: in some way or in the US. And it strikes
Speaker 3: me is that's the unusual situation, which is we don't
Speaker 3: typically associate volatile sovereigns with being the home of the
Speaker 3: most dynamic companies in the world. And so to my mind,
Speaker 3: I would love to have exposed more exposure to in
Speaker 3: Video and Microsoft and all of these companies that are
Speaker 3: making money hand over fist without having exposure to the
Speaker 3: US itself, And hence I might want to hedge.
Speaker 4: I mean, certainly, you know the equity market story, I
Speaker 4: mean that really isn't a class of its own, and
Speaker 4: as you say, that's really been a very very strong theme.
Speaker 4: But more broadly, you know, capital markets. If you think
Speaker 4: about how capital markets operate, that there's a whole ecosystem
Speaker 4: behind that, and you have the underlying securities obviously, but
Speaker 4: then you have the hedging instruments, and then you have
Speaker 4: a whole set of investors who are actually you know,
Speaker 4: taking part and the banking system is absolutely crucial in
Speaker 4: providing those hedging services. And I think when we last
Speaker 4: discussed this back in Jackson Hole, you know, we talked
Speaker 4: about how the FX swap market makes you know, money
Speaker 4: fungible across currencies. And you know, money is ultimately something
Speaker 4: to do with banks. So you know, the central bank,
Speaker 4: you know, issues high powered money. Commercial banks are there
Speaker 4: also to issue money that the other users will will
Speaker 4: take advantage of. And FX swaps are there, you know,
Speaker 4: basically providing this service of making money fungible across currencies.
Speaker 4: So you know, every piece fits into every other piece
Speaker 4: in that sense. And so you know, we should think
Speaker 4: about this in terms of the mutually reinforcing pieces of
Speaker 4: this you know, this network.
Speaker 2: What have you observed in terms of the actual trends
Speaker 2: in FX hedging costs, because, as you described it in April,
Speaker 2: suddenly it all starts kicking off a lot of large
Speaker 2: investors who are not that used perhaps to having to
Speaker 2: hedge their dollar exposure suddenly scrambled to do it x
Speaker 2: post as you described. Did that mean that the cost
Speaker 2: of actually doing so actually increased or was it still
Speaker 2: relatively cheap?
Speaker 4: Well, actually, it's primarily about how high the short term
Speaker 4: interest rates are actually, and in particular, if you're a
Speaker 4: non US investor investing in dollar assets, it's really how
Speaker 4: high the short term dollar interest rate is, because essentially
Speaker 4: what we're doing is, you know, you're pledging euros, let's say,
Speaker 4: and then borrowing dollars short term and then investing in
Speaker 4: dollar assets. And so it's really about how high that
Speaker 4: short term interest rate is relative to the yield you're
Speaker 4: getting on the asset itself. And so if you have
Speaker 4: a flat yield curve, you know, which is what we've had,
Speaker 4: or even inverted yel curve, then hedging costs are very high.
Speaker 4: And so in fact, you know, investors have typically hedged,
Speaker 4: and hedge ratios have fluctuated. There's no system matter survey,
Speaker 4: but it's fluctuated between forty and sixty percent. I mean,
Speaker 4: there are some pockets of official data, like the Japanese
Speaker 4: life insurance companies, but typically this is you know, really
Speaker 4: quite quite anecdotal. But what had happened in the last
Speaker 4: year or so was the hedge ratios had gone down gradually.
Speaker 4: Some firms were not even hedging at all, you know,
Speaker 4: they were trying to win both on the stronger dollar,
Speaker 4: but also on the high yields. Yeah, actually they just
Speaker 4: meant mentioned a very interesting point here. Actually, it's actually
Speaker 4: worth thinking about the parallels between this story about you know,
Speaker 4: advanced economy investors holding US DOT assets with the story
Speaker 4: about local currency emerging market bonds. You know, that's actually
Speaker 4: a very very you know, important asset class that really
Speaker 4: grew up after the GFC. And that's typical asset class
Speaker 4: where the investor would not hedge. So if you want
Speaker 4: to enter in to a large emerging market sovereign BONDERNT trade,
Speaker 4: you would actually buy the instrument on an unheedge basis.
