Lead-Lag Live
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Lead-Lag Live
Andreas Steno Larsen on Dollar-Yen Carry Trade Turmoil, Chinese Liquidity Trends, and US Construction Sector Risks
Discover how the recent turmoil in the dollar-yen carry trade has shaken the financial world in an insightful conversation with Andreas Steno Larsen, the esteemed creator of Steno Signals. Andreas brings his wealth of foreign exchange and investment banking experience to the table, shedding light on the significant leverage macro hedge funds placed on the US dollar against the Japanese yen. As Japan hints at shifting away from its QE program, Andreas helps us unpack the repercussions involving US non-farm payroll data, interest rate spreads, and intricate currency hedging practices by pension funds. Listen in as he provides a forecast for this trade, suggesting ongoing market adjustments.
Next, we turn our attention to the intricate web of global dollar markets with a focus on the limited role of Chinese banks in carry trades. Despite restricted access to dollar funding, we explore how the People's Bank of China impacts these markets through its US Treasury holdings and gold reserves. Andreas also delves into liquidity trends, forecasting significant movements towards the year's end and examining their potential effects on the job market and asset classes like gold and NASDAQ. We discuss strategic implications of the US Treasury's actions and how seasonal patterns influence market behavior.
Our episode also explores the shifting landscape of the US construction sector and the economic health challenges in China. With legislative shifts from the Inflation Reduction Act and the Chips and Science Act, we address the risks to construction jobs and the broader implications for the US business cycle. Andreas expects unemployment rates to rise above 5%, while also dissecting China's significant drop in domestic demand and its global impact on commodities. To wrap up, we reflect on the concept of Japanification within the US economy, comparing debt-to-GDP ratios and pondering long-term economic trajectories.
The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.
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my name is my publisher of the lead lag report. Join me for the rough hours, mr andreas steno larson uh, the man behind steno signals. Andreas, a lot of people are familiar with your work from various media outlets, but for those who don't know your background, who are you? What you? What have you done throughout your career? What are you doing currently?
Speaker 2:So I'm born and raised in foreign exchange. Professionally, I worked at various investment banks out of Northern Europe and then, a few years ago, I decided to venture into my own company. It's been a great journey and I mean frankly, I love being able to express myself exactly as I see fit, and it's one of the things that you grow tired of when you work for an investment bank, that you have to consider politics and all sorts of weird agendas when you discuss markets. So I can guarantee you that I speak my mind today if that's a phrasing in English, and I don't really have any soft spots, you cannot discuss with me. I'm up for it all.
Speaker 1:Most people aren't aware that Andreas and I got together over dinner. I think it was a year plus ago and you could see the difference in my face, by the way, from the fasting from when I was much heavier. I looked jolly back then. Is that a good word to use?
Speaker 2:Yeah, but what happened to my hair since? I don't know really.
Speaker 1:It's kind of cool. Well, it looks like it's lighter and more blonde. I don't know, part of, I guess, being outside the US. All jokes aside, let's get into what's gone on the last several weeks, because it feels like a whole market cycle took place between everyone freaking out about the reverse carry trade, giving me high fives and me saying actually probably they're going to rally the hell out of the market after that and then hit it again. I joked. A lot of people suddenly became an expert in the reverse carry trade within 24 hours. I want to get your take on it, because I actually do consider you to be a legitimate expert on a lot of things. What the hell happened about two and a half weeks ago? So I mean.
Speaker 2:I think it's. First of all, it's very fair to express some concerns around that dollar yen trade. It's been one of the most consensual trades among macro hedge funds. Roughly six quarters in a row. It's been one-way traffic. I mean it's been very easy to just ride the carry in the US dollar versus the Japanese yen. It's been trending up. The Bank of Japan did nothing to stop that. The Federal Reserve kept hiking interest rates relative to Japan and it was very, very easy to just ride it all. When we look at flows over those couple of weeks, my clear impression from the flow data that we're able to gather is that the rock was pulled from under. The macro hedge funds levered up in this trade. The macro hedge funds levered up in this trade. We're talking about the big known hedge funds here and they were all in this trade, partially in the trade versus the Chinese Wang as well.
