ETF Edge - Markets Now: Bonds, The Rise of Electronic Trading & the AI Effect 6/7/23

Episode Date: June 7, 2023

CNBC’s Bob Pisani spoke with Howard Lutnick, Chairman and CEO of BGC Partners, and Billy Hult, CEO of Tradeweb Markets, at the Piper Sandler Global Exchange and Fintech Conference in New York. They discussed the current market environment – with anxiety so high, why has volatility sunken to multi-year lows? Fixed income has enjoyed huge inflows, but could the Federal Reserve decision next week change the math on that? They also drilled down into the rapid rise of electronic trading, the impact of AI and the electronification of the bond market. In the “Markets 102” portion, Bob continued the conversation with Billy Hult from Tradeweb. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge Podcast is sponsored by InvescoQQQQ, supporting the innovators changing the world. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange traded funds, you are in the right place every week. We're bringing you interviews, market analysis, and breaking down what it all means for investors. I'm your host, Bob Pisani coming up on the show today. We are live from the Piper Sandler Global Exchange and Fintech Conference in New York City. Today on the show, we'll discuss the current market environment with anxiety so high.

Why has volatility sunk into multi-year lows? Fixed income has gotten a lot of love this year. But we'll talk about all that, and will that change depending on what the Federal Reserve does next week. Plus, the theme for this year's conference, a celebration of electronic trading. We'll drill down into the rapid rise of electronic trading, the impact of AI and the electrification of the bond market. Here's my conversation with Howard Lutnik, the chairman and CEO of BGC Partners, along with Billy Holt. He's the CEO of Trade Web Markets. I want to ask you about the debt ceiling because it's been an important inflection point in the market since last week.

The downside here that everybody keeps writing to me about is the U.S. Treasury is expected to sell an enormous amount of debt to deal with this. A trillion. A trillion. A trillion dollars. That's an enormous amount. In fact, that's a lot of debt. That's a lot of zeros. What does this mean then for bond investors?

What does it mean for the economy? Okay, they've been draining supply, right? So rates have been lower than you would think in the treasury bill market. Now they're going to hit it with all huge trillion dollars of sales that will make short-term treasury rates rise. And that will feel like an interest rate hike from the Fed. So you've got the Fed with all this selling, it'll feel more constrained, right? So that will help them skip, pause, don't raise, another way of saying it. And then you've got these regional banks going out of business.

They took a trillion dollars out of the regional banking system, put it in money market funds, and in the big four banks, the systemic banks. That felt like a hike also. So you have both of these things are going to constrain the Fed. The Fed is not raising. Don't buy it. They're not raising. Okay.

So this is good news. if you are worried about the Fed constantly raising rate, all of this is the effect of goodness. But it is going to slow the economy down a little bit. It seems like that, doesn't it? I mean, there's a lot of money getting pulled away here. Right. It's got the same effect, right? So they're not going to actually raise the rate. They're going to effectively tighten because the money came out of the banking system and they've got all this selling going into treasury. So you've got rates are effectively rising. That's the same as the Fed rising. And that's good for BGC partners. So what BGC does is.

is we trade on volume, volume, volume. This is all really good for volume. We got it up 9% for the quarter. So we're feeling really good. Volume's back. Rates are back. Businesses. But isn't raising the debt ceiling over the next year

is sort of a drain on global liquidity? Is this a headwin for the stock market? I think it's a headwin for the stock market. I do. Higher rates, remember low rates push people to take risk on, go buy stocks. You now have people saying, hey, maybe I should just put my money in treasurer.

I get 5% take no risk, and that's money coming out of the stock market. So I think the stock market's kind of on a sort of a steady kind of pause. We felt that the last couple of days, not up, not down. It's all AI, but the rest not as good. Yeah. The Fed is also continuing its quantitative tightening, right, at this point? There's more pressure on bonds as a result of that on top of it. So we've got several factors here that are conspiring essentially to push rates up.