Speaker 4: And you do that because you know, you think the
Speaker 4: emerging market currency will appreciate as well as the YEL
Speaker 4: four and so you win twice. You know, you gain
Speaker 4: both on the yield, you know, as well as on
Speaker 4: the exchange rate. But of course when the tide turns,
Speaker 4: that's when you know scramble to you know hedge ex
Speaker 4: post and that's exactly you know the same type of
Speaker 4: thing that we saw you know, in this in this episode.
Speaker 4: And you know, and there were actually emerging market investors,
Speaker 4: especially from Asia, who were you know, caught with a
Speaker 4: very low hedge ratios and there was this ex post
Speaker 4: hedging going on. So there's actually a very interesting parallel
Speaker 4: between you know, what was you know going on this
Speaker 4: April and the much older trade, which is the emerging
Speaker 4: market trade.
Speaker 2: So Joe, on the plus side, people aren't necessarily selling
Speaker 2: dollar assets. On the downside, the negative side, we're basically
Speaker 2: treating dollar assets the way we would allow emerging market.
Speaker 5: Pond were like, I think I'm going to buy some
Speaker 5: local currency US day. That's right, actually, but like, so
Speaker 5: what was it about April then that caused the like
Speaker 5: what I mean, we know there was yeah, the Launcher
Speaker 5: trade war and there were like massive tariffs, et cetera.
Speaker 5: But like, what was it about that such that people's
Speaker 5: impulses to hedge more expost factor as you've described it.
Speaker 5: What was the thing they said, Oh, we want to
Speaker 5: change our the our sort of our exposure to US dollars,
Speaker 5: even if we don't want to sell them.
Speaker 4: I think it's probably a combination of several things. But
Speaker 4: where the you know, where the investors found themselves in
Speaker 4: terms of the hedge ratios had a lot to do
Speaker 4: with this. Actually, if you look through your you know,
Speaker 4: Bloomberg news database, you'll find plenty of stories from twenty
Speaker 4: three for where let's say life insurance companies announce that
Speaker 4: they will not be hedging, you know there, so you
Speaker 4: know they would be holding let's say US dollar assets
Speaker 4: but without a hedge. And as I said, you know,
Speaker 4: there were some firms that didn't hedge at all. And
Speaker 4: in a risk of environment, what typically happens that you
Speaker 4: want to take some chips off the table, and that
Speaker 4: just means reducing your exposure. Yeah, and if you're exposed,
Speaker 4: you know, in this double whammy fashion, you know you
Speaker 4: would actually try and you know, either hedge ex post
Speaker 4: or reduce your exposure. It looks like from the evidence
Speaker 4: that it was very much the expost hedging story.
Speaker 2: So if people are hedging their dollar exposure more than
Speaker 2: perhaps some of them at least used to do, we
Speaker 2: have to worry about things like rollover risk or some
Speaker 2: sort of I guess duration mismatched where you have a
Speaker 2: short term hedge, whether it's a forward or a swap
Speaker 2: or whatever, mismatch to a longer term asset. I mean,
Speaker 2: this is this is what the BIS does on a
Speaker 2: day to day basis, is worry about potential risks so
Speaker 2: are you worried here?
Speaker 4: That's a really great comment, Tracy, And I think this
Speaker 4: was you know where I was going to go next.
Speaker 4: Of course, you have this. You know, once you hedge,
Speaker 4: you've hedged the currency risk at least until the maturity
Speaker 4: of the swap, which is typically you know, one month
Speaker 4: to three months. But it's a short term. It's a
Speaker 4: short term liability that you need to roll over, and
Speaker 4: from time to time you might get caught in a
Speaker 4: liquidity you know, stress episode where it's difficult to source
Speaker 4: the dollars to actually repay. And this was, for example,
Speaker 4: what happened during the GFC. It's also what happened during
Speaker 4: March twenty twenty when there was also a scramble for dollars.
