WEBVTT - Why The World Started Hedging Its US Dollar Exposure 0:00:02.720 --> 0:00:15.880 Bloomberg Audio Studios, Podcasts, Radio News. 0:00:18.120 --> 0:00:20.960 Hello and welcome to another episode of the Authoughts podcast. 0:00:21.040 --> 0:00:22.320 I'm Tracy Alloway. 0:00:22.120 --> 0:00:23.279 And I'm Joe Wisenthal. 0:00:23.840 --> 0:00:26.720 Joe, there are so many huge stories that you could 0:00:26.720 --> 0:00:29.040 pull out of this year, but I mean, like some 0:00:29.200 --> 0:00:32.240 actually really really big ones. So we had Liberation Day 0:00:32.360 --> 0:00:37.519 and the market crash. We had the continued weakness in 0:00:37.560 --> 0:00:39.920 the US dollar, which has been this sort of slow 0:00:40.000 --> 0:00:44.120 burned crash across the year. And we're recording this. Let's 0:00:44.120 --> 0:00:48.480 see October seventeenth, and you know, dollar down yet again. 0:00:48.720 --> 0:00:51.720 Well it is down, but however there's been a little 0:00:51.760 --> 0:00:53.800 you know, we hit hiss low in mid September. 0:00:53.920 --> 0:00:55.880 Don't make apologies for the dollar, Joe. 0:00:56.200 --> 0:01:00.840 You know, I just like keep going, all right, keep going. 0:01:00.880 --> 0:01:04.000 Then I might add something fall in the dollar. The 0:01:04.040 --> 0:01:05.160 fall in the doll is very big. 0:01:05.720 --> 0:01:06.000 So far. 0:01:06.040 --> 0:01:08.560 There's here but this huge ramp up in the price 0:01:08.560 --> 0:01:11.039 of gold, which seems to hit a new record all 0:01:11.080 --> 0:01:15.520 the time. And then we've had the continued strength slash resilience, 0:01:15.560 --> 0:01:18.720 whatever you want to call it, enthusiasm about AI in 0:01:18.840 --> 0:01:21.000 the stock market, and it really seems like there's this 0:01:21.120 --> 0:01:24.360 division at the moment between how people feel about corporate 0:01:24.400 --> 0:01:28.480 America and how people feel about sovereign America in the 0:01:28.520 --> 0:01:29.640 form of its currency. 0:01:29.840 --> 0:01:34.080 You know what I really regret doing tracing. I really regret. 0:01:34.160 --> 0:01:35.720 Did you have like a horde of gold that you 0:01:35.720 --> 0:01:36.240 got rid. 0:01:36.080 --> 0:01:38.959 Of over I took out a gold denominated mortgage. You know, 0:01:39.000 --> 0:01:41.319 I feel so stupid. I feel so stupid. Why did 0:01:41.360 --> 0:01:44.200 I do that? I could get paid in dollars and 0:01:44.240 --> 0:01:46.760 I took out a gold denominated mortgage. What was I thinking? 0:01:47.040 --> 0:01:47.120 No? 0:01:47.200 --> 0:01:49.240 I didn't, But had I done, that would have been 0:01:49.280 --> 0:01:50.400 a very bad trade. 0:01:50.720 --> 0:01:52.520 Yes, I remember those stories. 0:01:52.160 --> 0:01:55.520 From like, you know, a little bit of a tangent, 0:01:55.560 --> 0:01:57.880 remember all those stories from like the Hungarians they took 0:01:57.880 --> 0:02:02.400 out those Swiss denominated mortgage back of the two thousands. 0:02:01.720 --> 0:02:03.920 And that was very much a europe thing for a while. 0:02:04.120 --> 0:02:06.120 Yeah, that was a really funny list. We don't have 0:02:06.160 --> 0:02:09.320 to talk about that. But one thing, I was just 0:02:09.360 --> 0:02:12.440 the only reason I caveated the dollar fall, which I 0:02:12.480 --> 0:02:15.640 do think it has. It is quite a bit down 0:02:15.680 --> 0:02:18.160 from the beginning of the year. All that being said, 0:02:18.800 --> 0:02:21.560 it is striking in the last several weeks the degree 0:02:21.600 --> 0:02:25.400 to which a few of the very popular consensus ideas 0:02:25.400 --> 0:02:27.560 for this year are turning a little bit. And I 0:02:27.600 --> 0:02:30.360 say that tenure treasury is the time we're recording this 0:02:30.440 --> 0:02:34.200 October seventeenth has fallen below four percent. How many times 0:02:34.200 --> 0:02:36.960 did you hear about the steepener trade this year? How 0:02:36.960 --> 0:02:40.200 many times did you hear about fiscal dominance losing control? 