0:03

the macro macro trading With me, with

0:06

me, Alfonso of the founder of the

0:08

former head of former head of a large

0:10

European European I am Brent Donnelly, I am

0:12

Brent spectrum president of been portfolio I've

0:14

been a portfolio manager, day

0:16

trader at market maker at the

0:18

biggest commercial and investment banks in

0:20

the United States. States. I'm also

0:22

the author of Alpha Trader and the

0:24

of currency trading. If you want

0:26

to know what's going on

0:28

in markets and where they're going,

0:30

you found the right podcast. the

0:32

right podcast. Wune-Jorno everyone, Welcome back to the

0:34

macro trading floor, off-speaking, good good friend me, with me.

0:36

How's life? Hey Alfonso, it's beginning to look

0:38

a lot like Christmas around here,

0:40

so here, so are pretty good. good. Well, for

0:42

people who people who me, watch me,

0:44

I'm wearing a T -shirt that says

0:46

no problem, if you are on If you are

0:49

on instead, you might have a out

0:51

of it. it. I I was reflecting

0:53

with with Brent before clicking record people in

0:55

this industry. They take themselves

0:57

very seriously, I would say,

0:59

and I hope Brent and I

1:01

do actually the opposite. Actually,

1:03

know, speaking of of comedy in financial markets, there's

1:06

an amazing article in FT. I'll I'll

1:08

put it in the show notes. One

1:10

of of the funniest articles I've

1:12

read in finance in a long

1:14

time, time about the year outlooks and how

1:16

there's just like literally hundreds of

1:18

these year -end outlooks and the

1:20

lack of information content, it's a

1:22

great article anyways, I'll put it

1:25

in. Anyways, I'll was in. So there investor that

1:27

asked me, about my investment outlook

1:29

for 2025? 2025? So So he allocates

1:31

into the hedge fund. And I said,

1:33

well, I you mean what do you of outlook of

1:35

mean, mean, we have with a He can change

1:37

anything next week. So I'm not going

1:39

to give you any outlook to give you any

1:42

outlook said, 2025. there was a trick question.