Speaker 2:When we look at the real money community, say pension funds, asset managers, etc. They're not allowed to take a lot of currency risk by design, so they typically run currency risk only to a certain extent when they decide to invest in cross-border holdings. Take a very simple example of a Japanese live-in pension fund right, if they invest in US treasuries or if they invest in NASDAQ, they have a corporate policy of hedging parts of the currency exposure between the US dollar and the Japanese yen. So they are not the culprits here. The culprits are the hedge funds in naked FX bets betting on the dollar versus the Japanese yen. And all of a sudden, when we got a hike from Japan, a message that they're trying to get out of their QE program by 2026, good luck, by the way and pairing that with a few very weak key figures out of the US, not least the non-farm payrolls report, all of a sudden the tide turned on this trade, especially when you look at interest rate spreads between the US and Japan, and we saw a gap between real interest rate spreads in dollar versus yen and the actual spot developments in the FX market a few weeks ahead of this and bought a put.
Speaker 2:So we actually had this trade on our radar and I guess the signal to me was the continued rise in the dollar versus the Japanese yen when interest rate spreads actually started to narrow.
Speaker 2:That's typically not something that goes hand in hand over time and it didn't this time either. So when we look at dollar-yen right now and assess the fair value versus interest rate spreads adjusted for inflation, I think it's fair to assume that fair values are below 140, so still substantially below today's spot levels, and we're still on a sort of a slippery slope towards narrowing interest rate spreads between the US and Japan. I mean, just this morning we got a couple of research papers from the Bank of Japan, still talking about rates pressures, service inflation. It sounds like the Federal Reserve a year ago, right. And on the other hand we have Jay Powell taking center stage on Friday at Jackson Hole, probably announcing that the Federal Reserve will start cutting interest rates, right. So on a trend basis, this trade is done and we can obviously discuss the structural ramifications of that. But I think the first wave of very levered up trades in this dollar yen carry trade. They've been washed out and they're not back in the trade yet you said first wave.
Speaker 1:That makes it sound like you expect more. Let's talk about that yeah.
Speaker 2:So I mean, I've seen deutsche, Deutsche Bank and other investment bank outlets trying to assess the size of this overall carry trade and it is a tricky equation to get right, since you need to account for a lot of over-the-counter derivatives. So take the example of this Japanese live-in pension fund. Again, If they invest in a dollar asset, they will likely hedge, say, between 60% and 80% of that dollar exposure with an FX swap. So basically a matching position mitigating the FX risk between the dollar and the Japanese yen when they invest in NASDAQ or US Treasury. But when you look at the official accounts so the Bank of Japan, the GPIF, I think it's called the Government Pension Scheme they are not FX hedged to the same extent as the quote unquote private accounts in Japan. So they've built up a massive trade in the dollar versus the Japanese yen. And think about Japan this way trade in the dollar versus the Japanese yen and think about Japan this way.
Speaker 2:I mean, we've seen a couple of decades of extremely easy monetary policy in Japan, also relative to the US and even relative to Europe, meaning that the Bank of Japan bought more or less everything that was issued locally, thereby asking, for example, the government pension scheme to buy stuff outside of Japan because they've essentially squeezed them out of the market. They've also asked private pension funds, private asset managers, private hedge funds to buy stuff outside of Japan and they've obviously hit parts of this FX risk, but not all of it. So if you look at the net exposure of private accounts, my best assumption is that we're talking roughly a trillion dollars, including these FX swaps. But if you include the official accounts, take the example of the Bank of Japan, again, with a massive US Treasury holding, with a massive dollar reserve, with a massive dollar reserve, we're talking several trillions.
Speaker 2:And if you look at the sort of capability of swallowing a lot of negative returns due to a turning tide in the dollar versus the yen for these official accounts I mean, of course they can stomach some volatility it's not like Bank of Japan will have to bring down their risk exposure day one when they see a turning tide in the dollar versus the yen.
Speaker 2:But ultimately, as we've seen with the Federal Reserve, by the way, if they make a negative return, they'll have to go to their local treasury and ask for a deferred liability. It's kind of a technicality, but it's not something you get a high five from the politicians from asking for right from asking for right. We've also seen how it's turning into a slight topic in the US that we have a running deficit of the Federal Reserve due to negative running returns, negative cash flows. They can obviously print their way out of this, but that's essentially what they're telling us, that they don't want to do anymore. And in case they do not want to continue printing new, fresh Japanese Yens to cover for that negative cash flow, they'll have to take some structural decisions on whether to allocate to a larger extended hold.