0:02:40.240 --> 0:02:44.480 At the long end the dollar it stabilized a little bit. 0:02:44.639 --> 0:02:47.960 So it is a very interesting moment from markets in 0:02:48.040 --> 0:02:49.160 many respects right now. 0:02:49.320 --> 0:02:52.560 There's definitely a lot to talk about. Congrats on managing 0:02:52.600 --> 0:02:54.320 your personal FX liability. 0:02:54.720 --> 0:02:55.920 I'm doing a good job. 0:02:57.160 --> 0:02:59.679 Getting paid in dollars and paying your mortgage dollars. Well 0:02:59.720 --> 0:03:02.520 done show, All right, Well, you know, this is the 0:03:02.600 --> 0:03:04.440 kind of thing that a lot of big investors are 0:03:04.440 --> 0:03:07.200 thinking about at the moment, and we should definitely think 0:03:07.240 --> 0:03:10.280 about it too. And who is the one person that 0:03:10.320 --> 0:03:13.560 we really like to talk to when we talk about 0:03:13.560 --> 0:03:14.560 these big trends, And. 0:03:14.520 --> 0:03:17.360 Who is the one person that is always in town 0:03:17.400 --> 0:03:19.880 Because we're in Washington, DC right now, when we go 0:03:19.919 --> 0:03:22.359 to a new town, who is the other guy who 0:03:22.440 --> 0:03:23.960 always is probably going to be there at the. 0:03:23.960 --> 0:03:26.480 Same time, the person that we run into on the 0:03:26.560 --> 0:03:30.160 street in various outfits, Although this time you're wearing a suit, 0:03:30.240 --> 0:03:32.560 So there we go. The last time we run into randomly, 0:03:32.720 --> 0:03:35.960 you were wearing hiking gear and so were we. Anyway, 0:03:36.040 --> 0:03:38.400 we are here in DC. We have the perfect guest. 0:03:38.440 --> 0:03:42.040 As always, We are speaking once again with Hun Sunction. 0:03:42.280 --> 0:03:45.440 He is the economic Advisor and head of the Monetary 0:03:45.480 --> 0:03:49.480 and Economic Department at the Bank for International Settlements the BIS. 0:03:49.720 --> 0:03:51.880 We love talking to him and it's so great to 0:03:51.920 --> 0:03:54.280 have him here to talk about something that's really been 0:03:54.280 --> 0:03:56.720 on the minds of a lot of market participants, a 0:03:56.720 --> 0:03:59.160 lot of policymakers right now. So Hun, thank you so 0:03:59.240 --> 0:04:00.680 much for coming back on our thoughts. 0:04:00.880 --> 0:04:03.040 Thank you Tracy, thank you Joe. It's great to be back. 0:04:03.440 --> 0:04:06.120 Since Joe doubts my entire premise. 0:04:05.960 --> 0:04:08.240 For this episode, the entire premise at all. 0:04:08.680 --> 0:04:13.200 Now, let's just start with how unusual would you say 0:04:13.280 --> 0:04:15.880 this year has been? And I feel like so much 0:04:15.920 --> 0:04:17.839 has happened. We kind of have to cast our minds 0:04:17.880 --> 0:04:20.680 back to April when we did have Liberation Day and 0:04:20.720 --> 0:04:24.000 when we did see the dollar fall as the market 0:04:24.080 --> 0:04:27.720 was selling off, which was something that's not really supposed 0:04:27.720 --> 0:04:30.080 to happen. You're supposed to have investors reach for the 0:04:30.120 --> 0:04:33.440 safe haven of the green back in times of turmoil 0:04:33.520 --> 0:04:36.080 and stress. And now, you know, fast forward to October, 0:04:36.120 --> 0:04:37.800 I think we've gotten a little bit more used to 0:04:37.880 --> 0:04:42.000 that particular dynamic. But how surprised were you at that Well, it. 0:04:41.960 --> 0:04:47.200 Was a very unusual combination of events in April. So 0:04:47.240 --> 0:04:50.839 what we saw was the so called triple decline where 0:04:50.880 --> 0:04:55.600 you had stocks, bonds, and the dollar, yeah, falling in unison. 0:04:55.640 --> 0:04:59.360 And that's very unusual because in a risk off episode, 0:04:59.440 --> 0:05:03.640 you know, which April was, typically the dollar would rally. 