Back After A Six Week Break

SPEAKER_00 0:00

Hello and welcome once again to Equitel Conversations. I'm Gerald Ashley and as ever I'm joined by my good friend and colleague George Cooper. George, welcome.

George 0:12

Hi Gerald. Uh we've had a bit of a gap. It's good to be back.

SPEAKER_00 0:15

Yes, we um we gave ourselves a six-week break. Um we must be politicians somewhere. Well, we can certainly say there's been plenty going on, though it may be that there's a resurgence of some uh sort of market themes that were strong at the beginning of the year, maybe have faded a bit and started to come back. I mean, I've got a big long shopping list of things about the Fed, Kevin Walsh, and then Scott Besson at the Treasury. We can talk about, well, a whole heap of things, one of which should be government spending, I suppose, and which uh just continues to go along at a pace. And uh in the United States, um, US debt is heading towards, um, I find it hard to believe this number, but $40 trillion. But maybe underpinning all of these things, whether it's equities, commodities, the uh the Gulf and all the rest of it, and of course the government spending, is the state of global bond markets.

Bond Markets Near A Breaking Point

SPEAKER_00 1:16

And I think, do you want to give us a sort of quick view on where we are with with the bond markets? And then I think lots of things flow from that.

George 1:25

I I think we are not not so very far from potentially quite a serious crisis in the government bond markets. And I I wouldn't say it's just the government bond markets, because there is there is something else going on with debt capital markets generally, and that is that uh there's so much issuance now, so much borrowing to fund uh the the AI build-out and the data centers in the US, that the the amount of debt coming to the market, both public and private, is so big that it's starting to compete against the treasury market. So I think we're starting to pull the long end higher in yields with the private sector issuance, and then we've got what's going on with the Fed and the Treasury, because both of them are weighing on the lot on the long end in different ways. The Treasury is weighing on the long end just by the the virtue of how much money it's borrowing, and people are worried about inflation as a result in the long in the long run. Um, but the the new dynamic that's really kicked off that I think is is fascinating, or at least it is for uh Fed watchers like myself, is uh Kevin Walsh and what he's done with the change in communication strategy of the FOMC.

Forward Guidance Gets Buried

George 2:41

I I think that's worth talking about.

SPEAKER_00 2:43

Yeah, I mean I think a bit of background here. We've now um seen forward guidance dead and buried. Lots of whining from journalists and commentators. Oh, you know, how do we know what's going on? Well, maybe it is uh not a bad idea to inject a little bit of uncertainty in in the market. I guess the the cost of that is uh greater volatility. But I know you've got a particular angle on Kevin Walsh, who's come under some criticism, or I think you would say perhaps the market's misunderstanding what he's up to, illuminat illuminate us, as we say.

George 3:22

If we just take it sort of at face value what he's done, essentially the Fed, ever since really the days of Greenspan, since Greenspan's time and and beyond, the Fed and all of the other central banks, because they all sort of took their lead from the Fed, they were all operating under what I call uh the Fed talks and the markets listen sort of mode, which was that um the central bankers would give oblique, or sometimes actually quite straightforward, but they would give hints as to where monetary policy was going, sometimes quite directly, and uh the the dot plots are quite a direct version of that, and they would guide where the markets should be pricing rates in the future. Now, the problem with this, which is as Kevin Walsh has identified, and I think he's very correct in this, the problem with this is it undermines the market's signaling to the Fed. It stops the markets from being able to price where the markets think monetary policy should be, because the market is just pricing where it thinks the central banks want monetary policy to be. So you lose this signal, and effectively what you're saying is we're we're gonna sacrifice the wisdom of markets and rely entirely on the wisdom of central bankers, which with the best will in the world, they're not always that wise.

SPEAKER_00 4:46

No, I and I think, as you say, putting the market much more front and center to the process uh changes the dynamic quite a lot, actually, doesn't it?

George 4:58

Yeah, and and you know, the I think the line Walsh used was um you know the the market shouldn't be uh doesn't need to be as obsessed with the referee as it is at the moment. And I think that's that's very true. And of course, other things flow from that that mode of operation. If the markets are very confident of where interest rates would be in the future, then arguably that means that the markets might be complacent and you might get too much borrowing, too much leverage in the system, and you start to destabilize the systems.

SPEAKER_00 5:33

You could say it's in interfering with what would be the natural uh pricing of things.

George 5:38

Yeah. Yeah. So you know Kevin Kevin Walsh has, in my view, correctly identified this problem, and he's basically said, look, we're gonna give you much less guidance, you're gonna have to work out where interest rate policy should be going. And he's

The Maradona Theory Explained

George 5:55

also articulated what what Mervyn King described as the Maradona uh theory of monetary policy.