Speaker 4: And you know, when you're a long term investor, you've
Speaker 4: hedged using a short term effect swap, but you're holding
Speaker 4: you know, long term securities, you have a maturity mismatch.
Speaker 4: So either you have to somehow, you know, sell your
Speaker 4: long term assess which is going to be very difficult
Speaker 4: at a fair price, or you have to join the
Speaker 4: scramble for dollars with all the other borrowers of dollars
Speaker 4: in the market and so this is the paradox where
Speaker 4: you know you're a long term investor, but actually you
Speaker 4: have this short term you know, dollar obligation. And so
Speaker 4: you know we are swapping one well, we are actually
Speaker 4: you know, exchanging one type of risk for another. We're
Speaker 4: actually changing currency mismatch for maturity mismatch. And you know, empirically,
Speaker 4: if you look at the evidence over the years, it's
Speaker 4: when the dollar is falling for a long period of
Speaker 4: time that these head ratios become very, very high. So
Speaker 4: you know, a good example is the period before the
Speaker 4: GFC when a dollar was you know, really falling, you know,
Speaker 4: quite considerably. But then what happened at the GFC was
Speaker 4: of course in a dollar really spiked because there was
Speaker 4: a scramble for dollars. So you know, there's always this
Speaker 4: trade off. You either have to beart some currency risk
Speaker 4: or you bear this maturity risk, and then the bear
Speaker 4: this maturity mismatch risk, I should say, and and so
Speaker 4: we you know, it's really you know, changing one type
Speaker 4: of risk or another.
Speaker 3: Tracy really loves currency markets because she loves the fact
Speaker 3: that when the line moves, it's you can never tell
Speaker 3: whether it's the numerator or denominator that's at fault.
Speaker 2: But this is sarcasm, by the way, for those who don't.
Speaker 3: No, I hate you hate currency markets because you never
Speaker 3: know whether we should be telling it's the numertor.
Speaker 2: Do you say the dollar is going down. Someone's going
Speaker 2: to be like, oh no, but it's up against like
Speaker 2: some obscure currency that no one's ever heard of.
Speaker 3: But EM and you mentioned EM and many EM bond
Speaker 3: funds indices and in currency is doing very well. And
Speaker 3: so this gets to the question, is this numerator story
Speaker 3: is it about dollar weekening or is it about so
Speaker 3: we've been talking a lot about financial flows. Has something
Speaker 3: changed though in the sort of underlying economic fundamentals of
Speaker 3: a lot of ems. I've heard some rumblings about this.
Speaker 3: People excited about EMS in a way that I don't
Speaker 3: think they were excited about to the same degree during
Speaker 3: the twenty tens at all. And I just while we
Speaker 3: were chatting, I pulled up a bunch of lines of
Speaker 3: EM related funds currency all doing very well. In your research,
Speaker 3: are there fundamental changes in the EM world that are
Speaker 3: like people are excited about for reasons other than the
Speaker 3: fact that the dollar is week.
Speaker 4: So this is right timely Joe and as it happens.
Speaker 4: On Monday, we published a bulletin exactly on this question.
Speaker 4: Are the emerging markets doing well because of better policy,
Speaker 4: better fundamentals or is it really about the global financial
Speaker 4: market trends? And the short answer is it's a bit
Speaker 4: of both. And you would and you would you know,
Speaker 4: not think of otherwise. Why is it better fundamentals? Well,
Speaker 4: I think it's certainly there's been much better policy, especially
Speaker 4: monetary policy, and also the emerging markets have have really
Speaker 4: been buoyed by actually, you know, the week of dollar,
Speaker 4: the week ofd dollar has been a tailwind for much
Speaker 4: of the year. This is why emerging market assets have really,
Speaker 4: you know, rallied quite hard. And there's a parallel with
Speaker 4: credit spreads as well, because you know, when credit is
Speaker 4: doing well, we also tend to see emerging market as
Speaker 4: it's also doing well. And if we break it down,
Speaker 4: so why would a weakening dollar be a tailwind for
Speaker 4: emerging markets? Well, you know, in the simplest possible case,
Speaker 4: if a borrower has borrowed dollars but then has invested
Speaker 4: in local currency assets, you know, there's this currenty mismatch.