0:05:04.320 --> 0:05:06.120 You know, there'll be a kind of safe have and flow. 0:05:07.040 --> 0:05:10.320 And you know, back then, there was of course a 0:05:10.320 --> 0:05:13.960 lot of news and you saw a lot of stories 0:05:14.480 --> 0:05:17.400 back then about you know, possibly the dollar, you know, 0:05:17.480 --> 0:05:20.000 losing its international status and so on. I think in 0:05:20.080 --> 0:05:24.120 retrospect that was, you know, quite hasty, and I think 0:05:24.160 --> 0:05:27.040 now that we have the data, we can piece together 0:05:27.920 --> 0:05:30.640 in a more kind of coherent way what was going on. 0:05:31.800 --> 0:05:36.240 And in short, I think it was a kind of 0:05:37.279 --> 0:05:43.039 hedging story where investors who had lots of exposures to 0:05:43.120 --> 0:05:46.400 the US dollar, we're trying to reduce some of those exposures. 0:05:46.440 --> 0:05:47.960 And we can get into some of the details and 0:05:47.960 --> 0:05:51.799 how you know, that kind of trade might transpire, and 0:05:52.640 --> 0:05:54.960 it just so happens that this is also the year 0:05:55.000 --> 0:06:00.719 that the BIS conducts its triannual survey of f X markets, 0:06:01.720 --> 0:06:04.000 and we've just published the results, and I think we 0:06:04.040 --> 0:06:07.799 can also shed some more light on the events in April. 0:06:08.240 --> 0:06:10.440 Let's keep it big pictures still, and then we'll drive 0:06:10.520 --> 0:06:14.159 down into specific months and weeks. What people work for 0:06:14.160 --> 0:06:17.920 the BIS, they prey must take out mortgages and Swiss 0:06:17.920 --> 0:06:20.960 Frank there living there in bars anyway, sidetrack, what are 0:06:21.000 --> 0:06:23.000 some of the big takeaways from this year service? 0:06:23.040 --> 0:06:27.239 Yeah, yeah, so I think well, actually before we go there, Joe, 0:06:28.600 --> 0:06:32.119 I mean, it's worth you know, thinking about how FX 0:06:32.160 --> 0:06:35.039 market is really a figure in the investment strategy. So 0:06:35.360 --> 0:06:37.440 you know, if you're a long term investor, let's say 0:06:37.440 --> 0:06:40.360 that you're a Euro area pension fund, what you have 0:06:40.560 --> 0:06:47.120 are obligations to your you know, local euros beneficiaries in euros, 0:06:47.720 --> 0:06:49.840 but you have a very large balance sheet and so 0:06:49.960 --> 0:06:54.080 you need to have a very broad exposure to global assets, 0:06:54.160 --> 0:06:58.080 you know, including those in non euro denominated assets. So 0:06:58.120 --> 0:07:01.720 what tends to happen is some of the euros are 0:07:01.720 --> 0:07:06.839 then converted into dollars to invest in in dollar assets. 0:07:07.600 --> 0:07:08.919 But of course what you want to do is to 0:07:08.960 --> 0:07:12.640 make sure that you hedge that currency risk. And this 0:07:12.800 --> 0:07:16.200 is where this instrument called an FX swap really comes 0:07:16.200 --> 0:07:21.320 into its own, and it's an operation where essentially the 0:07:21.480 --> 0:07:26.160 Euro Area investor pledges some euros and then borrows dollars 0:07:27.000 --> 0:07:30.080 and then with those dollars then go into dollar denominated assets. 0:07:30.720 --> 0:07:34.800 And as you do that, you also promise to unwind 0:07:34.840 --> 0:07:38.080 that transaction at a known exchange rate that affixed in 0:07:38.120 --> 0:07:41.160 a moment in the future. So essentially, once you've gone 0:07:41.160 --> 0:07:47.160 through that transaction, your currency risk is hedged. Now exactly 0:07:47.200 --> 0:07:50.360 how much of your foreign portfolio you hedge in this 0:07:50.440 --> 0:07:54.120 way that varies over time, I mean it depends, for example, 0:07:54.360 --> 0:07:59.160 on you know, how high the hedging costs are. Because 0:07:59.200 --> 0:08:02.720 you're typically doing this fairly short term and you're rolling 0:08:02.760 --> 0:08:06.480 over these hedges. What's important is the short term dollar 0:08:06.760 --> 0:08:09.440 interest rate, because you know, you're borrowing dollars in order 0:08:09.480 --> 0:08:13.640 to invest in dollar assets. So when the short term 0:08:13.640 --> 0:08:16.320 interest rate is very high, that's typically a time when 0:08:16.360 --> 0:08:19.320 hedging costs are very high. And so what had happened 0:08:19.360 --> 0:08:22.040 over the last few years was that these so called 0:08:22.080 --> 0:08:25.440 hedge ratios. You know, the proportion of your assets that 0:08:25.520 --> 0:08:29.280 you actually hedge had been really you know, trending down. 0:08:29.960 --> 0:08:33.040 And you know to the extent that some investors you know, 0:08:33.120 --> 0:08:35.520 didn't hedge at all, And why would you if the 0:08:35.559 --> 0:08:38.960 dollar is surging and the hedging cost is so large. 