1:44

was a trick question. Excellent. So gives you an outlook

1:46

of you an outlook probably you can ignore,

1:48

I would say. ignore, I would say. Yeah, it's more

1:50

marketing, I guess, I guess, than functional. And that's a

1:52

that's a good segue, actually, into what

1:54

we're probably going to talk about today,

1:57

because. about today, because it's getting very interesting

1:59

as we get get January 20th and

2:01

we still don't really know what the

2:03

policies are going to look like. We

2:05

know like the outlines of a plan

2:08

or whatever but what are you thinking

2:10

now for let's say the outlook for

2:12

the first two months of the year

2:15

let's be more realistic. You're trying to

2:17

pin me down now. So I would

2:19

say that when it comes to the

2:22

US, I had a fun conversation with

2:24

two clients this week and they both

2:26

came with two different angles. Both of

2:29

them completely valid narratives. So I'm going

2:31

to put them through for a second

2:33

and then I'll tell you what I

2:36

think could use to hear your thoughts

2:38

as well. So the first was, nobody

2:40

remembers the first six months of the

2:43

presidency. and therefore Trump will sacrifice growth

2:45

and it will come in hard and

2:47

it will pressure Europe and Canada and

2:50

China and everyone and because his ultimate

2:52

game is to also pressure power to

2:54

lower rates so by weakening the economy

2:57

then power will have to say oh

2:59

crap I need to cut rates and

3:01

then Besson comes in and refines is

3:04

that a cheaper rates I mean all

3:06

seems to kind of make sense. And

3:08

then at some point, Trump can claim

3:11

a win, and then he can basically

3:13

soften the stance and the economy will

3:15

recover because of lower rates. And so

3:18

this was case A. And in option

3:20

A, then the trades there would be

3:22

that you have to sell the dollar,

3:25

sorry, you have to buy the dollar

3:27

because Trump comes in very aggressive on

3:29

tariffs. and that the Fed's going to

3:32

cut rates and maybe you have to

3:34

sell some stocks as well because this

3:36

combination isn't great really tariffs low growth

3:39

and you know this was the the

3:41

first and then another client said no

3:43

no no what are you talking about

3:46

I mean Trump is pro growth he's

3:48

never going to sacrifice growth he wants

3:50

stalks to the moon and so it's

3:53

going to be all deregulation and so

3:55

it's going to be all deregulation about

3:57

capping oil prices and you know not

3:59

be very harsh on tariffs and first

4:02

get power to cut rates gently stalks

4:04

to the moon refinancing done of the

4:06

of the treasury trillion maturities and after

4:09

that he will kick in with tariffs

4:11

and all the trade is just the

4:13

opposite. Buy equities, sell the dollar. So

4:16

okay that's case A case B both

4:18

completely valid question to you now what

4:20

do you prefer? So I guess that

4:23

kind of does reveal the binary nature

4:25

of this whole thing but I think

4:27

those two views both overestimate the power

4:30

of the president of the US to

4:32

to control all the markets it sounds

4:34

a little bit more like she than

4:37

than the United States to me but

4:39

the thing that I so I'm much

4:41

more with number one I think that

4:44

Trump's regret on doing Obamacare and other

4:46

kind of useless things that didn't really

4:48

work out in 2017 is reflected in

4:51

his picks, right? I mean, he's picked

4:53

the most hawkish aggressive people. And so

4:55

to me, I like scenario one a

4:58

lot better, which is come in and

5:00

I think Just slapping on the 60%

5:02

tariff on China or 25 on Canada

5:05

and Mexico on day one seems very

5:07

unrealistic. Like I think there's enough voice

5:09

of reason, say, from Bessen and from

5:12

Musk, saying you can't just do that

5:14

and expect the economy to function. So

5:16

I think more realistic would be some

5:19

kind of smaller tariff on day one,

5:21

say 10% across the board, and with

5:23

the threat to increase them, and then,

5:26

you know, three months later or six

5:28

months later when it's set to go

5:30

to cataclysmic levels, magically some kind of,

5:33

you know, agreement will be made and

5:35

Trudeau will say, okay, we're. We're adding

5:37

10,000 border guards and we're going to

5:40

look at the flights that are bringing

5:42

terrorists across the border or all that

5:44

kind of whatever they end up deciding.

5:47

And then Trump can slowly pull back

5:49

and things kind of stabilize. So to

5:51

me, I think there's going to be

5:54

a lot of angst in Q1, dollar

5:56

much higher, and probably stocks lower, honestly.

5:58

like a stupid thing to say when

6:01

stocks go up every single day but

6:03

the reality is they don't obviously right

6:05

I mean it's maybe 60 or 70%

6:08

of quarters stocks go up they don't

6:10

go up every single quarter so I

6:12

would be betting on and I'm betting

6:15

on on a stronger dollar and the

6:17

really interesting thing about it is that

6:19

I feel like it's one or the

6:22

other, like wherever euro dollar or dollar

6:24

Canada is now, it's just not going

6:26

to be here in February or March.

6:29

It's either going to be, you know,

6:31

dollar cad's going to be 300 points

6:33

lower or 500 points higher, or it's

6:36

going to go up and then they

6:38

cancel the tariff since it goes down.

6:40

But either way, the way that volatility

6:43

and spot are priced right now, I

6:45

feel like we're in this sort of,

6:47

uh, It's a disequilibrium essentially. Like it's

6:50

a binary disequilibrium where either the tariffs

6:52

happen or they don't, but because they're

6:54

kind of partially priced in, you're going

6:57

to see a big reaction from markets

6:59

either way. For me,

7:01

the most interesting part of

7:03

your comment was that you

7:05

put Musk and Voice of

7:07

Reason into the same sentence.

7:09

And I know it's very

7:11

early over there in the

7:13

US, but that was interesting.

7:15

This is not a political

7:17

podcast. Just kidding. So, okay,

7:19

let's try to analyze a

7:22

bit your perspective here. I

7:25

mean, one thing I have to agree

7:27

on is that if you look at

7:30

the volatility that has been priced in

7:32

certain effects markets, it's really, really low

7:34

on Canada. We talked already a while

7:37

ago and regardless of these threats coming

7:39

closer, potential threats coming closer, it doesn't

7:41

seem like effects trees are very scared

7:44

of potential jumps in there. That's something

7:46

that like if you work for a

7:48

hedge fund or you have a mandate

7:51

in options, I think in effects there

7:53

is quite a lot of interesting things

7:55

to do. For example, the ball is

7:57

much more priced and appreciated in bond

8:00

markets, for instance, than it is in

8:02

effects. And when it comes to the

8:04

equity market, the case, so if you

8:07

go around and you say you want

8:09

to buy some puts or be a

8:11

bit more bearish, people are going to

8:14

laugh you out of the room, which

8:16

is a good setup. I like when

8:18

people want to laugh people out of

8:21

the room because it means the consensus

8:23

is very strong. I think there are

8:25

a couple of charts going around on

8:27

stocks that show that the investors have

8:30

that stocks are going to go up

8:32

next year. Now, you said something right,

8:34

stocks do go up. or in statistical

8:37

terms if you want to sound fancy

8:39

you can say the distribution of return

8:41

as a positive drift you can save

8:44

this for your manager you know go

8:46

there next week it's going to work

8:48

but the the interesting thing is if

8:51

you look at downside protection in equity

8:53

markets and you try to compare put

8:55

prices and to do that you have

8:58

to find environments where the volatility was

9:00

more or less the same in terms

9:02

of realize you have to find out

9:04

those where interest rates were the same.