Speaker 1:I love this. I think you were joking, but I wasn't sure. I think the carry trade is at least 300 trillion. Now, the thing about that 300 trillion folks is that Andreas purposely did not put the currency, so maybe you saw that Dogecoin for all I know, in which case it might actually be the accurate number. But I guess this is the point. It's like nobody knows the exact number, but we know it's probably still sizable because of the options and derivatives to your point that are attached to it.
Speaker 2:Yeah, exactly, and I mean the Bank of International Settlements. They try to gauge the size of this derivatives market, but they do so with a long time lag right, and I also saw a couple of their spokesmen suggesting that the size of this private dollar yen carry trade was around a trillion when you adjust for the FX derivatives. But again, it was like plus minus trillions, right, it's not really a firm number that they're posting, right? And what I can say is that we've certainly not seen a washout of that more structural Dolly End trade and frankly, I mean it feels kind of reminiscent of 2007. I guess you remember that very well as well, michael, because in 2007, we also. But Bank of Japan is one of a kind when it comes to mistimed policy tightening and, yeah, maybe we are in a 2007-like scenario. It's not necessarily because I think there are a lot of similarities to the great financial crisis, but it's just always a warning signal when Bank of Japan tries to tighten policy. It is.
Speaker 1:I think it's interesting. The narrative has been Japan wants inflation right, and now it looks like they're actually nervous about it.
Speaker 2:Yeah, they do. I mean, take a look at the two research papers that they published this morning. They sound completely out of whack with the tune we hear from the Federal Reserve, the European Central Bank, Bank of England, you name it currently even the PBOC. In China, they're all talking about disinflation now goods deflation, wages coming down, and in Japan they're talking about wages being sticky. They're talking about labor shortages.
Speaker 2:It sounds like Jay Powell 15 months ago and, interestingly, they come to this conclusion right at the time where all other central banks start moving in the opposite direction, which is obviously a very, very big story for the FX market. We know how foreign exchange markets are driven by interest rate spreads and maybe, in particular, interest rate spreads adjusted for inflation. And if inflation comes down in Japan, which is very likely, if the Japanese yen strengthens I mean it's a very open economy when it comes to import and exports and they pair that with rising nominal rates in Japan, it's hard to square that with a dollar-yen trade still structurally very long when you look at official accounts in Japan, when you look at official accounts in the US, et cetera. So I think there's more to this story on a structural level, but the hedge funds are out of it.
Speaker 1:There's a question off of X I'll share here. How about the Chinese banks? Given the difficulty they've had borrowing locally, might the SOE or peristatal Chinese banks be sizable carry trade participants.
Speaker 2:Yeah, I don't think they are, and the reason why I say so is that it's very tricky for them to obtain that funding. When you look at various official statistics on the involvement of Chinese banks in dollar markets, I think you get to the conclusion that they're more or less irrelevant on a global scale. There is a bit of activity in the dollar liquidity facility from the PPOC. We've seen a pretty decent spike in that repo facility, but we're still talking about less than a percent of the entire asset base of the Chinese banking system asset base of the Chinese banking system. So, no, they're not as actively involved in this carry trade, given that they don't have a strong access to dollar markets. But the People's Bank of China has been very active in this carry trade as well.
Speaker 2:Look at the statistics on official holdings of US treasuries. I mean, that is, in essence, a carry trade. They are holding US treasuries in their official reserves. They've, to a certain extent, tried to bring that amount of treasuries lower and they've replaced it with gold, but gold is still a dollar trade and, indirectly, they're still exposed to this carry trade via their gold position. So I think it's a structural shift that we've seen and it's been accelerating since 2020 with no interest rates in Japan, with no interest rates in China. And look at interest rates in China right now. I mean they're still being compressed despite what's ongoing in Japan, and I think the Japanese monetary authorities they dislike that trend a lot in China since they trade a lot with each other. So the Chinese carry trade officially is also relevant, but the private banks are less involved.