0:08:38.960 --> 0:08:42.760 And so when the turbulence broke earlier in the year, 0:08:43.240 --> 0:08:47.280 a lot of investors were basically caught with very large 0:08:47.320 --> 0:08:53.040 dollar exposures, you know, having not hedged. And I think 0:08:53.160 --> 0:08:56.400 one piece of evidence that you know this was that 0:08:56.640 --> 0:08:59.960 the events of April was very much an expost hedging story, 0:09:00.080 --> 0:09:02.720 you know, hedging after the fact was that, you know, 0:09:02.760 --> 0:09:06.760 we saw a lot of the telltale signs of swaps 0:09:06.800 --> 0:09:10.240 being taken out and dollars being sold happening in the market. 0:09:10.400 --> 0:09:13.840 So what would happen is, you know, if an investor 0:09:14.160 --> 0:09:17.960 is holding dollar assets, you know, without a hedge, but 0:09:18.040 --> 0:09:21.040 you're concerned about the dollar falling, then what you would 0:09:21.080 --> 0:09:23.560 do is you would put on a hedge X post. 0:09:23.720 --> 0:09:26.240 You would put on a hedge after the event. And 0:09:26.280 --> 0:09:29.679 you could do that, for example, by actually then engaging 0:09:29.800 --> 0:09:33.760 in an FX swap right there, but then selling the 0:09:33.800 --> 0:09:36.600 dollars that you've acquired so rather than investing those dollars 0:09:36.600 --> 0:09:40.160 into dollar assets, you simply sell it in the spot market. 0:09:40.679 --> 0:09:43.800 What that kind of dynamics would would imply is that 0:09:43.800 --> 0:09:47.160 there would be you know, lots of downward pressure in 0:09:47.200 --> 0:09:52.080 those situations where institutional investors are trying to you know, 0:09:52.240 --> 0:09:57.240 raise their head ratios. But expost So back to the triannual, 0:09:57.640 --> 0:10:00.920 what do we see there that to you know, puts 0:10:00.920 --> 0:10:04.240 additional light on this episode. By the way, on the triangle, 0:10:04.320 --> 0:10:08.120 you know this, it's just so happens that the sampling 0:10:08.160 --> 0:10:11.760 period was April this year, amazing, so you know, it 0:10:11.840 --> 0:10:15.680 may be slightly distorted by the events of you know, 0:10:15.720 --> 0:10:18.480 the April episode. On the other hand, the silver lining 0:10:18.559 --> 0:10:21.800 is that we have some great data on really the 0:10:21.880 --> 0:10:24.640 you know, the events of the of the April episode. 0:10:24.880 --> 0:10:28.040 But the headline numbers are really quite you know, quite notable. 0:10:28.200 --> 0:10:33.200 It's nine point six trillion dollars daily flow. This is 0:10:33.640 --> 0:10:36.720 like something like almost thirty percent higher than the previous 0:10:36.760 --> 0:10:40.840 survey in twenty two. The dollar is still very much 0:10:40.880 --> 0:10:44.440 the dominant currency. It's ninety percent of all of the 0:10:44.520 --> 0:10:48.160 transactions have the dollar on one side. It's even higher 0:10:48.200 --> 0:10:50.960 than what we saw in twenty two so you know, 0:10:51.040 --> 0:10:56.520 in spite of the survey being affected perhaps by these 0:10:57.400 --> 0:10:59.400 you know, stress events in April, you know, we think 0:10:59.400 --> 0:11:01.160 we've got a very very very good sort of take. 0:11:01.960 --> 0:11:04.040 One of the things that we noticed this year is, 0:11:04.080 --> 0:11:06.160 of course, you know, as well as the FFX swaps, 0:11:06.200 --> 0:11:09.680 which is by far the largest segment of the of 0:11:09.720 --> 0:11:13.920 the transactions, we also see a lot of a big 0:11:13.960 --> 0:11:19.400 increase in the spot transactions and also outright forwards. So 0:11:19.520 --> 0:11:22.280 let me just explain that for your listeners. You know, 0:11:22.320 --> 0:11:25.600 when you engage in US in an effect swap, you know, 0:11:26.679 --> 0:11:31.600 the investor with borrow dollars by pledging euros, and then 0:11:31.880 --> 0:11:35.640 there's also a promise to reverse that. Now that promise 0:11:36.160 --> 0:11:39.559 is called a forward, and of course you can get that, 0:11:39.920 --> 0:11:41.760 you know, without going through the swap. You can just 0:11:41.800 --> 0:11:43.720 go to a deal and say, look, you know, just 0:11:43.840 --> 0:11:46.640 sell me a outright forward so called, and then I 0:11:46.679 --> 0:11:48.920 would actually then have a dollar obligation. 0:11:50.360 --> 0:11:53.160 A swap is like a spark trade plusure forward exactly. 0:11:53.200 --> 0:11:56.360 Okay, it's that combination. And what we see is as 0:11:56.400 --> 0:11:59.560 well as the swaps, we see the two components, the 0:11:59.600 --> 0:12:03.200 spot and the forward being very very large this year. 0:12:04.480 --> 0:12:06.839 And we think that the events of April must have 0:12:06.920 --> 0:12:10.920 had a you know, had an impact because you know, 0:12:11.000 --> 0:12:14.760 as well as getting a swap and selling the dollars 0:12:14.800 --> 0:12:17.080 in the spot market, you can also just ask a 0:12:17.160 --> 0:12:20.040 dealer for a forward contract, but then of course the 0:12:20.080 --> 0:12:23.080 dealer has to hedge, so you know there's going to 0:12:23.080 --> 0:12:27.680 be a spot sale anyway, and so that combination would 0:12:28.040 --> 0:12:30.920 actually lead you to a situation where both the spot 0:12:31.360 --> 0:12:34.439 and the forward transactions go up a lot. And that's 0:12:34.480 --> 0:12:35.320 exactly what we see. 0:12:35.360 --> 0:12:35.760 Interesting. 0:12:35.840 --> 0:12:38.520 So this is another piece of the evidence that this 0:12:38.679 --> 0:12:41.520 was very much exposed hedging. And let me mention just 0:12:41.520 --> 0:12:44.320 two other things on this. We put out a bulletin 0:12:44.400 --> 0:12:47.240 earlier in the summer we you know, lay out all 0:12:47.240 --> 0:12:50.480 the other pieces of evidence that we could gather. But 0:12:50.640 --> 0:12:53.600 it's also notable that if you look at the actual 0:12:53.640 --> 0:12:57.640 portfolio flow numbers, the international portfolio flow numbers, there was 0:12:57.720 --> 0:13:00.920 no real selling in April, so you know, there was 0:13:00.920 --> 0:13:04.000 a very very small outflow, but on the scale of things, 0:13:04.040 --> 0:13:07.520 it was really tiny. There was certainly no you know, 0:13:07.640 --> 0:13:11.679 concerted portfolio outflows you know from the US. So that's 0:13:11.760 --> 0:13:15.040 really the i think, perhaps the most you know, compelling 0:13:15.080 --> 0:13:18.080 evidence that the so called sell America trade was not, 0:13:18.760 --> 0:13:23.160 you know, was not the story behind the eight episode. 0:13:36.840 --> 0:13:41.160 Why should we care, either qualitatively or quantitatively if this 0:13:41.360 --> 0:13:44.240 was a hedge America story and not a sell America's 0:13:44.280 --> 0:13:45.439 story outright. 0:13:45.200 --> 0:13:48.440 Over the long term, it is possible that you know, 0:13:48.520 --> 0:13:53.040 long term investors would then reassess their global exposures. And 0:13:53.080 --> 0:13:55.760 you see and you hear a lot of anecdotal evidence 0:13:55.840 --> 0:13:58.720 that you know, these conversations are going on, but so 0:13:58.800 --> 0:14:02.840 far that hasn't really you know, translated into actions. But 0:14:02.920 --> 0:14:06.679 I think what you know does flow very you know 0:14:06.760 --> 0:14:09.679 clearly from you know, from the actions in the spring, 0:14:10.000 --> 0:14:12.800 is that when we look at the various pieces of 0:14:12.840 --> 