9:07

So all the components that go into

9:09

option pricing were more or less the

9:11

same as today because that's the only

9:14

way to standardize really the cost of

9:16

options over time. If you do that

9:18

you will see there are a couple

9:21

of episodes when this was the case

9:23

for example 2006 and 2007. Realized Vol

9:25

was very low interest rates were roughly

9:28

where they are today so you can

9:30

compare and you will see that the

9:32

cost of downside protection is pretty much

9:34

as low as it was in early

9:37

2007. Now, in caveat, last caveat, low

9:39

cost of protection doesn't mean you will

9:41

make money by buying ports, it just

9:44

means that from an expected value perspective,

9:46

you could think about buying some protection.

9:48

Yeah, you know what's interesting is today's

9:51

Friday the 13th. So I was obsessing

9:53

over the number 13 for some reason

9:55

and I was looking at so a

9:58

lot of times when people look at

10:00

the VIX they'll see it at 12

10:02

or 13 and be like this is

10:05

unsustainable Minsky moment instability breeds stability and

10:07

all that and actually VIX, the most

10:09

common handle for the VIX to close

10:11

on is 13. So like 9% of

10:14

all days since 1990, the VIX is

10:16

closed on a 13 handle. And, you

10:18

know, 82% of all days, the VIX

10:21

has been below 25. So normally, like

10:23

low kind of stable ball is the

10:25

standard and then, you know, everything else

10:28

is an aberration. But to your point,

10:30

just something that popped into my head

10:32

about drift. I think that's the central

10:35

reason why commodities are just always a

10:37

way more difficult trade than stocks, because

10:39

innovation and technology are bullish for stocks

10:41

and bearish for commodities. The extraction of

10:44

commodities becomes more and more efficient, you

10:46

know, with shale, for example, being an

10:48

important technology. And so there's a negative

10:51

drift to me in commodities, which is

10:53

why Malthus and all those people that

10:55

bet on higher commodities, you know, in

10:58

the long run, have always been wrong.

11:00

So I just, I think that's an

11:02

interesting aspect of the commodities thing because

11:05

people always look at like stocks versus

11:07

commodities and go like, wow, this thing,

11:09

this thing's been going down for a

11:12

zillion years. Well, the reason it's going

11:14

down is because stocks have positive drift

11:16

and commodities have negative drift. Yeah, and

11:18

let's specify why. I mean, it's not

11:21

like an axiom, it's like an undeniable

11:23

truth, but there are reasons why that

11:25

is the case. I mean, stocks are

11:28

a positive drift because, believe it or

11:30

not, stocks go up over the long

11:32

run reflecting earnings growth. So, wow, companies

11:35

make money and therefore stocks go up.

11:37

And I know that in a certain

11:39

year, 90% of the ball of or

11:42

the upside performance of stock markets can

11:44

be valuation or buybacks or whatever the

11:46

long run. stocks have a positive drift

11:48

because they have earnings growth behind them

11:51

right and for commodities you can say

11:53

the opposite brand because basically we produce

11:55

new commodities basically every year so every

11:58

year we increase the supply of these

12:00

commodities they don't have cash flows behind

12:02

them they are commodities right and so

12:05

actually they tend to have a negative

12:07

drift So the interesting thing is that

12:09

when you look at the expected value

12:12

of a trade, the mean or the

12:14

drift of the distribution is not the

12:16

only thing that matters. You have to

12:19

look at the entire distribution. So commodities

12:21

tend to have a... positive right tail.

12:23

So in terms of inflation, they tend

12:25

to perform really well, for example, right?

12:28

Great portfolio diversification properties as well. Stocks

12:30

have the exact same problem. They have

12:32

a deep negative tail from time to

12:35

time. You'll go down 30, 40, and

12:37

50%. So that's the nature of... That's

12:39

super interesting. So you're actually being compensated

12:42

in commodities because you have positive convexity

12:44

on supply shocks, I guess. An inflation.

12:46

So when you look at like portfolio

12:49

allocation, right, you will have some... Why

12:51

stocks at the cornerstone of portfolio locations

12:53

is because they have positive drift, right?

12:55

And so people like to have certain

12:58

expectations of positive returns over time. Problem

13:00

is that you also buy negative tails

13:02

for stocks, right? I mean, if you

13:05

were in the 60s or in the

13:07

40s, you went down like 40% 50%

13:09

on stocks, right? And so you don't

13:12

want that. You want diversification. And commodities

13:14

will give you negative drift, but they

13:16

will give you that inflation hedge in

13:19

they act as a portfolio diversify. There

13:21

is no right or wrong when you

13:23

look at assets, there is just expected

13:26

value in that specific moment. Like when

13:28

you buy commodities, you need to expect

13:30

that there is going to be an

13:32

inflation surprise and pretty any time soon

13:35

or otherwise you're bound to lose money.