Speaker 1:So actually this is another good question off of X and I want to go in this direction anyway. So I'm going to share the screen with a post that you put out. What's your current view on liquidity and possible impact of the job market revisions? It's bullish. It's a spring forth cutting cycle. Would you short gold again? Now I'm going to share. Hopefully I can get this properly showing. Here we go. This is a great chart that Andreas put on his X account. The growth factor is weak in market lead during July. So talk about that question in the context of this data and what happened in July, because I myself have noticed from a market perspective, a lot of shifts started taking place that first week.
Speaker 2:Yeah yeah, it was very nasty and it caught me by surprise. I'm thankful that we run these now costs on a daily basis because otherwise I would have been caught completely wrong footed on this. It took me a week or so to really acknowledge what was going on. But to start with the question on dollar liquidity, the green line in the chart here is a running probability of rising liquidity and actually, if you include the numbers from today and yesterday, we've seen a slight pickup in the probability of rising liquidity. I think there are two major waves of liquidity worth mentioning here ahead of New Year's. So we still have, on a trend basis, a liquidity addition from the overnight repo facility at the Fed Reserve. So when the US Treasury issues T-bills on a net-net basis, they convince the money market funds with money parked at the Fed Reserve to buy these T-bills on a net-net basis. They convinced the money market funds with money parked at the Federal Reserve to buy these T-bills and thereby increasing the amount of liquidity available for the commercial banking system. But we're running on fumes on that trend and we are close to some sort of de facto flaw in the overnight reverse repo facility because obviously these money market funds they do not want to send a signal to the Federal Reserve that the facility is no longer of use. So I think we're close to some sort of natural flaw there.
Speaker 2:Then come Q4, we'll get a liquidity addition from a drawdown in the Treasury General Account. And the Treasury General Account is basically a measure of the idle liquidity held by the US Treasury at the Federal Reserve System. So they hold a quote-unquote, a war chest of liquidity that they can rely on in times of liquidity stress in T-bills and Treasury markets, for example. But they're not allowed to hold a lot of idle cash ahead of a debt ceiling deadline, and we obviously have such a deadline upcoming on the other side of New Year's. So what we typically see is that the treasury is forced to bring this facility close to zero ahead of the actual deadline. It's not something that they will forecast. They will not forecast. They draw down of the treasury general account in the quarterly refunding announcements. They will not tell you in speeches, but it just happens mechanically because they need to. They're not allowed to incentivize politicians to negotiate for months, so they simply have to bring this war chest down.
Speaker 2:That is a liquidity addition. It's not a high quality liquidity addition, if that makes sense because we ultimately know that they will replenish this facility once they're allowed to after a new debt ceiling suspension. But in any case, I think it's very likely that the liquidity will increase from here and until new years. We have weakness coming up in September due to seasonal patterns. We have a lot of tax payments coming in mid-month, so September is not a strong month for liquidity and I think we're close to some sort of short-term peak in liquidity before a very strong Q4. So what I'm saying here is that September will not be a strong liquidity month, and it's typically something that also spills over to NASDAQ and gold. By the way, I see that the question also refers to my short gold trade and thank you for mentioning that. That's really worked out well.
Speaker 1:They love sticking it to us, man, they love to hit us.
Speaker 2:But yeah, frankly it's been the worst trade I've had on the books over the summer and I mean the seasonality in gold is extremely poor in September. So I'm kind of sticking to my guns on that trade but I'm not adding to it. Let me put it like that In relation to the last part of the question on the job market revisions, they'll be out tomorrow at 10 am Eastern. This is the annual revision of non-farm payrolls data. So we'll get a revision of the data up until March this year and I've obviously seen how Zero Hedge has posted a lot of stories on this being one of the larger revisions in modern history and I agree with that. It will be a large negative revision.
Speaker 2:So why is there a need to revise the non-farm payrolls data lower? Well, let's start from this. If you look at the nonfarm payrolls data, it's surveyed based on a monthly basis, so they survey establishments and ask them whether they've hired or not through a month. When they revise this data in the annual adjustment they use the quarterly data from the Census Bureau and the census data is based on insurance data. So essentially they'll have a look at roughly 90% of the entire establishment sample across the US. On the employment insurance data. The US on the employment insurance data. So why is there currently a major gap between non-farm payrolls and the census data, by the way, also the household survey? Well, first of all, because we have illegal immigrants in the labor force to an extent that we haven't seen, probably ever, and obviously if you hire an illegal immigrant, you're not going to insure him or her. That's one reason why we have a gap.