SPEAKER_00 6:02

Oh, oh, what's that?

George 6:05

So they the Maradona theory of monetary policy, and this is you know a big part of Walsh's argument. Basically, there was a there was a football match. Um, I can't remember which one it was, but uh famous football match that Mervyn King quoted, where Maradona basically just ran down the middle of the pitch with lots of defenders trying to tackle him from left and right. He just ran down the middle, faked a few times which way he was going to dribble the ball, shook off all of these defenders, and then just scored a goal straight in the middle of the next. So the analogy with monetary policy is the central bank is Maradona in this model, it's able to actually keep interest rates much more stable. It doesn't have to move them that much because the markets are the defenders, if you like, they're guessing which way monetary policy is going to go. So they're pushing up the long rates or pushing down long rates, and then they are then doing the work for the Fed. So the Fed itself doesn't have to move interest rates as much. That's um, I think it's a it's a great analogy, uh, I think it's a valid analogy, and uh as I say, I think Walsh is sensible to put it forward. But that say that said, I think he's actually he's playing another angle here, and I think this is what the markets are starting to sense, and that is I don't think he's really making this change of communication out of some sort of desire to improve the academic theoretical framework.

When The Fed Cannot Hike Enough

George 7:37

I think what he's doing is just simply making a virtue out of a necessity. Right. And by that I mean what he's doing is he's recognizing that inflation risks are high, but he can't really uh hike rates as much as is needed. And he can't hike rates as much as needed because uh the fiscal deficit in the US and the existing uh debt level already are just out of control. And all of the borrowing, the new borrowing, has been moved to the front end of the curve. So that debt is being rolled over very quickly.

SPEAKER_00 8:18

If he puts base rates up that feeds straight in, doesn't it? Yeah.

George 8:23

Yeah, within a few months, as those T bills roll off and and are reissued at the higher base rates, the debt service cost for the US Treasury is going to balloon.

SPEAKER_00 8:33

Now, part of the other dynamic of the overall market is that the huge amount of borrowing by the private sector, uh specifically AI. I've got a number here, and it these numbers get thrown around how true this one is. People estimate the AI industry is looking for $750 billion in total. And um I don't have the exact numbers to hand, but there's still a lot of that still to go. And this is a nice old-fashioned phrase of crowding out. So are the tech pros starting to impact this market in a big way?

George 9:11

They are, but j just to come back to the the dynamic on on what I think uh uh Walsh is doing. If he can't hike rates as much as he should, he knows that the long end is going to sell off. It's going to start anticipating higher uh higher inflation in the future. So what I think he's doing is he's just using that narrative in his own favor. So he's saying if the long end sells off, that's the that's the market doing the tightening for me, therefore I don't need to hike rates, and and therefore he he sort of gets away with failing to do his inflation fighting.

A Coordinated Plan To Inflate Debt

George 9:53

If we then play that into the treasury side, which has just come in with Scott Bessant's um uh action in increasing uh long-term treasury purchases, what this new uh lack of forward guidance might be doing is causing the long end of the treasury market to sell off so that those treasury bonds trade at a discount where they were issued. That then, at some point in the future, allows the Fed to more meaningfully increase the purchases of those long bonds, which it buys at a discount, then replacing them with T-bills, allowing the debt level of the US to be reduced, because you're you're you're buying a bond that was issued at par and you maybe buy it back at 70 cents.

SPEAKER_00 10:40

Though, of course, you do increase the the so-called rollover risk because it everything's getting more and more in the short end.

George 10:48

Yeah, there's no there's no free lunch on this. So I mean the the reality is the debt is it is dangerously high, and funding it all with T-bills is uh is risky, especially given that a lot of those T-bills are being held now by hedge funds.

SPEAKER_00 11:03

Who themselves could well be you got a lot of leverage involved. So this this is quite a dangerous cocktail, then isn't it?

George 11:11

It is, but I think what um between them, what uh Kevin Walsh and Scott Bessant are doing here is I think they're they're effectively working together uh in a coordinated way, and they are attempting to create a situation that brings the debt down in real terms in them in the most orderly manner possible, which is basically inflated away. And I and I think that's what uh that's what the markets have sensed. Um Kevin Walsh gave his his second press conference the 29th of July, uh where he really reinforced these messages about not giving forward guidance and the market doing the work for him. And basically, since that speech, gold has started its rally again, the the dollar has started falling, broad-based commodities, you know, basically all of the commodities are now starting to increase. So I I think the market is sensing what he's doing, and it's the it's the debasement trade is back.