13:37

That's the nature of it. With stocks,

13:39

it's the opposite brand. You can go

13:42

years with not much happening and stocks

13:44

love not much happening. That's perfect because

13:46

macro is, you know, not volatile and

13:49

you keep making money. They're just two

13:51

different assets. Right. And I guess good

13:53

commodities traders identify supply shocks or things

13:56

like in uranium, for example, you know,

13:58

that trade worked well because there wasn't

14:00

enough supply. So maybe that's going to

14:02

happen in other commodities. But anyways, that

14:05

was a whole non sequitur. That was

14:07

interesting. We weren't even planning on talking

14:09

about that. But one thing going back

14:12

to the complacency on the dollar is

14:14

there should be, in my opinion, premium

14:16

on options that trade after inauguration because

14:19

the tweets obviously are moving markets to

14:21

some extent but they're still kind of

14:23

like subject to any change you know

14:26

that they're not policy they're just tweets

14:28

and sure they may be bargaining chips

14:30

and they give you some insight into

14:33

what the policy will be but ultimately

14:35

January 20th is when you know there's

14:37

there's a binary kind of switch from

14:39

like bullshit to actual policy being executed

14:42

and some of the policies can be

14:44

executed on day one for example tariffs

14:46

so there should be a premium on

14:49

options that expire after January 20th in

14:51

FX and there really barely isn't like

14:53

if you look at one month which

14:56

expires before in three months there's barely

14:58

even a spread compared to what's normal.

15:00

So I just I bring that up

15:03

not to tell people to sell one

15:05

month and buy three months, but just

15:07

to indicate that there's there's really not

15:09

very much priced in for some kind

15:12

of chaotic moment in January or February

15:14

of 2025. And I mean, honestly, I

15:16

think there should be a lot priced

15:19

in because either the dollar's gonna rip

15:21

or it's gonna sell off like crazy

15:23

like in 2017 the dollar had rallied

15:26

similar to now and then Trump didn't

15:28

do anything in 2017 so the dollar

15:30

created because expectations weren't met so either

15:33

you know the the expectations are gonna

15:35

be met or they're not and either

15:37

way there's gonna be a big move.

15:40

Yeah so in general optionality is not

15:42

something you pay a lot for and

15:44

as a. an old sage once said

15:46

it's better to buy an umbrella when

15:49

the sun is shining not when it's

15:51

raining that will be a bit too

15:53

late. Talking about optionality and interesting things

15:56

going on we have our friend from

15:58

Switzerland and Europe that seem to be

16:00

going back to their old days and

16:03

Switzerland specifically because they're slashing rates so

16:05

fast that zero lower bound it's never

16:07

been a lower bound for Switzerland but

16:10

that zero interest rate environment is very

16:12

close to happening Europe also, they're planning

16:14

to slash rates by another 100 basis

16:16

points over the next four meetings, that's

16:19

going to bring interest rates below 2%.

16:21

It's not zero, but it's going fast

16:23

back to what used to be a

16:26

low-rate environment in the European continent. So

16:28

any comments, Brand, we can just go

16:30

back and try to, once I was

16:33

asked to measure how many 50 euro

16:35

bills could be stored in a vault.

16:37

Well I remember that yeah yeah when

16:40

rates were negative people are like well

16:42

I'll just put a billion dollars in

16:44

a in hire a bunch of security

16:47

guards and the security guards will cost

16:49

less than the interest that I'm receiving

16:51

by whatever anyways negative rates are insane

16:53

but yeah it's really interesting with Switzerland

16:56

because They're starting to fall back into

16:58

that thing that Japan was in for

17:00

a long time where you have very

17:03

low inflation or deflation, you have very

17:05

low rates and you have a strong

17:07

currency and no credible defense or no

17:10

credible weapons really to break that cycle.

17:12

That's the problem that Switzerland has. It's

17:14

just mind-blowing that the carry on on

17:17

Swiss right now like if you if

17:19

you buy dollar Swiss and it goes

17:21

down 300 points over one year you

17:24

actually break even because of the carry

17:26

like it's and dollar Swiss doesn't move

17:28

that much so the carry is amazing

17:30

but the problem is there's just that

17:33

sucking sound of like the SMB has

17:35

no credibility right they they intervened in

17:37

EuroSwist starting from 1.4. And we're at

17:40

0.93 now. And so in the end,

17:42

like for the end, what broke it

17:44

was Abenomics, and that was a completely

17:47

different set of policies. So the Swiss

17:49

thing is super interesting. I think there's

17:51

a lot of interesting trades to do

17:54

on the carry side, but I'm not

17:56

like all that excited about being short

17:58

Swiss simply because of the carry, because

18:00

a lot of times it's been. mean,

18:03

Swiss has been a trap for what,

18:05

since I remember 2009 was when they

18:07

were intervening, you know, so whatever that

18:10

is, 15 years they've been intervening and

18:12

it's been going up. So you need

18:14

something to break that. I'm not sure

18:17

what it is. Go ahead. Some war

18:19

stories on Switzerland, so I have a

18:21

friend who lives in Poland. And Poland,

18:24

whether you know it or not, they

18:26

looked at this Switzerland thing and they

18:28

said, what? They have rates at zero?