Speaker 2:And I think the second part of this story is that the non-farm payrolls is probably overstating still the amount of births to deaths in the tiny employer space. So what I'm talking about here is the model-based assumption on the amount of new businesses opening month-on-month in the US relative to the amount of closures. When we see foreclosure data now and also data on bankruptcies, my best guess is that they're trending up. We can gather that data from Bloomberg on a weekly basis and on the amount of openings, I'm still a little bit skeptical. I mean, when you look at the birth to death ratio, it's like it has three or four X, since before the pandemic, there are some signs of tiny employers being more important when you look at job openings etc. So it's not fully out of sync with reality, but it is probably the part of the non-farm payrolls that you need to be aware about when you look for these revisions. So, yes, we'll get a revision of close to a million tomorrow.
Speaker 2:In my opinion and I mean I'm from a small country, denmark we can more or less count the number of unemployed manually, right? Well, it's apparently a mess to figure out how many unemployed there are in the us economy and also how many employed, um, people you guys have got over there. So I mean, I don't really my impression is that no one knows. That's what I'm trying to say here. Um, I don't know whether you concur with that view, michael, but uh, I 100%.
Speaker 1:I think we're looking for specificity. In an era of all this data where the range of the margin of error is so wide, you can't really have confidence in anything, although I do think that the fact that treasury yields are dropping on the long end probably means some money is betting on the revisions actually being being pretty sizable, to your point.
Speaker 2:Yeah yeah, uh, and I mean to the point on uh, on interest rates, I think we've seen a major shift in the reaction function from the federal reserve over the past month. Um, and I guess that is also a function of of landslide in the growth gauges through July. We've seen very weak labor market report in July. There was initially a debate around whether this was a result of the storm barrel. A result of the storm barrel. I think, after stomaching the data, that we can basically set that thesis aside.
Speaker 2:I don't think it's likely that the storm had a big impact on non-farm payrolls, since the way that they conduct this establishment survey basically rules out the possibility that weather-related temporary layoffs played a big part in weakening the data.
Speaker 2:So it mattered for initial claims, it didn't really matter for the Dunfarm Bayrolls report and we actually had a decrease in the amount of temporary layoffs in Texas and Louisiana, the two states mostly impacted by the storm. So something happened, especially in the labor market through July. I think we've been through a quarter. In the second quarter, very low hiring but also very low firing. But we're now getting to the point where the hiring trends are sufficiently weak for this to become a concern for the Federal Reserve and they have a dual mandate right. So that is why I think it makes a lot of sense to try and price in more interest rate cuts from the Federal Reserve than, for example, for the ECB or the Bank of England or other central banks, because they solely look at inflation, while the Fed Reserve has now received the perfect excuse to start cutting pretty aggressively.
Speaker 1:Presumably that means credit spreads have to widen. I mean rising unemployment should be tied to default risk. Yeah, yeah, I tend to widen.
Speaker 2:I mean rising unemployment should be tied to default risk. Yeah, yeah, I tend to agree, and I mean the starting point for spreads is obviously very tight and when you look at flow data there is a major divergence or discrepancy to the cutting cycle expectations. We saw around New Year's Recall the sudden massive inflow into fixed income around Powell's pivot in Q4 last year into the early innings of this year. We saw inflows to fixed income. We saw a major bet on a lot of interest rate cuts this year, but we also saw inflows to high yield. This time around we see a lot of inflows to fixed income again, but not to high yield, and I think that's a strong clue that this is a different credit cycle to what was expected around New Year's and at the time I guess the vibe was that okay, they will prematurely cut interest rates a lot, while this time around the vibe is more okay. They have to do it now because of a landslide in the labor market.
Speaker 1:I want to touch on housing a bit here. I'll share it on the screen A chart you put out looking at construction payrolls and new private housing under construction and the post you put out said these are some of been that causation around lumber as a tell on housing starts and the housing health in general is very much still active. All right, and I think you could see it on the commodity signaling side. Let's talk about housing because this is the other dynamic which I think is maybe being ignored and taken for granted in terms of how this could be a real headwind.