I think the Fed's got to stop their quantitative tightening. soon. It's enough already. It's enough. You have the Fed coming in and selling. It's all going to go just kind of quieter, more steady. The Fed's going to stop pretty darn soon. We've spoken often about the competition of the Treasury's and the money market funds and the ETFs are presenting for the stock market right now. Money market yields are continuing to rise. They're about, even with the earnings yield of the S&P 500, it's 4.5% somewhere around there. Are we going to continue to see money flowing out of equities and into money market funds and the Treasury bond ETFs? I think it's going to continue because people are just starting to get into their heads.

I can make 5% without risk. Imagine that I can make 5% without risk. So maybe some of those stocks don't look so good. So you're going to see the stock market go sideways. But the bond market's going to continue to draw in money and get a lot of power. So bond markets are where people are going to be talking. Yeah, you know, I want to talk to equities. The S&P is trading at the current levels, at 20-23 estimates, at nearly 20 times, 23 earnings. That's not what I would call a recessionary multiple. And folks, if you don't know, typical 17 times, when you're talking about recessionary multiples are 10, 12, 13, we're at 20. The stock market is not signaling any kind of recession at all. What does this tell us? Does it mean anything? Or is the market? of misreading things?

Well, it's a fun place to bet now. You've got the two-year note that says, hey, it's only at four and a half, right? And overnight rates are at five. That means they must be expecting a cut. The only reason they cut is if there's a recession. You've got the stock market at highs. What's wrong with this picture?

It's one of the two. Is there going to be a recession or the stock market? I would bet on a recession. The bottom markets tend to be more right. So I think stocks are going sideways to slightly lower. It's just the way it's going to go. It's remarkable because the earnings are not dropping. Essentially, everyone's been wrong expecting this earnings, not only a recession, but an earnings recession.

In a recession, normally you get 10, 20, 25 percent drop in the earnings. And the estimates haven't changed for this year. It's basically flat compared to 2022. So everybody says, well, the analysts are idiots and they're slow to react and they don't move fast enough and they're waiting for the CEOs to tell them what to do. But so far they've been right. The market has been correct so far. But what you're seeing is a tighter credit market. When companies come to the market to borrow, there's tighter.

There's just not as much money around. Rates are higher. It's going to be tougher on them. And I think you're going to see it start to weigh in. You got the real estate market. That's going to have a tough time. Every time commercial real estate loan comes due, they're having a tough time. Rewoling those loans.

Tough markets in real estate coming. Tough markets rolling your debt in the credit markets. Tider credit means eventually that feels like a weight on the equity markets, it's going to pull us a little lower. Not a lot lower, but a little lower. I can see what you're saying about commercial real estate. I have a friend in the business and he said, well, normally these commercial loans are five years right now. They were 4%. The ones that are rolling over now, I'm seeing 9%. So if you've got a five-year commercial loan rolling over, I said, what does that mean? He said, well, you know what it means. Some people

are going to hand back the keys. That's what it means. They're not going to be able afford that. So I totally make sense to me what you're saying on the commercial side. $1.5 trillion of commercial loans coming due in the next three years. $500 billion of them are going to throw the keys back to the banks. So the banks are going to be in a tough spot. Say this number again. 1.5 trillion coming to the next three years. You think one third are going to turn the-one third.

Because let's face it, if rates go to eight or nine and your rents haven't gone up like that, the math doesn't work. Give the keys back to the bank. It's the greatest change in commercial real estate over the next three years. Together, we talked about it here, right now together. It's coming like a tidal wave, and it's going to change a lot of things, and it's going to keep the Fed's hands nice and tight. They're not raising rates.

You heard him, not raising rates. Now, regional banks, I want to talk you about that. They've been rebounding recently. These concerns seem to have ebbed a little bit here about deposit flight. Is this no longer an issue or is this going to somehow come back in some new form and bite us, essentially? It's going to come back because if you think about it, if the deposits don't leave, but you now have to spend 4% on your deposits, you were paying 20 basis points and they're going to pay 4%. Seriously, how do you make money? You've got all these old mortgages you put out at 5% and you are only paying 20 basis points on your loan on your deposits.