18:31

Rates at negative? Now we're going to

18:33

do something cool. Polish banks are going

18:35

to offer to Polish citizens mortgages in

18:37

Swiss franc. Okay

18:40

now try to figure this out okay

18:42

so you're in Poland the country which

18:44

is growing really fast like seven eight

18:46

percent nominal growth you are used to

18:49

have nominal rates at like five six

18:51

percent in Poland okay all of a

18:53

sudden somebody comes and says hey buddy

18:55

do you want to buy a house

18:57

in Warsaw and I'm going to give

19:00

you a mortgage in Swiss franc at

19:02

like one and a half percent you're

19:04

like sure mine and so what happened

19:06

is that there were quite some mortgages

19:08

issued in Swiss franc and a few

19:11

years later The Swiss franc had rallied

19:13

aggressively against the Polish lottery despite the

19:15

carry, despite the interest rate differential brand.

19:17

It's basically like you said, right? I

19:19

mean, these guys keep having a strengthening

19:21

currency, the Swiss francs, and they can't

19:24

stop it. There is no way that

19:26

they can't stop it. It's just like

19:28

a sucking sound. So what happened is

19:30

that all these households figured out that

19:32

the mortgages they had at 2% actually

19:35

were not that good after accounting for

19:37

the fact that the Swiss franc was

19:39

appreciated like 10% a year versus the

19:41

Polish slotty and it actually caused quite

19:43

an imbalance in the economy and you

19:46

know central banks and policymakers had to

19:48

intervene. So there is quite something that

19:50

you know betting against Switzerland and only

19:52

looking at Kerry is is quite difficult.

19:54

They accumulated one trillion dollar of reserves

19:56

over time. I mean, they just keep

19:59

buying all they can, euro assets, dollar

20:01

assets, they own NASDAQ, they buy everything

20:03

they can and they sell us with

20:05

Ford, of course, they still come weak

20:07

in the currency. Yeah, and those structural

20:10

short positions are interesting. Like for a

20:12

long time, emerging markets were always short

20:14

dollars. I mean, they still are obviously,

20:16

but there were, there used to be

20:18

times when E.M. was so short dollars

20:21

that if some kind of shit hit

20:23

the fan, the dollar just absolutely exploded

20:25

against every currency because they were all

20:27

structurally short via debt. And those things

20:29

can be monstrous. And then the interesting

20:31

thing too is so like you're a

20:34

ECB terminal I think is like what

20:36

terminal pricing or implied pricing is 1.7

20:38

or something like that I think. And

20:40

you look at that or even RBA

20:42

is starting to get sound a little

20:45

bit more dubish. And then you look

20:47

at that in contrast to what's going

20:49

on with the Fed. And. I think

20:51

a few times we've been here where

20:53

like Fed pricing's kind of slowed down

20:56

and I think it was April or

20:58

May of 2024 I think there were

21:00

people were talking about maybe Fed might

21:02

hike and stuff and those trades have

21:04

always been a fade but I'm starting

21:06

to wonder now with inflation so sticky

21:09

on on a lot of measures like

21:11

on-core especially all the core measures and

21:13

wages and everything are still around three

21:15

four percent. Whether we might get, and

21:17

I know this is a scenario you've

21:20

talked about for ages, a repeat of

21:22

1995 where you got three cuts in

21:24

95 and then on hold for all

21:26

of 96, I think it should be

21:28

on the bingo card that Fed does

21:31

nothing in 2025, but do you think

21:33

that's possible or do you think there's

21:35

still definitely going to be cuts? So

21:37

as I try to mumble something that

21:39

makes sense, I'm going to try as

21:41

well to open my... probability priser thing

21:44

because... Oh yeah, I wanted to know

21:46

what the probability of that is actually.