Speaker 2:Yeah, so when you look at housing starts, we had a terrible July and we're now down roughly 10% year over year, as you can see from the chart. The interesting thing is that we see an increase in the construction payrolls and we even saw that in the very weak labor market report from July. It made a new cycle high. When you look at the sort of decomposition of construction payroll numbers, I think the Inflation Reduction Act kind of saved the day for the construction sector through 23. When you look at construction activity in manufacturing relative to residential, we saw a major shift around the implementation of the Inflation Reduction Act and the Chips and Science Act and we actually saw a pretty decent drawdown in the investment activity in residential real estate.
Speaker 2:Now, with housing starts down, with the stimulus from the Inflation Reduction Act leveling off, I actually think there's a pretty decent risk that we see that year-over-year drawdown in construction jobs as well. If you look at construction job openings, we've seen a very nasty drawdown basically since April and we typically see openings moving ahead of actual jobs. So when you do not post a lot of openings anymore, that's probably the first management decision you take ahead of potentially laying off people later in the cycle. So I would be surprised to see a continued rise in the construction payroll numbers through the second half of the year, and that is a very strong signal.
Speaker 2:When it comes to the business cycle and I've been, for good and for bad, pretty upbeat on on the us cycle up until early july uh, when I see a chart as the one you just showed, michael, it tells me that some of the sort of underlying fundamentals in the business cycle they're starting to weaken. And I mean it may be that other parts of the business cycle are doing better than construction, but construction is a good old school indicator that the central bank will likely also watch and therefore I think this is a strong clue that they finally have their excuse to cut interest rates. And I also think it's a very strong clue when it comes to the broader employment patterns over the next six months. I would be surprised if unemployment prints below 5% in six months from now.
Speaker 1:Yeah, prints below 5% in six months from now. Is there a chance that, as the US weakens, somehow China magically picks up the slack? I saw this headline briefly this morning, just something around the lines of they're coming up with some kind of almost like a special purpose vehicle to buy up homes that are unoccupied. I mean, it looks like there might be some actions being taken on that end. Is there any chance that maybe some of this I don't want to say doom and gloom around the US gets countered by maybe some optimism on China?
Speaker 2:I look at China every single day to figure out whether that is a feasible thesis. And when you look at the export momentum, right now in China, it's doing pretty okay. When you look at the domestic demand and I know I've been saying this for a few years in a row it's absolutely on the floor and I cannot stress the extent of the drawdown of the domestic demand, especially in the construction sector in China. When you look at new housing starts, we're not seeing a recovery in China, because why build new apartments when you have a declining population? That's question number one. Question number two why would you expect China to keep buying the same amount of raw materials if they're not building anymore?
Speaker 2:I get probably a few handful of questions every week on the base metals trade and the relation to China. And we obviously had a major spike in the copper price during the early innings of the spring and into May and all of a sudden the tide turned rapidly on that trade. And all of a sudden the tide turned rapidly on that trade and what happened in May and in June was that China decided to export a lot of their excess capacity in the raw materials space. We're talking exports of aluminum, we're talking exports of copper. There you go. I mean, it's exceptionally out of the ordinary. We're talking three, four standard deviations and this is a symptom of the local demand for copper being down 30 to 40% in China.
Speaker 2:The real estate sector was, on the margin, the largest consumer of copper on earth. China used to consume 50% of all copper and now that's at least 30% lower. And I'm sure we're talking about EVs and wind turbines and stuff like that. But when you look at the sales of EVs globally, it's also leveling off right. So you don't really have momentum behind that green transition either.
Speaker 2:So I'm very skeptical around this commodity super cycle right now and I'm very skeptical around the domestic demand in China. And I think and I'd like your take on that as well, michael, I know you've done a lot of academic work on the housing cycle and the lumber cycle and all that of academic work on the housing cycle and the lumber cycle and all that, assuming that house prices dropped every single month, say, by 50 basis points in the US, I think we would see something very similar in the US economy domestic consumption being on the floor, saving rates up, and that's essentially what's happening in China. You see house prices down 25, 50 basis points a month and you have to save because you're levered to the titties. Pardon my French.