0:14:16.559 the global financial system, every part depends on other parts, 0:14:17.200 --> 0:14:20.360 and there is this network effect where provided that everyone 0:14:20.400 --> 0:14:23.920 else is doing what they're doing around the US dollar, 0:14:24.680 --> 0:14:29.080 then it's also in my interest. So actually, you know, 0:14:29.120 --> 0:14:33.320 be part of that ecosystem. So if you have this 0:14:33.440 --> 0:14:36.520 kind of need network effect, it's very difficult to have 0:14:36.600 --> 0:14:38.520 this whole sale shift away. 0:14:38.840 --> 0:14:41.800 One of the things that I think is unusual, and 0:14:41.880 --> 0:14:44.240 I probably said this in a few other episodes, but 0:14:44.400 --> 0:14:47.640 what I think is striking about this environment is that 0:14:47.760 --> 0:14:50.680 if you look at the US it can come up 0:14:50.720 --> 0:14:53.120 with a long list of reasons to be concerned, which 0:14:53.160 --> 0:14:58.280 we don't need to come down recapitulate now. On the 0:14:58.320 --> 0:15:02.600 other hand, the most affitable, impressive, cutting edge companies in 0:15:02.640 --> 0:15:05.360 the world that everyone would love to have exposure to 0:15:05.480 --> 0:15:07.640 in some way or in the US. And it strikes 0:15:07.680 --> 0:15:10.320 me is that's the unusual situation, which is we don't 0:15:10.360 --> 0:15:15.520 typically associate volatile sovereigns with being the home of the 0:15:15.560 --> 0:15:18.840 most dynamic companies in the world. And so to my mind, 0:15:19.200 --> 0:15:21.680 I would love to have exposed more exposure to in 0:15:21.800 --> 0:15:24.200 Video and Microsoft and all of these companies that are 0:15:24.200 --> 0:15:27.920 making money hand over fist without having exposure to the 0:15:28.000 --> 0:15:31.320 US itself, And hence I might want to hedge. 0:15:32.320 --> 0:15:34.880 I mean, certainly, you know the equity market story, I 0:15:34.880 --> 0:15:37.240 mean that really isn't a class of its own, and 0:15:37.280 --> 0:15:39.760 as you say, that's really been a very very strong theme. 0:15:40.440 --> 0:15:43.160 But more broadly, you know, capital markets. If you think 0:15:43.160 --> 0:15:47.359 about how capital markets operate, that there's a whole ecosystem 0:15:47.400 --> 0:15:51.280 behind that, and you have the underlying securities obviously, but 0:15:51.360 --> 0:15:54.200 then you have the hedging instruments, and then you have 0:15:54.440 --> 0:15:56.680 a whole set of investors who are actually you know, 0:15:57.000 --> 0:16:01.800 taking part and the banking system is absolutely crucial in 0:16:02.280 --> 0:16:06.040 providing those hedging services. And I think when we last 0:16:06.040 --> 0:16:09.040 discussed this back in Jackson Hole, you know, we talked 0:16:09.040 --> 0:16:13.280 about how the FX swap market makes you know, money 0:16:13.280 --> 0:16:18.120 fungible across currencies. And you know, money is ultimately something 0:16:18.240 --> 0:16:20.720 to do with banks. So you know, the central bank, 0:16:20.920 --> 0:16:25.000 you know, issues high powered money. Commercial banks are there 0:16:25.040 --> 0:16:28.520 also to issue money that the other users will will 0:16:28.520 --> 0:16:32.400 take advantage of. And FX swaps are there, you know, 0:16:32.480 --> 0:16:37.000 basically providing this service of making money fungible across currencies. 0:16:37.520 --> 0:16:40.680 So you know, every piece fits into every other piece 0:16:40.680 --> 0:16:42.480 in that sense. And so you know, we should think 0:16:42.480 --> 0:16:47.960 about this in terms of the mutually reinforcing pieces of 0:16:48.000 --> 0:16:49.440 this you know, this network. 0:16:51.200 --> 0:16:53.880 What have you observed in terms of the actual trends 0:16:53.920 --> 0:16:57.680 in FX hedging costs, because, as you described it in April, 0:16:57.880 --> 0:17:01.480 suddenly it all starts kicking off a lot of large 0:17:01.520 --> 0:17:04.280 investors who are not that used perhaps to having to 0:17:04.320 --> 0:17:07.600 hedge their dollar exposure suddenly scrambled to do it x 0:17:07.720 --> 0:17:11.320 post as you described. Did that mean that the cost 0:17:11.400 --> 0:17:14.520 of actually doing so actually increased or was it still 0:17:14.600 --> 0:17:15.400 relatively cheap? 