21:48

The CME Fedwatch thing does like a

21:50

rough calculation with that. I don't even

21:52

know what they're using for that. me

21:55

fire it up. So, okay, let's see,

21:57

what do you want to know? That

21:59

the Fed is going to be on

22:01

hold in 2025. So I want to

22:03

bet Fed on hold, what's my payout,

22:06

I guess would be my question. Okay,

22:08

let me come back to you. So

22:10

this podcast is getting very dynamic. Very

22:12

dynamic. Hope that I don't blow up

22:14

the computer by doing that. So, okay,

22:16

there you go. So Federal Reserve on

22:19

hold, it means that they cut in

22:21

December though, right? So they have to

22:23

go back, they will have to go

22:25

to like, was it 4% if they

22:27

cut in December or 425? I don't

22:30

know, I thought it was 4. I

22:32

think it's 4. Yeah, okay. So next

22:34

year. odds that they're going to be

22:36

on hold is whoa that's actually not

22:38

that low whoa it's like something around

22:41

35% as we speak okay so that's

22:43

not that that's not as low as

22:45

I would have thought I mean it's

22:47

so it's to consider this a one

22:49

out of three scenario is not an

22:51

aberration I would say brand right I

22:54

mean it's totally fine to assume that

22:56

there is a 33% chance that they

22:58

don't do anything. At the end of

23:00

the day, if you look at the

23:02

absolute number of cuts on the screen,

23:05

right, not a distribution, but just at

23:07

the cuts themselves, then for next year

23:09

you have something like, probably I think

23:11

two, two and a half cuts as

23:13

the model outcome, let's see. you have

23:16

about wow 50 basis point only make

23:18

like two cuts that's all you have

23:20

so that's like the mean of the

23:22

distribution so make sense that zero cuts

23:24

like 30% or something yeah that sounds

23:26

right okay so the interesting thing is

23:29

if you contrast that to what people

23:31

actually think I don't think you would

23:33

find that many people that think feds

23:35

on hold all year but yeah maybe

23:37

it's just because we're used to the

23:40

Fed moving a lot but I mean

23:42

obviously there's been many years where they

23:44

were on hold so looking at GDP

23:46

I mean I mean, even the job

23:48

state, I like, it just all to

23:51

me just looks like it's back. 1718.

23:53

And then I guess then the question

23:55

just becomes, where's neutral? And I mean,

23:57

you're laughing like, good luck. Yeah, the

23:59

thing with neutral is that I think

24:01

essentially the real way, like you can

24:04

look at all the models and all

24:06

that and put 500 PhDs on it

24:08

and you'll get a bunch of different

24:10

answers, which they do have. But I

24:12

think the real way that the Fed.

24:15

identifies neutral is they compare where policy

24:17

is to financial conditions over time and

24:19

as financial conditions remain loose with higher

24:21

interest rates then they raise their estimate

24:23

of neutral so like if you spend

24:26

a year where financial conditions are loose

24:28

and rates are here well you go

24:30

oh well shit I guess neutral is

24:32

not two then you know like I

24:34

mean it might be three and a

24:36

half but it's not two it's not

24:39

two and a half so I think

24:41

that's what's happening now is if you

24:43

look at what Bowman and other people

24:45

at the Fed are saying they're like

24:47

maybe neutral is a little bit higher

24:50

and it's kind of like this a

24:52

little bit of a circular situation because

24:54

by the time they actually reprice neutral

24:56

and you know the long-term dot moves

24:58

up That's probably the time where at

25:01

that point you're actually waited so long

25:03

that Fed funds actually is restrictive and

25:05

then things crap out and then your

25:07

estimate of neutral goes lower because it's

25:09

pro-cyclical. So I think the question is

25:11

with so much uncertainty on neutral and

25:14

then financial conditions still being very loose

25:16

and the private sector being very strong

25:18

in the US. you know what how

25:20

much can you really cut when you

25:22

don't know where neutral is? Yeah I

25:25

think I agree with you the problem

25:27

is that unfortunately brain there is no

25:29

skew in this trade anymore because one

25:31

surprise only two cuts for next year

25:33

I mean sure it can go to

25:36

one cut because it's hardly going to

25:38

go to zero okay simply because people

25:40

are going to be willing to pay

25:42

some premium right for cuts next year

25:44

in case there is a worsening in

25:46

the economy so it can go to

25:49

one cut but that's it man I

25:51

mean like it's a lot of it

25:53

is priced already. The market thinks by

25:55

looking at the shape of the curve

25:57

as well that the neutral in the

26:00

US is around 3.5%. And what I

26:02

mean with the shape of the curve

26:04

is that you can look at the

26:06

steepness of the curve and basically understand

26:08

where the market thinks neutral is because

26:11

if. the market brings rates pricing below

26:13

this understandable neutral then the curve after

26:15

that point is going to be steeper.

26:17

So the idea is say neutral is

26:19

three and a half if the Fed

26:21

cuts to 325 the curve then is

26:24

going to steepen up after that in

26:26

the assumption that cutting below neutral strengthens

26:28

growth and inflation down the road. And

26:30

right now that point seems to be

26:32

around three and a half percent on

26:35

the US curve. And so The fat

26:37

dot for long, how's it called like

26:39

long run potential, whatever they call it,

26:41

neutral rate basically, it's still below three.