Speaker 1:I think it's a CFE level, four term, by the way. No, but I think it's the reverse wealth effects. Look for all the talk we have about the wealth effect. The wealth effect is primarily around housing. I mean, the Federal Reserve itself has said that. When it comes to the US, it's the same dynamic everywhere globally. Most people's wealth is their home. So if you're going to be seeing to your point, your own value dropping on a persistent basis, yeah, you're not going to go out and spend as much because you're worried about that savings vehicle which is your house no longer saving and being a store of value. But there are cycles still, right. I mean it doesn't matter if it's in China. Presumably, there is a floor for housing and real estate in China and it's been so well documented and it's been ongoing for so long. I mean I would think a contrarian would say, yeah, okay, it's still on the floor, but time kind of takes care of these things.
Speaker 2:Now, I would need to see firm signs of the Chinese government trying to bring the bad stuff on balance sheet. Basically, we've seen a few attempts via, for example, the issuance of this special bond, to try and allow Chinese regional authorities to take some of the bad debt and some of the unoccupied housing on balance sheet, but the size of these facilities is neglectable still and we would need to see major fiscal stimulus to change my view on this. Is it feasible that we get such a fiscal bazooka from China? Well, they just had, was it a month ago?
Speaker 2:Their annual gathering, and typically we see the policy decisions being leaked over the course of the weeks following, and we haven't really seen strong signs, I'd say, of the Chinese authorities trying to bring these issues on balance sheet. So I still have to say no, michael I, I I'm on the watch daily for for clues on on whether to change my view on this. Uh, the chinese authorities and china daily and uh, the newspapers out there, they've been crying wolf on this story for ages without nothing really happening. So they're obviously trying to convey a message of fiscal support, but I mean, the numbers do not add up yet.
Speaker 1:It's an interesting point from Kevin Monzo on X Pollution data still shows weakness in China. Yeah, yeah, I tend to agree.
Speaker 2:Monzo on X pollution data still shows weakness in China. Yeah, yeah, I tend to agree. It depends a bit on the region, but if you look at pollution data, we're roughly back to where we were ahead of the pandemic, meaning that the Chinese economy is probably GDP-wise back at square one, is probably GDP-wise back at square one, but I don't think we've seen actual growth in China since 2021. We've had a nasty recession, not a reported recession, but a nasty recession. Look at the pollution data in 2022 and 2023. The industrial activity was substantially down on the year. It's improved a little bit this year, but we're back to 21 levels. We haven't exceeded them. And, yeah, even with the nasty drawdown that we had due to lockdowns and all that in the US economy and in Europe, we're past the goalpost from 2020 by quite the margin. So China's not growing, but we're growing in the West, at least up until July.
Speaker 1:You know, the thing to me about July is and I put this on a pin post if you look at what happened in July, yen bottomed, value versus growth bottomed, small versus large bottoms, international versus us bottomed. I mean, I don't know if I want to make too much out of it, but it does seem like july did mark a real secular cycle shift, maybe yeah, uh, I think there's a.
Speaker 2:I think that's a decent and feasible thesis. So I've studied cutting cycles and how cross-asset markets typically play out after Bank of Japan pulls the rock from under the stalling and carry trade. We've seen that quite a few times in history. We've seen that quite a few times in history and if we set aside nasty recessions, there's clearly a tendency towards small cap performing better in such an environment. I took notice of a couple of stories related to small caps over the past 48 hours. One is from Bloomberg.
Speaker 2:I don't think we've ever seen such a high number of mentions of the Federal Reserve in earnings calls. So they're all praying and they essentially ask Jay Powell to cut interest rates now, and they essentially ask Jay Powell to cut interest rates now. We've seen very easy financial conditions in the US, but only for Silicon Valley. Right, they've had extreme multiples and they've had plenty of cash, since they're cash-heavy many of them, they've even earned on these high interest rates. But if you look at the average company included in the Russell Index, they've been complaining about interest rates for years now and they are celebrating now.
Speaker 2:It's actually one of my favorite indicators in the US economy, the NFIP survey. So it's a monthly survey conducted among SMEs and for the first time in a long while, they do not report interest rates and financial constraints as their biggest concern as of August. That's a game changer and frankly, I mean, beneath the hood, a sign of optimism in this big and yeah well, in this massive segment of SMEs, and I would be overly surprised if we see outperformance in the Russell in the next six months as a consequence of this.