Speaker 4: But then there's a windfall when the when the dollar weekends.
Speaker 4: That's a very simple story. It's probably not the most important.
Speaker 4: But there's another very interesting element here, which has to
Speaker 4: do with the so called risk taking channel. And the
Speaker 4: idea here is if you have a very diversified, you know,
Speaker 4: portfolio of these of the loans to all of these
Speaker 4: current sy mismatch borrowers, the improved credit risk on these
Speaker 4: borrowers really you know, shrinks the tail risk in the
Speaker 4: credit for the you know, for the lender. So if
Speaker 4: you like, the value at risk goes down, and that
Speaker 4: really opens the door to two more credit. So this
Speaker 4: is very very strong relationship between a week of dollar
Speaker 4: and faster growth of dollar denominated credit. And because of
Speaker 4: how important dollar credit is for supply chains, if there's
Speaker 4: any product, if there's any good that out there that
Speaker 4: relies on very complex supply chains, global value chains, those
Speaker 4: products will tend to do very well. And what you've
Speaker 4: seen is actually, in spite of the week of dollar,
Speaker 4: exports have gone up in these very highly sophisticated goods,
Speaker 4: and much more so than the goods that are much
Speaker 4: more affected by just a simple the simple trade effect
Speaker 4: and exchange rate. So semiconductor for example. I mean this
Speaker 4: has been one of the surprises. Clearly there's the AI boom,
Speaker 4: but it's not just that. If you look at semiconductor
Speaker 4: trade exports from Asia that's really been very, very resilient
Speaker 4: this year, and anything that has to do with global
Speaker 4: supply chains you would also see. But there's a you know,
Speaker 4: there's a sting in the tail here because, as we
Speaker 4: talked about earlier, emerging markets increasingly are becoming net creditors
Speaker 4: to the rest of the world, and there was very
Speaker 4: little hedging going on, and so when you're caught in
Speaker 4: one of these down drafts, you get hit both from
Speaker 4: you know, the wiki dollar and also the and also
Speaker 4: the high yields. And so we saw a lot of
Speaker 4: this you know scrambling, you know, back in April. So
Speaker 4: it's primarily a tailwind, and it has been a tailwind
Speaker 4: for a long time. But there is this third element,
Speaker 4: this new element, which I think we need to keep
Speaker 4: an eye on.
Speaker 2: What do you see when you look at the price
Speaker 2: of gold. So we are recording this on October seventeenth.
Speaker 2: It's coming down a tiny bit this morning, but still
Speaker 2: above four thousand dollars an ounce. What is that telling
Speaker 2: you about how investors are feeling about various global currencies
Speaker 2: at the moment.
Speaker 4: Well, Tracy, I mean, we we hear a lot about
Speaker 4: the so called debasement trade, but I think that's probably
Speaker 4: overdoing things. You know, Debasement is really about the value
Speaker 4: of money relative to you know, goods and services. We
Speaker 4: don't really see a surge in inflation. We don't see
Speaker 4: surge in the price of you know, even commodities. I mean,
Speaker 4: look at you know, look at oil, look at other commodities,
Speaker 4: you know, everything other than gold. And so I think
Speaker 4: we should probably look for a more tailored explanation for
Speaker 4: gold other than simply the you know, this broader sort
Speaker 4: of sense of you know, you a flight from you know,
Speaker 4: fiard currencies, and you know, I think one thing which
Speaker 4: goes back to our initial conversation on the role of
Speaker 4: the dollar in the global financial system. Certainly central banks
Speaker 4: have been big buyers of gold, and there has been
Speaker 4: you know that sort of you know, set of very
Speaker 4: sort of firm you know backdrop to you know, to
Speaker 4: the market, and other people have jumped on the bandwagon
Speaker 4: in a way it's actually behaving like a risk asset.