Now you're going to pay 4%. I just don't think their business model is right. I think the regional banks are in big trouble. We had 4,100 of them in America. If you said, what? Yeah. Why do we have 4,100? What if we had 3,600?

Do you think anybody would care? The people who own them would care. The rest of us? Yeah. I think there's going to be way less, and the Fed's going to have to allow the big banks to buy them. That's a change. That 4% is an enormous number.

I made fun of my mother two months ago, who called me pulling money out of her bank account, getting 0.2% saying, Robert, I'm putting it in a one-year CD, and should I buy bonds directly from the government? I said, Mom, don't go buying bonds from the government. The CDs are perfectly fine. But there's the problem. There it is. If you have to pay 4% on everything you used to pay 25 basis points for, that's a really, really big change in your business. Just a couple minutes left. Let me get to your thoughts on the economy here. The economy refuses to die. Everyone is waiting for a recession that hasn't come yet.

Is it coming? We've been waiting for this for eight months, nine months, ten months. It's got to be coming, but it is very impressive. The statistics you keep seeing continue to show us growing. If you looked at the statistics of the service sector is still on fire of inflation, food, you go to a restaurant. Can you believe what things cost? Go to the supermarket and buy some eggs. It's outrageous how they've doubled in price.

So these things have got a hit in the economy. I think a recession is going to come at the end of this year. It's coming. But it's a mild one. It's a mild one. Okay. I agree with it. All right.

So is it soft landing? That's a soft landing. Well, it's a mild recession. I don't know if that's a soft landing. Compared to better than a bad landing, I guess. So is a soft landing to slow the economic activity down? It's going to bring inflation down. It's going to get the Fed to stop hiking rates.

Fed's got to be done. All these factors are going to stop the Fed, all this stuff, talk about skipping. How about they were talking about? They were talking a couple of weeks ago about raising rates. Now that's gone. Now it's a skip. Now they think July is a 75% of a hike. I don't think there's a 75 chance of a hike.

I think it's not coming. I think the Fed's got to calm it down because they're worried. The theme of this conference is the future of electronic trading. You've been around a long time. You've seen the whole arc of this thing. Talk about artificial intelligence. How is it going to change the economy? How is it going to impact your business?

How is it going to impact CNBC Viewer? who were traders, for example? Everything is going to get more efficient. It's just going to get more efficient. Programmers can say, I need A, I need C, go fill in B. That's going to happen across the board. When you're looking for investments, you're going to say, what's the cheapest stock?

What's the cheapest stock? What's the cheapest this? What's the cheapest that? It's going to let you be much, much more efficient. It's going to be tough on the people. What I call the belly of the beast, right? The best people will be employed. The young people will still be our future. It's the belly of the beast that's going to be in trouble.

And, you know, AI is going to automate a lot of those jobs. And it's going to make things more efficient, but it's going to be tough. And that's why these companies are doing so. The important thing, I think, here, is that we're going to see some big changes coming in the next few months. And the problem is the viewer is rather confused about the state of the economy right now. But you think the soft landing is intact or relatively soft landing. So I know. It's not a smash.

What you're saying to me is very optimistic, actually. You know, I think the whole point here is you don't see imminent crash in the stock market, right? I do not. I know you don't have year-end targets. You're not a strategist, but where do you think we're going to be at the end of the year? I think the equity market's slightly lower than here

at the end of the year, but not a big deal. I think rates here at the end of the year, not a big deal. I think, unfortunately, what I've got to say is not a big deal, not a big deal. Okay, that's reassuring to everybody. This is a man I've been talking to for more than 20 years, folks, so I very much value his opinion. Howard, thank you very much for joining us. We really appreciate your time.