0:17:16.080 --> 0:17:19.960 Well, actually, it's primarily about how high the short term 0:17:19.960 --> 0:17:23.800 interest rates are actually, and in particular, if you're a 0:17:23.840 --> 0:17:27.520 non US investor investing in dollar assets, it's really how 0:17:27.600 --> 0:17:30.360 high the short term dollar interest rate is, because essentially 0:17:30.720 --> 0:17:33.760 what we're doing is, you know, you're pledging euros, let's say, 0:17:34.119 --> 0:17:38.040 and then borrowing dollars short term and then investing in 0:17:38.080 --> 0:17:40.720 dollar assets. And so it's really about how high that 0:17:40.760 --> 0:17:43.000 short term interest rate is relative to the yield you're 0:17:43.040 --> 0:17:46.639 getting on the asset itself. And so if you have 0:17:46.680 --> 0:17:49.200 a flat yield curve, you know, which is what we've had, 0:17:49.400 --> 0:17:53.400 or even inverted yel curve, then hedging costs are very high. 0:17:53.440 --> 0:17:56.560 And so in fact, you know, investors have typically hedged, 0:17:56.680 --> 0:18:00.600 and hedge ratios have fluctuated. There's no system matter survey, 0:18:01.080 --> 0:18:04.040 but it's fluctuated between forty and sixty percent. I mean, 0:18:04.040 --> 0:18:06.720 there are some pockets of official data, like the Japanese 0:18:06.960 --> 0:18:09.960 life insurance companies, but typically this is you know, really 0:18:10.040 --> 0:18:14.800 quite quite anecdotal. But what had happened in the last 0:18:14.840 --> 0:18:19.560 year or so was the hedge ratios had gone down gradually. 0:18:20.119 --> 0:18:22.560 Some firms were not even hedging at all, you know, 0:18:22.600 --> 0:18:25.680 they were trying to win both on the stronger dollar, 0:18:25.960 --> 0:18:29.480 but also on the high yields. Yeah, actually they just 0:18:29.560 --> 0:18:34.280 meant mentioned a very interesting point here. Actually, it's actually 0:18:35.280 --> 0:18:38.879 worth thinking about the parallels between this story about you know, 0:18:38.920 --> 0:18:43.720 advanced economy investors holding US DOT assets with the story 0:18:43.920 --> 0:18:47.600 about local currency emerging market bonds. You know, that's actually 0:18:47.600 --> 0:18:50.920 a very very you know, important asset class that really 0:18:50.960 --> 0:18:55.680 grew up after the GFC. And that's typical asset class 0:18:55.720 --> 0:18:58.560 where the investor would not hedge. So if you want 0:18:58.600 --> 0:19:03.600 to enter in to a large emerging market sovereign BONDERNT trade, 0:19:03.640 --> 0:19:07.760 you would actually buy the instrument on an unheedge basis. 0:19:08.560 --> 0:19:11.240 And you do that because you know, you think the 0:19:11.280 --> 0:19:15.280 emerging market currency will appreciate as well as the YEL 0:19:15.440 --> 0:19:18.160 four and so you win twice. You know, you gain 0:19:18.280 --> 0:19:20.879 both on the yield, you know, as well as on 0:19:20.960 --> 0:19:24.439 the exchange rate. But of course when the tide turns, 0:19:24.480 --> 0:19:27.640 that's when you know scramble to you know hedge ex 0:19:27.760 --> 0:19:30.879 post and that's exactly you know the same type of 0:19:30.880 --> 0:19:34.439 thing that we saw you know, in this in this episode. 0:19:34.520 --> 0:19:38.119 And you know, and there were actually emerging market investors, 0:19:38.720 --> 0:19:42.159 especially from Asia, who were you know, caught with a 0:19:42.320 --> 0:19:45.240 very low hedge ratios and there was this ex post 0:19:45.280 --> 0:19:48.399 hedging going on. So there's actually a very interesting parallel 0:19:48.640 --> 0:19:51.840 between you know, what was you know going on this 0:19:51.960 --> 0:19:55.640 April and the much older trade, which is the emerging 0:19:55.680 --> 0:19:56.480 market trade. 