Speaker 4: And the events today and you know, last week as well.
Speaker 4: Rather than there being a flight to gold during stress times,
Speaker 4: what we're seeing is it's behaving a bit like bitcoin
Speaker 4: and the risk asset, So it sort of tells you
Speaker 4: that there's been a little bit more of a speculative element,
Speaker 4: you know, here, but it's certainly behaving in a way
Speaker 4: that's very different from the historical norms.
Speaker 3: You know, for a long time, Trace has talked about this.
Speaker 3: For a long time. You could sort of model the
Speaker 3: price of gold via real rates, and when they're very
Speaker 3: low or suppressed or whatever, gold went up. It kind
Speaker 3: of seemed like it changed not long after Putin had
Speaker 3: a bunch of his money seized. And when you talk
Speaker 3: about central banks accumulating gold, being woken up to the
Speaker 3: fact that your money is never really your money if
Speaker 3: it's in a bank, it seems like it could be
Speaker 3: part of it.
Speaker 4: Well, Joe, I mean, certainly, there are very few assets
Speaker 4: which are not the liabilities of someone of someone, and
Speaker 4: you know, typically whether it's a fixed income instrument or
Speaker 4: an equity, it's someone's liability, so someone has the obligation
Speaker 4: to pay you. And gold is one of those which
Speaker 4: is not the liability of of of of any particular individual.
Speaker 4: I think, you know, when we look back, we can
Speaker 4: see these sort of broad, you know, swings in the
Speaker 4: price of gold. After the breakdown of Bretton Woods in
Speaker 4: the early seventies, you know, there was a brief spike,
Speaker 4: but then we had a very very long period when
Speaker 4: you know, gold wasn't doing very much. I think it's
Speaker 4: probably something even before the Russian invasion of Ukraine, Joe.
Speaker 4: So you know, we've seen the trend where something you know,
Speaker 4: like this has also happened actually a few years back,
Speaker 4: even even before the Russian invasion of Ukrainian twenty two.
Speaker 4: But I think it's you know, this this element, this
Speaker 4: this attribute where it's not the liability of any particular uh,
Speaker 4: you know, legal entity or individual. I think you know
Speaker 4: is giving this a particular Yeah.
Speaker 2: So I'm looking at the top menu on Bloomberg right now,
Speaker 2: and you know, it's feeling a little bit nervy at
Speaker 2: the moment. So the number one story is banks trio
Speaker 2: of alleged frauds, sparksphere of broader issues. So this is
Speaker 2: the idea that this is Jamie Diamond's cockroach idea that
Speaker 2: we're starting to see some losses emerge from either outright
Speaker 2: frauds or just bad investments, and people are starting to
Speaker 2: get a little bit nervous. Do you see any sorts
Speaker 2: of I guess credit oriented concerns out there at the moment?
Speaker 4: Well, Tracy, I mean, certainly this week is a very
Speaker 4: news rich environment. We love you are you are you know,
Speaker 4: contributing to that, and I think it's great. You know,
Speaker 4: we we we hear a lot of these comments, uh,
Speaker 4: you know, on credit. Certainly, credit standards have been eroding
Speaker 4: for a long time, and we have been one of
Speaker 4: the many voices, you know, even before this week, you know,
Speaker 4: just pointing out that credit spreads have fallen to historical lows.
Speaker 4: But if you look at the the trajectory of credit
Speaker 4: to the private sector and compare that to what's been
Speaker 4: happening to government debt there, that really isn't a comparison.