So what's next? Where do we go from here? What's next for bonds? What's next for bond ETFs? After six months of huge inflows into treasuries. So let's get some other perspectives on this. I want to talk now with Billy Holt. He's the CEO of TradeWeb.

TradeWeb operates as an electrical. electronic over-the-counter marketplace for trading fixed income products. Billy, thanks very much for joining us. Really appreciate your time. I think you were standing right there on the sidelines. You heard me talking to Howard. What's your sense on where bond prices are going, particularly now that the Treasury Department is going to be selling a lot more bonds

to meet those deficit needs. I know that seems to be a concern of a lot of people, but a lot of viewers have heavily invested in bond DTFs right now. Yeah. First of all, thanks very much for having me on. following Howard is a little bit like following the, you know, the Rolling Stones. I'd like to make an old guard, new guard joke, but I like Howard too much to make that joke. Even though we are on television, I just kind of made it.

Great to be here. It's an amazingly interesting time to be in this business right now. Trade Web is so focused on keeping transparency in these different marketplaces that we are in. Where rates are going, always hard to know. I think about the William Goldman quote, nobody knows anything. The one thing I know for sure is that the ETF movement is forward moving all the way. A long time ago, Bob, and I was mentioning this to you before, I got a book from BlackRock five years ago that said this is how the ETF market works.

Trade Web built a ETF platform five years ago, it's one of our biggest businesses today. That's a one-way movement around the creation of ETFs. And, of course, William Goldman was a famous screenwriter. Those who don't understand that reference and wrote a book where he basically had a famous chapter where he said, nobody knows anything about the movie industry or how it works or why it's successful. Nobody knows anything. Changes are coming all of the time. And you heard me this morning, and I was talking a lot about the resistance that my business has had all the way through.

All of these markets have developed in these significant ways, transparency, price efficiency, technology being applied to fixed income has been a huge movement over the past. bunch of years. I know you're not a strategist, but as I said, the viewers are heavily invested in bondings, particularly short-term treasury ETFs. Any thoughts on where prices are going to, given the fact that the treasurer is going to be selling a lot? I get this question all the time. People are anxious about it. Any sense of where rates are going back down a little bit from here. You know, for sure, the Fed is getting out of, you know, a bunch of these different markets that they've been playing heavily on. That will have a role around movement. I think the most important thing to think about in terms of the government bond and the government bond market

and how it's functioning is really where is the liquidity in the marketplace? The one thing that we saw for sure in that period of time, Bob, around March, was some challenges around the liquidity of the market, particularly in the deep off the run area. There's a lot of conversation about regulation coming into the market. And then what I would say is significant levels of market structure change coming with potential all-to-all trading, which is essentially, the ability for the buy side to trade with the by side in the big areas of the government bond market. All very interesting innovations coming. I want to talk about that, but again, they're very invested here in the bonding.

You're trying to get an answer. How about other spaces, corporate bonds, high yield bonds? They've sort of been forgotten and neglect. They have. I mean, again, the high yield market went through significant stress in March. Very illiquid, very difficult for real risk positions to come on and go off the platform. I think the corporate bond market's going to struggle for a while. Obviously, trace volumes are significantly off.

That's not an area where I would say you can feel very good about where the volumes of that businesses are going. That being said, again, continued transparency in corporate bonds in credit is super important for the marketplace. The stock market went electronic 25 years ago. I was on the floor of that in 1990, the mid-1990s. bonds have been startlingly slow to go electronic. I know that's slowly changing. This is the heart of your business. You said here at this conference

that your greatest competitor is actually a telephone. That people still are not lazy, but they tend to still trade, particularly the institutional traders, bonds by the telephone. Why aren't bonds more electronics? I'll make another literary reference for you. Back to Liar's Poker, you know,

these were, and Bonfire, But then these were the masters of the universe. Very resistant to change. They ruled the roost. Absolutely right, the change happens slowly. But at the end of the day, more innovation, more price transparency are one-way trains around the development of these marketplaces. So tell me a little bit about the impact.