SPEAKER_00 12:15

Uh, which is I I guess I hinted at at the intro that we've been through quite a uh a lot of activity over the last three or four months, but in a way, um, the world is maybe starting, or markets are starting to settle around the first two or three months of the year, just as Donald Trump unleashed the attack and war or whatever one wants to call it against Iran.

Gold Commodities And The Halo Trade

SPEAKER_00 12:39

Um, to widen this out from the bond markets, you've already touched on the fact that base metals and apparently also soft commodities are starting to tick up. When I know that a lot of people watch it's a copper price, and that's certainly moving. Difficult, if not impossible, to um make any sensible predictions about oil because it's such a political market at the moment. Um, it seems to go up and down ten dollars on a on a sort of turn of a six months. But um, you touched upon gold, and that does seem to be starting to uh uh attract interest again. And as per the title of this uh little podcast, the halo trade seems to be back, which is obviously commodities, hard assets. And um what about the low side, which I I think of as the um low, I'm gonna get this wrong now.

George 13:36

Is it some low obsolescence?

SPEAKER_00 13:39

Obsolescence. That that was the word I was.

George 13:43

Low obsolescence. Um to put it put it another way, hard assets thing things that are essential and can't be printed and don't go out, right? Don't go out of out out of use, which is really, you know, it's commodities, it's mining companies, it's the uh the old-fashioned dull stuff that uh that we need. Um and sometimes we forget that we need them. So yeah, I I think we're back in that. You know, call it the halo trade. I I prefer probably the debasement trade or the monetization trade, um, because that's that's really what's going on.

Value Stocks Versus Long Duration Tech

SPEAKER_00 14:20

Now that's causing us that's causing maybe a split for want of a better phrase in the way we look at equity markets. I mean, again, at a at a very sort of general level, people say, oh, equities are very overvalued, you know, the US market is off the gauges. But the the true story is somewhat more subtle than that, isn't it?

George 14:42

Yeah, so it it is, and and I think we can, you know, if I put my old uh bond hat on and use that to look at at the equity markets, essentially what we've just described with with what Bessant and Walsh are up to, that's going to give us a steeper yield curve. Now, if you've got very long-duration assets, which are tech companies that are uh you know not earning money now, and theoretically they hope they'll be earning money in the future, yeah, and they're being funded with long maturity debt, then this is a problem because you've got high valuations and they're they're now being hit by a higher discount rate. So I think this is a big challenge for the the the debt, the um the longer duration tech stocks. But on the other hand, you've got another part of the equity market, which is highly cash generative, very sh effectively quite short duration assets, and they're going to get lower interest rates because they're not the Fed isn't going to push up rates as much as it should do. I'm not saying they're not going to put push up rates at all, but not as much as they should do. So I think you've got a situation where, to put it crudely, value stocks trading on low PEs are going to get a boost, whereas growth stocks trading on high PEs maybe are going to get uh get a headwind. You know, that might be too simplistic a way to look at it.

SPEAKER_00 16:11

The um the discount factor, of course, what it does is it pushes down um the likelihood of all these golden profits being quite so golden. You know, the assumptions have to be marked down, and presumably that will get reflected in the price at some stage.

George 16:27

Yeah, well, you know, if if you're a data center now, you you've a data center business, you've got a uh a prospective amount of revenue. Well, much more of that revenue has to go to fund the debt costs. Yeah. So the economics of the business deteriorate.

SPEAKER_00 16:43

Right. A phrase you've used in the past, and maybe we should make more of an effort to popularize it, is um your uh your contention that really it the market balances between the sort of bubble end of things and what you've coined the anti-bubble. And that's essentially what you're saying at the moment, then, is that the anti-bubble is a sort of steady-eddy sort of stuff that might actually do quite well.

George 17:10

Uh, you know, a lot of people are saying uh the the stock market is horribly overvalued. I think if you look if you look just at the index level, yes it is, but that's because the stock market now is very dominated by these mega cap companies trading on very high multiples. But there's a whole host of uh other companies which are much smaller just because their valuation is much lower, then they're much smaller trading on lower multiples. Um, and they to me look like an anti-bubble in the sense that they look abnormally cheap in the context of what's going on in the world, and should be, I think, beneficiaries of the debasement trade in the long run. Because what what we've got to remember is the the purpose of debasing your currency is basically to push up real asset prices and push down relatively the real value of debt.

SPEAKER_00 18:11

Yes. It it it's the get out of jail card, isn't it, really, for governments.