Speaker 4: So it's certainly before the GFC, the big growth was
Speaker 4: in the credit to the private sector, especially in the
Speaker 4: form of mortgages. But after that, what we've seen is
Speaker 4: credits the private sector has really been very subdued, and
Speaker 4: instead it's really been the government in a bond market
Speaker 4: which has grown tremendously now what we're seeing now is
Speaker 4: you know, some signs of the erosion or credit standards,
Speaker 4: you know, coming back to bite. But if you're worried
Speaker 4: about something very systemic, if you're worried about systemic risk,
Speaker 4: the first thing to ask is how fast has this
Speaker 4: grown in the recent past. And typically something that's grown
Speaker 4: very rapidly, will you know, give you some course for concern.
Speaker 4: In this case, the really rapidly growing element has not
Speaker 4: been credit to the private sector. It's been credit to
Speaker 4: the government and in particular the government bond market. So
Speaker 4: we should have you know, we should of course worry
Speaker 4: about you know, these you know, these events, and of
Speaker 4: course the headlines you know create you know, as I said,
Speaker 4: it's a very news rich environment. We hear that, yeah,
Speaker 4: and we hear the same stories in the panels. If
Speaker 4: it's really a concern about, you know, is this the
Speaker 4: precursor to the next you know, systemic crisis, it's probably
Speaker 4: not the case.
Speaker 3: Actually just brings a mind something that I don't think
Speaker 3: I've really asked in such a way before. But another
Speaker 3: thing that's grown a lot is the stock market or
Speaker 3: equity equity markets.
Speaker 4: There was actually a.
Speaker 3: Really good article in the Wall Street Journal several days
Speaker 3: ago about the degree to which equity exposure, at least
Speaker 3: in the US has spread demographically, so a lot many
Speaker 3: more like working class households own stocks than they used to.
Speaker 3: When I think about people who are in the business
Speaker 3: of being worried about financial stability, I don't think the
Speaker 3: stocks are high on their radar. They're called risky assets.
Speaker 3: We all know they're risky, and usually crises don't emerge
Speaker 3: from assets that we all agree are risky. Crises emerge
Speaker 3: from assets that we think are going to be redeemed
Speaker 3: from a dollar's worth we're going to get a dollars
Speaker 3: back or whatever, or worried about getting back at all.
Speaker 3: But I'm curious, from the perspective of someone who professionally
Speaker 3: maybe worries, how do you and your colleagues think about
Speaker 3: equity exposure, especially given the widespread view that equity exposure
Speaker 3: is fueling consumption in the United States, a driver of
Speaker 3: the economy, that there's a lot of speculative acts, Like
Speaker 3: is there much modeling work being done on equity and
Speaker 3: risky assets specifically as a source of broader risk?
Speaker 4: Absolutely, I think I think the you know, the main
Speaker 4: channel would be through the real economy, through through real
Speaker 4: economic activity, rather than through let's say a de leveraging
Speaker 4: episode or an equidity episode. I think it's worth thinking
Speaker 4: back to the dot com bubble of two thousand. You know,
Speaker 4: that was a period, of course when the valuations were
Speaker 4: even more extreme, and when the stock market fell in
Speaker 4: two thousand, of course we did see some effect, and
Speaker 4: of course a lot of investors lost money, but there
Speaker 4: was nothing like the same kind of impact on the
Speaker 4: real economy that we had with the GFC. And very
Speaker 4: simplistic way of putting this is whenever you have debt
Speaker 4: of various kinds, that's when you should be worried, because,
Speaker 4: as you said, it's when you're promised one dollar but
Speaker 4: then you don't deliver. That's when you know there are
Speaker 4: sort of ripercussions throughout the economy. Now, clearly with the
Speaker 4: equity markets, there are wealth effects. So you know, if
Speaker 4: you have a very large portfolio, you feel richer and
Speaker 4: then you spend more, and so there is a real
Speaker 4: economy effect of the stock market. And so if we
Speaker 4: see a pullback in the stock market, very sustained pullback,
Speaker 4: we will see some effect like that. Now, the estimates
Speaker 4: of the wealth effect on consumption, for example, has varied
Speaker 4: over the years, but given the if you like, the
Speaker 4: democratization of stocks, we could expect a slightly larger magnitudes.