Speaker 1:Yeah, I always emphasize the point that the Russell can outperform by being down less. Yes, I mean that happened from 2002. I mean the happened from 2002. I mean there also, you could argue, is even at core basis more value than growth, because growth is tech right, which is? This has been kind of another theme of mine, which is for the bulls. I think the only question that matters is can the market broadly rally without tech sector momentum? And the problem is the earnings are just not there outside of tech.
Speaker 2:Yeah, yeah, yeah, momentum, and the problem is the earnings are just not there outside of tech.
Speaker 2:Yeah, yeah, uh, I, I mean, a very simple study on earnings since 2020 reveals that, uh, we've seen earnings in one sector, in one sector only, more or less right, um, it's. It's been an outright bizarre divergence between the max seven and the rest of the pack, but they've had to deal with extremely tight financial conditions and I know Mike Green is a friend of yours as well, michael, and he's been very vocal about a two-tiered financial conditions index and I actually think it makes a lot of sense, because if you look at everything outside of Mac7, they've reported very tight financial conditions, tight credit conditions. They've been scared of laying off people because of the secular tightness in the labor market and the tight labor force and all that. But a few million immigrants later, that's no longer an issue either when you ask them in this monthly survey. So the tide has turned on a lot of these trends. The labor market is not securely tied anymore and there is actually, for once, something to cheer about if you're the owner of an SME.
Speaker 1:So, to a certain extent, let's talk about standard research, because first of all I got to get your web designers' contact info really well laid out on the website. But talk about the kind of research you put out.
Speaker 2:So we are pretty short term. Since we cater to an active investor audience investor audience what we do is that we now cast the probability of rising inflation, rising growth and rising liquidity on a daily basis. So we've used the last couple of years on developing tools to actually predict in real time whether inflation is increasing or decreasing, whether growth is increasing or decreasing and whether liquidity is increasing or decreasing, and I think that is a very agile framework if you're trying to navigate the volatility that we currently see. Over the years I've been in the business of trying to predict, I mean quarters and years ahead. It's tricky. I mean you can look at risk-fremious and probably decide on whether you like the risk-fremious inequities relative to bonds and stuff like that.
Speaker 2:But I prefer something more agile when I take investment decisions and to a certain extent, I think it kind of mirrors what you also do in some of your strategies, michael, where you basically look at risk on, risk off. That's kind of what we're trying to do here, with three main parameters for asset allocation and macro markets, and then we get a daily probability and you can essentially map which assets to invest in during various regimes. So always something to look at on a daily basis on our webpage. Since we're so short term and so agile, I'm trying to turn on the light again here. It's late in their books.
Speaker 1:There you go uh, for those that are watching, I'm a big fan of andreas I mean, I enjoyed our dinner when I actually ate back in the day, uh and I encourage everybody to follow him on x. We'll do one last question here and then we'll wrap up. From tom on YouTube. Question is is the US on a path towards Japanification? Would this mean the US dollar becomes the carry trade instead of the yen? Well, that's a new one. Yeah, let's go with that.
Speaker 2:It will take a few years to get there. But I'm not overly concerned of Japanification in the US yet. But if we're talking about the long-term trajectory, sure, we're all heading towards Japanification. In terms of debt levels, in terms of interest rate payments on the official treasury debt and all that, I think there's pretty clear light in the sand around roughly 120% of debt to GDP. That's one of the few good research pieces I've read on this. I'll post the link to the research paper after this in case you're interested.
Speaker 2:But when you look at it historically it's been at least if you use like 300 years of data it's been a clear line in the sand for many countries when they've crossed 120% debt to GDP. And why that exact number? Well, it kind of brings you to a point where it's very difficult to turn the tide. We're talking about debt levels that encourage further spending. We're talking about debt levels that encourage pressure on the local central bank to try and help with the funding and all of that. So, yes, we're getting there. And interestingly enough I think, at least if you look across the 10 countries only a handful of Northern European countries are currently not on a path to share planification. If you assess that question from a debt-to-GDP ratio perspective.
Speaker 1:On that happy note, I appreciate those that watched this live stream. I always enjoy talking to Andreas and please, folks, do me a favor, check out LeadLag Live on YouTube YouTube, apple and Spotify. I will see you probably in a week and a half, taking some time off. Thank you, andreas, I appreciate you.
Speaker 2:Always a pleasure, michael.
Speaker 1:Cheers everybody, thank you.