George 18:15

Yeah. And yeah, you know, I I say I say I think uh Mr. Besson and Mr. Walsh are are working together as a sort of tag team in this, and that's not a criticism. I I'm actually very impressed with with the strategy that that particularly Kevin Walsh is is taking. They they've both inherited a situation that's unsustainable, and they've got to make the best of it.

SPEAKER_00 18:39

Yeah.

George 18:39

The the criticism for all of this, if if it should go anywhere, is really at the at the political level, uh, that you know nobody, and this is not not a US comment, this is a a global comment, politicians generally are just not willing to grasp the nettle of excess spending.

SPEAKER_00 18:58

I mean it it is quite astonishing that we have a new administration in the UK. I don't think in the sort of myriad of what are generally quite trivial announcements, or small in terms of budget effects overall, but not one of them has talked about cutting spending. It's all been about additional spending. And I think this is a a topic we discussed almost a year ago um with the political commentator Helen Thomas, um, when we said, well, at some point there has to be some sort of crisis to stop this. But um maybe we uh could keep going on. I mean we had that conversation a year ago and and nothing has changed.

George 19:43

Arguably the the the bond market selling off is a stepping a step in the direction of of the crisis. Eventually the bonds um the bond markets are going to say no more borrowing. But of course, if if all the central banks do what the the US has done and roll all the funding to the front end, this game can carry on for quite a long time. So I I don't I don't see it stopping uh in a crisis at the moment. I think it it's it is going to carry on uh going. And you know, just from a pragmatic point of view, if that's the way it is, you you've got to you know think about how to how to make the best of it and and how to avoid the worst of it.

SPEAKER_00 20:27

Yeah, essentially you're trying to deflate uh things in a gentle and controlled manner and without things blowing up, I suppose.

George 20:36

I mean, if if I were if I were in either of um uh uh Bess and O'Walsh's seats, I would I would pretty much be doing what they're doing.

SPEAKER_00 20:46

Well, let's hope that's right then. We shall see. Um

Passive Investing Makes Bubbles Bigger

SPEAKER_00 20:52

another sort of bit of um destabilization, which again we often bang on about, but it it just continues, is the rampant, I would say, indexation of equity markets now. This large uh this so-called passive investment, or I don't know, I sometimes think ignorant investment. You know, I have to buy it because it's been bought. Oh, it's being bought even more, I'll have to buy some more. Um, and that has now got to quite a uh a large part of the overall market, isn't it?

George 21:27

Oh it it's completely dominant. And you know, this this is I think it's allowing these bubbles to get bigger, the the investment bubbles to get much bigger than they uh would have done in the past. Um you know, in in the past, when you had quite a lot of what what was called actively managed money, you would get people like famously Tony Dye, if anybody remembers that name. You would you would get people who are managing large pools of money who would pull money away from the bubble. And effectively act as a policeman. Now, famously he uh he basically got pushed out of his job uh just as the markets were rolling over and he was about to be uh vindicated. Um so you know even he uh wasn't a powerful enough force in his day. But right now the the corrective mechanism through active management, I think is more or less uh well, it's it's a sleep, put it that way.

SPEAKER_00 22:30

The theme here seems to be that the stabilizers are off everywhere, they're off in equity markets. Um, I think this move to the short end of funding in the bond market, and again, a lot of it is with hedge funds who are geared, um, is hardly a stabilizing effect. And then um, I know we just touched on it a few minutes ago, but um uh government spending just rolls on and on. Um, but I'm getting your your view here, George, that maybe we could have this conversation in a year's time, that there isn't we're not gonna wake up to some humongous explosion or what have we talked about today that's changed.

George 23:10

We've talked about you know Kevin Walsh changing the um the guidance framework of the Fed, but in in reality that's that's an interesting detail, and I think it's an important detail, but it is a detail in the in the broader picture. These processes have been in place for years, and I think and I think probably carry on, you know. So we we have to we have to deal with that reality. I was

The US Debt Clock Reality Check

George 23:34

uh just before we we came on, I was just looking at um a website quite that I I haven't looked at for years, which is the um the US debt clock website, uh, which is always good entertainment because it it's it's presented in quite dramatic fashion. You see the amount of US debt ticking away.

SPEAKER_00 23:55

We'll put we'll put a link into the uh show notes so people can have uh equal enjoyment of it.

George 24:01

Yeah, but there's just a few stats that that I think are noteworthy on on that. So US national debt has ticked over 40 trillion, I think that happened last week, which works out debt per citizen at about $116,000 per person.

SPEAKER_00 24:21

Wow.