Speaker 4: But on the scale of things, that effect tends to
Speaker 4: be very small compared to the kinds of effects that
Speaker 4: are associated with de leveraging episodes.
Speaker 2: Do you see any pockets of leverage out there that
Speaker 2: aren't getting enough attention at the moment?
Speaker 4: Well, I think you're very good at shining a light
Speaker 4: on those all those pockets. Actually, I think probably, I
Speaker 4: don't think I can really say anything here that you
Speaker 4: haven't heard of, but I think it's certainly worth bearing
Speaker 4: in mind the broad magnitudes. Yeah, in one of the
Speaker 4: things that we've you know, we've talked about a lot
Speaker 4: this year in our various official publications is the fact
Speaker 4: that even you know, safe acets can be a source
Speaker 4: of stress in the market, because it's not default that
Speaker 4: you know, propagates stress. It's more than de leveraging. I think,
Speaker 4: you know, if let's say, long rates were to you know,
Speaker 4: shoot up, and therefore mortgage rates also shoot up, you know,
Speaker 4: that would be a really big deal for the real economy,
Speaker 4: and that would happen even without any defaults.
Speaker 3: By the way, when we started this conversation, the tenure
Speaker 3: was below four percent. It's above it now. So keeping
Speaker 3: our listeners up to date on what's going on in
Speaker 3: the treasury market. October seventeenth, twenty twenty.
Speaker 2: Five, very good. I mean, the other interesting thing is
Speaker 2: if all the acting like a speculative asset, Now, what
Speaker 2: happens when all of that starts reversing and you know,
Speaker 2: the thing that you thought was worth four thousand dollars
Speaker 2: is no longer worth four thousand dollars, and gold is
Speaker 2: typically used as collateral.
Speaker 3: I always say, you know, it's really scary when you
Speaker 3: see people like intensely buying gold because like what's up?
Speaker 4: Like what?
Speaker 3: But what's really scary is why they start selling, right,
Speaker 3: Because again, no, you's true, right, because actually no one
Speaker 3: has you have to be a real psychic have a
Speaker 3: gold denominated mortgage, you have dollar denominated mortgages, et cetera.
Speaker 3: And so when you see like usually one of those
Speaker 3: things you notice is that in a real credit event,
Speaker 3: when you really get that vic spike and people are
Speaker 3: really worried about making that payment on their mortgage, and
Speaker 3: they're really worried about paying their monthly subscription to their
Speaker 3: Bloomberg terminal. They need dollars and then they sell gold
Speaker 3: and you're like, oh, things are getting really.
Speaker 2: Rough, all right.
Speaker 3: I think that was a comment, that question comment not
Speaker 3: even a question.
Speaker 2: Thank you Joe for your comment. And it's always lovely
Speaker 2: catching up. This is been fantastic. Thank you so much
Speaker 2: for coming back on the show.
Speaker 4: Thank you very much, tra Sick, and thank you Jeff,
Speaker 4: Thank you so much.
Speaker 3: As us.
Speaker 2: Joe, I always enjoy catching up with him. He has
Speaker 2: a fantastic way of explaining things in a very soothing,
Speaker 2: calming manner. I do think so. Nuance is important, absolutely,
Speaker 2: and technicalities in the market are important. So if the
Speaker 2: dollar going down is being exacerbated by hedging versus people
Speaker 2: selling dollars outright, that is an important thing to talk
Speaker 2: about and to capture. However, I still feel like the
Speaker 2: direction of travel is not fantastic for the dollar itself.
Speaker 2: If people are treating dollar assets the way they used
Speaker 2: to treat local em bonds in terms of hedging, that exposure, Yeah,
Speaker 2: that doesn't seem great necessarily for the US.