26:43

So one of the things I think

26:46

they will do at the next meeting

26:48

brand is pump that up, I think

26:50

above 3%. Now that basically means for

26:52

the Federal Reserve that to come back

26:54

to a neutral stance, they really have

26:56

to cut a few times and that's

26:59

it. And they can take their sweet

27:01

time. But again, we're basically just repeating

27:03

an narrative which is already priced so

27:05

that's like... We sound like talking heads

27:07

on the NBC body, so we should

27:10

maybe do something else. Well, the problem

27:12

with neutral too is that I think

27:14

it's highly contingent on the distribution of

27:16

liabilities in the economy. So if the

27:18

government is the primary liability holder, who

27:20

cares? I mean, they can put Fed

27:23

funds, say everyone's refinance at zero and

27:25

the government has all the debt, like

27:27

to the extreme. If Fed funds goes

27:29

to 10%, the economy is not really

27:31

going to care. So I think neutral

27:34

is a lot more about you know,

27:36

where the liabilities are financed. And so

27:38

that's why I think the US and

27:40

Canada, for example, are so different because

27:42

there was this massive deleveraging in the

27:45

US in 07-08, and now, you know,

27:47

consumer balance sheets are great, whereas that

27:49

deleveraging never happened in Canada. I mean,

27:51

a lot of it never happened in

27:53

a lot of countries. So I think

27:55

that probably means. neutral is completely different

27:58

in Canada than it is in the

28:00

US, not just because it's a different

28:02

economy, but because people have massive debt

28:04

there and they don't in the US.

28:06

Yeah, so looking at the shape of

28:09

the curb in Canada, for example, I

28:11

have it in front of me right

28:13

now, so neutral in Canada is now

28:15

assumed to be below 2% rent, which

28:17

is a while different to 3.5% in

28:20

the US. And I think it reflects

28:22

fundamentals. You're perfectly right. I mean, the

28:24

US is leaving the phase where Effectively

28:27

the government is taking on the baton

28:29

of levering up the economy through their

28:31

own balance sheet, right, deficits and debt

28:33

all over the place, but the US

28:36

private sector is allowed to deal average,

28:38

which is really solid, right? I mean,

28:40

when you have less mortgages, less corporate

28:42

refinancing, you have less pressure on the

28:45

private sector, then does it make sense

28:47

that neutral rates are higher? Yes, it

28:49

does, right? It's the economy can sustain

28:51

a bit higher yields in that case.

28:54

just circulated the piece this week that

28:56

looks at all, you know, this balance

28:58

of leveraging in different economies and who's

29:00

using that, generating the highest return on

29:03

GDP, who can afford higher rates and

29:05

who can't. In general, guys, if you're

29:07

listening to the podcast, you just can't

29:09

think brand or eye on Bloomberg, if

29:12

you have questions about whatever. Something for

29:14

brand, something for me, just fingers, you

29:16

know, we don't hold secrets, we're going

29:18

to talk to you. We don't bite.

29:20

I mean, at best, some Italian accent

29:23

from my side, your way, but that's

29:25

it. That's how much I can harm

29:27

you. One thing I was thinking about

29:29

this with the leverage in Canada and

29:32

the other countries and then the US

29:34

sort of seems immune is one thing

29:36

I wonder is how much leverage there

29:38

is though in financial markets in the

29:41

US like if you look at the

29:43

ratio of levered long ETFs versus leverage

29:45

short it's never been higher you know

29:47

every single sentiment thing says everyone's bullish

29:50

so that makes me think that there's

29:52

a possibility of a correction in Q1

29:54

as well just as like to take

29:56

a little bit of the leverage out

29:59

of the leverage out of the system.

30:01

As opposed to the U.S. economy tanking,

30:03

I could see equities correcting even in

30:05

it. a world where the US economy

30:08

ends up being okay, just simply because

30:10

it does feel like there's a lot

30:12

of leverage in the financial system, in

30:14

crypto, in equities, in the US, that's

30:17

how it feels to me, as opposed

30:19

to even though there's no leverage in

30:21

the actual real economy. Yeah, I think

30:23

you're perfectly right. I mean, there are

30:26

some of these indicators of leverage in

30:28

markets, but even if you look at

30:30

things like. that are implicit leverage. So

30:32

for example, if you look at credit

30:34

spreads, credit spreads are at the tightest

30:37

level in 25 years, 25 years. But

30:39

not only in the US, like if

30:41

you take stuff like the spread between

30:43

Italian gobies and German gobies, it's like

30:46

100 basis points. Guys, 100 basis points

30:48

is the same level at the top

30:50

of QE when the ECB was buying

30:52

more bonds than the governments were issuing.

30:55

Okay, so that's, that's. the point where

30:57

we went to 100 basis points and

30:59

that's where we are today. Why do

31:01

I say that credit spreads are implicit

31:04

leverage? It's because you're looking at an

31:06

asset where you cannot make more than

31:08

the spread itself. You can only take

31:10

the coupons home and then there is

31:13

a bit of mark-to-market change, if spreads

31:15

tighten, you can get a little bit

31:17

more of P&L your way, but the

31:19

loss you're exposed to in case something

31:22

goes wrong. It's huge, it's huge. and

31:24

there are a lot of these traits

31:26

going on brand where people are sitting

31:28

on the negative skew which is a

31:31

way of you know getting implicit leverage

31:33

if you wish like you're selling a

31:35

lot of volatility away and if something

31:37

blows up it blows up for good

31:40

and there are a lot of these

31:42

going on. Right, and any system that's

31:44

systematically selling options or selling leverage is

31:46

getting worse and worse, you know, skew-wise

31:48

as well. So, I mean, that's just

31:51

something to watch for. I just feel

31:53

like going into Q1 price for perfection

31:55

as, you know, people don't want to

31:57

sell now because of tax and all

32:00

that, but there is a lot of

32:02

risk to me in Q1, so I'm

32:04

going to be a lot more cautious

32:06

in Q1. that doesn't come for another

32:09

18 days. So. 18 days in your

32:11

trading size like two. But let's just

32:13

chat for a second more about leverage.