0:19:56.640 --> 0:20:00.320 So Joe, on the plus side, people aren't necessarily selling 0:20:00.359 --> 0:20:05.120 dollar assets. On the downside, the negative side, we're basically 0:20:05.160 --> 0:20:08.240 treating dollar assets the way we would allow emerging market. 0:20:08.280 --> 0:20:10.800 Pond were like, I think I'm going to buy some 0:20:10.840 --> 0:20:16.760 local currency US day. That's right, actually, but like, so 0:20:16.800 --> 0:20:19.119 what was it about April then that caused the like 0:20:19.200 --> 0:20:22.120 what I mean, we know there was yeah, the Launcher 0:20:22.200 --> 0:20:24.320 trade war and there were like massive tariffs, et cetera. 0:20:24.320 --> 0:20:28.440 But like, what was it about that such that people's 0:20:28.920 --> 0:20:33.000 impulses to hedge more expost factor as you've described it. 0:20:33.359 --> 0:20:37.000 What was the thing they said, Oh, we want to 0:20:37.080 --> 0:20:40.680 change our the our sort of our exposure to US dollars, 0:20:40.680 --> 0:20:42.200 even if we don't want to sell them. 0:20:42.520 --> 0:20:45.960 I think it's probably a combination of several things. But 0:20:46.480 --> 0:20:49.560 where the you know, where the investors found themselves in 0:20:49.680 --> 0:20:52.080 terms of the hedge ratios had a lot to do 0:20:52.119 --> 0:20:55.520 with this. Actually, if you look through your you know, 0:20:55.560 --> 0:20:59.399 Bloomberg news database, you'll find plenty of stories from twenty 0:20:59.400 --> 0:21:05.879 three for where let's say life insurance companies announce that 0:21:05.920 --> 0:21:08.960 they will not be hedging, you know there, so you 0:21:08.960 --> 0:21:12.040 know they would be holding let's say US dollar assets 0:21:12.040 --> 0:21:15.679 but without a hedge. And as I said, you know, 0:21:15.720 --> 0:21:18.600 there were some firms that didn't hedge at all. And 0:21:18.760 --> 0:21:22.119 in a risk of environment, what typically happens that you 0:21:22.520 --> 0:21:25.400 want to take some chips off the table, and that 0:21:25.520 --> 0:21:29.160 just means reducing your exposure. Yeah, and if you're exposed, 0:21:29.320 --> 0:21:33.240 you know, in this double whammy fashion, you know you 0:21:33.280 --> 0:21:36.800 would actually try and you know, either hedge ex post 0:21:37.440 --> 0:21:40.680 or reduce your exposure. It looks like from the evidence 0:21:40.680 --> 0:21:42.840 that it was very much the expost hedging story. 0:21:43.840 --> 0:21:46.960 So if people are hedging their dollar exposure more than 0:21:47.160 --> 0:21:50.639 perhaps some of them at least used to do, we 0:21:50.680 --> 0:21:55.840 have to worry about things like rollover risk or some 0:21:55.880 --> 0:21:59.320 sort of I guess duration mismatched where you have a 0:21:59.400 --> 0:22:02.840 short term hedge, whether it's a forward or a swap 0:22:02.960 --> 0:22:07.000 or whatever, mismatch to a longer term asset. I mean, 0:22:07.040 --> 0:22:09.080 this is this is what the BIS does on a 0:22:09.160 --> 0:22:12.520 day to day basis, is worry about potential risks so 0:22:12.800 --> 0:22:13.720 are you worried here? 0:22:14.560 --> 0:22:18.439 That's a really great comment, Tracy, And I think this 0:22:18.640 --> 0:22:21.719 was you know where I was going to go next. 0:22:22.520 --> 0:22:25.480 Of course, you have this. You know, once you hedge, 0:22:25.520 --> 0:22:28.480 you've hedged the currency risk at least until the maturity 0:22:28.520 --> 0:22:31.640 of the swap, which is typically you know, one month 0:22:31.720 --> 0:22:36.399 to three months. But it's a short term. It's a 0:22:36.440 --> 0:22:40.200 short term liability that you need to roll over, and 0:22:40.280 --> 0:22:42.760 from time to time you might get caught in a 0:22:43.520 --> 0:22:48.879 liquidity you know, stress episode where it's difficult to source 0:22:48.920 --> 0:22:52.000 the dollars to actually repay. And this was, for example, 0:22:52.000 --> 0:22:55.800