Speaker 3: I mean no, I mean, look, it's sort of you know,
Speaker 3: I think of a currency as sort of like being
Speaker 3: the token at Chuck E Cheese, you know, and you
Speaker 3: want to play the games. But it was really nice
Speaker 3: of like the token is going up and you can
Speaker 3: play the games at.
Speaker 2: Play more games, or eat more pizza.
Speaker 3: Or or eat more pizza. But I think we're in
Speaker 3: this situation where people want to keep playing the games,
Speaker 3: they just don't really like the whole arcade.
Speaker 2: And yeah, yeah, this.
Speaker 3: Is this is the way I think about it. The
Speaker 3: games are still fun, it's just that you're worried about
Speaker 3: the direction of the arcade.
Speaker 4: Yeah.
Speaker 3: And so I think, because this is why, you know,
Speaker 3: like how are you getting You're not going to like
Speaker 3: do business in the United States, give me a break.
Speaker 3: That's completely unrealistic, even if you don't like if you
Speaker 3: put it the direction of travel. And so I think
Speaker 3: sort of intuitively you could sort of understand why I
Speaker 3: don't want to leave town. I just don't want to
Speaker 3: have arcade exposure.
Speaker 2: Absolutely. I guess what we kind of need. We need
Speaker 2: another big crisis so that we can observe what gold
Speaker 2: does during that time. Yeah, and also what the dollar
Speaker 2: does during that time.
Speaker 3: I think I'm gonna run with this our actually I'm
Speaker 3: gonna win.
Speaker 2: It's a really good analogy because like, if.
Speaker 3: You think like or you know, Chuck E Cheese has
Speaker 3: a lot of fun games. But also I don't really
Speaker 3: think the business swallow Chuck E Cheese. It's like that
Speaker 3: good like how dare you?
Speaker 4: Well?
Speaker 3: A lot of them have closed out, but it doesn't
Speaker 3: mean the games inside were less fun. So I don't
Speaker 3: want to hold those tokens in my pocket forever. I
Speaker 3: want to have exposure in case they go they go
Speaker 3: to business or something like. That doesn't make the games
Speaker 3: less fun in the meantime. And you've solved this problem
Speaker 3: of wanting to play the games but being worried about
Speaker 3: the future of Chuck E Cheese by hedging them.
Speaker 2: I'm going to restart Chuck E Cheese and roll it
Speaker 2: out across the country, just to ruin your analogy, your
Speaker 2: preferred market analogy. No, I think it's a good one.
Speaker 3: Thank you. Finally all right, but I will not be
Speaker 3: taking out Chuck E Cheese denominated well, no, so that
Speaker 3: would be the great thing. If you could imagine getting
Speaker 3: a Chuck E Cheese token denominated mortgage and then it
Speaker 3: goes out of business. You don't even have to pay back.
Speaker 1: You know.
Speaker 2: I'm pretty sure somewhere in like a box somewhere I
Speaker 2: still have a bunch of like Chuck E Cheese, these
Speaker 2: tickets or something like that. Maybe I should take them
Speaker 2: out anyway.
Speaker 3: So this is another interesting question because what is the
Speaker 3: exchange ratio between a token and a ticket?
Speaker 4: Right? Yeah?
Speaker 2: And I don't know.
Speaker 3: This is sort of like one of those communist countries, Chucky.
Speaker 3: This is a paper that someone write, Chuck E che
Speaker 3: is the dual circulation economy in which they have tokens
Speaker 3: for the games and tickets for the prizes, and how
Speaker 3: they manage that exchange ratio is very similar to us
Speaker 3: a planned economy.
Speaker 2: Do you think I can find someone to provide like
Speaker 2: a swap on a token versus a ticket or something.
Speaker 3: I think there's something here. I think we're I think
Speaker 3: we're hitting on something important.
Speaker 2: Okay, I think we should end. We should leave it there,
Speaker 2: all right. This has been another episode of the Authoughts podcast.
Speaker 2: I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3: I'm Joe Wisenthal. You can follow me at the Stalwart.
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