32:15

I think we should. So if you're

32:18

a trader and you do have access

32:20

to leverage, so you trade futures or

32:22

options or whatever you do that has

32:24

implicit or explicit leverage, is there any

32:27

tips that you have for people when

32:29

handling leverage? So I don't think leverage

32:31

is necessarily bad in general, but it

32:33

is often how people get ruined. So

32:36

like I would say before any other

32:38

consideration, eliminating risk of ruin or getting

32:40

it very, very, as close to zero

32:42

as reasonably possible, and honestly you should

32:45

be eliminating it, is the most important

32:47

thing. So that is rule number one

32:49

and you know that's what brought down

32:51

Jesse Livermore and like a lot of

32:54

famous traders is no matter how good

32:56

of a trader you are the distribution

32:58

of the P&L can be horrendous if

33:00

you use too much leverage. So I

33:02

think leverage is you know, often employed

33:05

by professionals and even by retail and

33:07

it's completely fine. It's just, do you

33:09

have a way of managing the risk

33:11

in the end? So like if, you

33:14

know, say you're, say you're sitting there

33:16

and your normal position is $10 million

33:18

a n, but you see a great

33:20

position where your risk, you know, you

33:23

can use a tight stop and be

33:25

long $100. I mean, that's perfectly reasonable

33:27

as long as you can stop out

33:29

of it, right? So I think the

33:32

issue with leverage generally is that it

33:34

creates positions that are too big to

33:36

get out of at a reasonable price.

33:38

So if your process is I'm going

33:41

to risk 2% of free capital on

33:43

each trade or each day or whatever,

33:45

and then you use leverage and then

33:47

you can't get out and you lose

33:50

9% of your free capital, then that's

33:52

what leverage can do for you. But

33:54

it can also give you better returns.

33:56

so I don't know, I'm not really,

33:59

I don't, I'm not down on leverage

34:01

in general, I just think it's part

34:03

of a comprehensive risk management system essentially.

34:05

Absolutely. So I have two comments on

34:08

there. The first has to be trading

34:10

with leverage and I think together with

34:12

applying stops to any of your trades,

34:14

even unlevered in a trading setup. The

34:16

most important thing there is liquidity gaps,

34:19

because you've got to make sure that

34:21

the stops can be executed and the

34:23

level you want, because if you apply

34:25

leverage on a liquid asset, then you're

34:28

in for a ride, and that's where

34:30

the problem is kicking. At the portfolio

34:32

level, I think people underestimate the power

34:34

of leverage in terms of announcing diversification.

34:37

I mean, if you run a portfolio

34:39

and you want to have all assets,

34:41

like... stocks and commodities and bonds and

34:43

effects and you want to have all

34:46

of them contributing equally to the risk

34:48

of your portfolio, then I'm sorry to

34:50

break it to you but without leverage

34:52

that's not possible because stocks or oil

34:55

are way more volatile than gold or

34:57

five-year bonds. So leverage is then a

34:59

way to basically equalize the volatility contribution

35:01

of each of your assets in your

35:04

portfolio, something known as risk parity as

35:06

well. And that can be a great

35:08

help to diversification of the portfolio as

35:10

long as you use it properly. So

35:13

nothing bad per se about leverage is

35:15

more about how you use it and

35:17

what's the mentality behind it. I mean,

35:19

do you understand that you're levering up

35:22

and you're magnifying your gains and your

35:24

losses because a few people tend to

35:26

forget that? Right and actually one more

35:28

point on that so the simple way

35:30

to avoid the downside obviously is to

35:33

do it through options and but one

35:35

trap people can fall into is looking

35:37

at the leverage of an option and

35:39

saying wow like that thing pays eight

35:42

to one let me do that but

35:44

without actually looking at the expected value

35:46

of like it only happens once every

35:48

12 times or whatever so anyways I

35:51

think we're getting towards the end here

35:53

is there any other anything else you want

35:55

to throw in? No not really just again if you're not

35:57

watching on YouTube but you're to the show.

35:59

show. You should know you can

36:01

also watch it on watch it

36:03

charts and all. charts and all. And to

36:05

take yourself not seriously, to keep

36:07

learning every day. And you

36:09

can read it on my shirt.

36:12

on No shirt. No problem. No problem. That was

36:14

was it for day I I guess,

36:16

Brent. We We next week. week.

36:18

right. Thanks. Thanks, everybody. Ciao, guys.

36:20

guys. right. Ciao. The content provided

36:22

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36:26

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