George 24:21

But debt per taxpayer, this one really uh debt per taxpayer, $361,000. Now, if you think if you think about the average taxpayer, how much tax is the average taxpayer going to pay in their working life? My my guess is then they're probably gonna struggle to pay back that uh debt per taxpayer. But the the other one I just worked it out. Uh so the according to the debt clock, the US is spending about $7.3 trillion of the federal spending, $7.3 trillion a year, of which about $1.7 trillion is deficit spending. In other words, it's it's unfunded. And that means that basically about 23% of all spending is borrowed money.

SPEAKER_00 25:13

Good crazy, which is uh quite extraordinary. It it it it that is extraordinary.

El Nino Fertiliser And Food Inflation

SPEAKER_00 25:18

I'm I'm gonna throw one quick brick in the pond at the end, another inflationary brick. Um, and some people get very excited about this, others yawn. But um, we have our favorite weather system, El Nino is back. I'm gonna get the cycle wrong. I think it's about every seven or eight years. And the um without going into the depths of uh uh how the weather systems work, the general view is that it it affects crops quite badly, and this may be a push on on soft commodities. Now you may dismiss that and say, well, it'll all be absorbed into normal market mechanisms, but it's yet another little factor that is inflationary.

George 26:02

Um yeah, we we've actually been watching the soft commodities quite closely. I think the you know whether El Nino is part of it or not, I don't know. But what we do know, pretty certain of, is that because of the the US-Iran war, the uh the supply of fertilizers coming out of the Gulf has been curtailed dramatically. Yeah. Fertilizer prices have gone up. So there's there's a suspicion that farmers have probably changed their planting uh plans as a result of that. You know, we if we put that with some extreme weather, El Nino, higher fertilizer costs, and that I think there's a there's a good reason to see at least an an upside risk of of inflationary uh food inflation basically next year. Um so yeah, that that's definitely one that we've got on our uh on our radar screen to watch.

SPEAKER_00 27:00

It kind of feeds into the uh overall story, I suppose.

Book Recommendations For Market Nerds

SPEAKER_00 27:04

Um well we've we've we've done our sort of 30-35 minutes that we normally do before people have heard enough of uh our various views on markets, but uh before we go, we'll do uh our usual trick of book recommendations. Um I've gone for a book that's been recently published uh called 1873, um by uh an ex-markets guy who turned into a writer called, I'm gonna get his name wrong here, I suspect, but Leakwat Achemed. Um the the cheerful uh strap line is the first Great Depression and the making of the modern world. Um 1873 is one of those dates that is now so far away it's sort of faded, really, but it was a classic um bust after the boom of the US uh American Civil War. And uh, of course, this is before the days of central banks. And one of the uh interesting aspects was as uh when credit markets failed and banks started failing, there was a there was a huge move towards gold. And um not only towards gold, but to degrading the idea that silver uh was also uh a useful long-term asset. The net effect of that was quite significant deflation, hence a depression. So there are not many people on the planet around now that remember 1929, but as sure as hell nobody remembers 1873. But it's the same old story of speculative uh credit, booms in go-go industries, uh overvalued, and almost event uh, you know, at some point the music stops. Now, as we all know, all crashes are slightly different, but um they always reveal, you know, that there's uh dodgy dealing, false accounting, all the rest of it. So this is all in this book, so it's it's kind of a nice knockabout sort of review, really.

George 29:12

Yeah, for for those of you listening who uh who don't recognize the name, so Lierkut Ahmed uh is the gentleman that also wrote Lords of Finance. Ah, yes. Which was uh about um the the central bankers that I think the subtitle was the central bankers that broke the world or something like that. I was lucky enough to meet Liercut uh a few years ago when after he wrote uh his first book. Um, and I don't think everybody knows this, but he was actually a bond fund manager, so he he's quite steeped in the in the capital markets as well.

SPEAKER_00 29:48

It's a it's a worthwhile book. I think it's definitely worth reading.

George 29:52

It is, it's a very good book. So I'm going to I'm gonna go with another finance-related book. I'm gonna go with The Fund by Rob Copeland. Um, it's the story of Bridgewater and Ray Dalio. It's just a a rollicking good read of sort of insider gossip. It's I think it's probably a little bit harsh on on Bridgewater and Ray Dalio, but nonetheless, it's a it's a fascinating read. And I thought with um with all the focus on situational awareness, uh what's been happening with that fund recently, I think people might enjoy the uh uh the the fund book as well.

Wrap Up And Next Month

SPEAKER_00 30:31

Well, it sounds like we've stuck to our usual mantra. I've got a book about depression, and you've got one which I suppose has got a sort of um whether it's a positive angle or at least an entertainment angle to it. I think that's gonna do us for this uh episode. So, George, thanks very much.

George 30:48

Thank you, and we'll be back in about a month.