This is a show about ETFs, about the impact of bond ETFs on bond liquidity. You know, the ETF haters always used to say, oh boy, go ahead and trade these passive investments. vehicles, but when you have something that's thinly traded, like, you know, some bonds or some other product, the minute you hit a lot of volatility, everything's going to fall apart because the underlines aren't going to be able to trade. And it seems like none of that actually happened. No, the ETF market held up in such a significant way. And I think one of the more important things to remember is the most sophisticated players, Bob,

that live and breathe in my space, are so oriented towards ETF, creating technology. around liquidity in ETFs, that that market is exceptionally solid. Exceptually solid. Yes. So the important thing here that's amazing to me is, in a way, the bond ETF tail kind of wags the dog because what happened was when there was not a lot of liquidityness, this happened in Chinese equities trading as well. What happened when there was not a lot of liquidity was the ETS.

The ETF set the price, not the other way around. And it's a remarkable ability for the market to figure out a price, even if the underlines weren't necessarily as liquid. That's right. In the analogy you gave Howard about your mom looking to express an interest in the treasury market, she's going to do that ultimately through an ETF. And that becomes the way that the investors wind up expressing a view in the market. That's not going to change. It's the easier, more liquid way of expressing a view. Yeah.

We're back talking with Billy Holt from TradeWeb, the CEO of TradeWeb, who's speaking here at the Piper Sandler Global Exchange Conference. You know, I want to draw the line between the viewers who own bond ETFs and what you actually do. You're really about making the market more electronic. Yeah. Bond trading has not really come through that real evolution that stock trading had. What percentage of bonds are traded electronically?

It depends on the market. Even the very first business, Bob, that we were in, global government bonds, can still have up to 40% of that market trade on the phone. So back in the day, as you can imagine, it was end user to salesperson who would yell over a crowded trading floor with the pizza boxes everywhere. Where's the market on five-year notes?

The trader would yell back, the salesman related to the client, like all of this inefficiency. And so market by market, trade web, created efficiencies and brought technology into all these businesses, you know, starting in 1998 all the way through. But let me ask you, I mean, this may seem like a silly question, but why should the viewer who owns bond ETFs care about electronification of the market? If I go on my Schwab account, I want to buy bonds or my fidelity account or whatever, and I want to buy bonds, it seems like a one-click process to me. Why should I care about more? A transparent marketplace, a market that is functioning at the highest level, is paramount important to the investors.

It starts with the biggest asset managers in the world, meeting liquidity on buys and sales of five-year notes or liquid mortgages or interest rates swaps. And how those markets function, the transparency around those markets has an enormous trickle-down effect to the users and to the viewers' lives. And just as a procedural question, if I'm on pick a platform, I'm on Schwab or a fidelity or something like that, and I buy a bond, who actually does the trade? Would Trade Web actually be? Yeah, we would be involved in the trade. An example like that, I think, would go through a retail platform, and there would be an investment advisor acting on behalf of the client. The retail business has been a very strong and good business for us for a while. The core business, as you know, Bob, is the institutional business with the PIMCOs of the world.

trade with Goldman Sachs. Yeah. You had a great quote here describing how much resistance there is. This is a big business. So the JP Morgan's of the world make a lot of money on over-the-counter trading. And you had a great quote. You said, transparency is the enemy of my profit, meaning that electronic markets are more transparent than over-the-counter markets.

And that's why there's so much resistance, because it's a big profit in business. And some of that, and some of what I said, I think, is in the past tense. You know, that was the history of the evolution of all of this. The reality is, as these markets have gone more electronic, more transparent, specifically recently, post-pandemic, the banks have done exceptionally well in this space that we live in. I want to ask the same question. I asked Howard Lutnik, which was the theme of this conference is the past and future of electronic trading, and now it seems very much dominated from the artificial intelligence or AI perspective.

I mean, with the understanding that everybody already uses algorithms and pattern recognition, how is AI changing the trading business? What is it going to mean for you? It's going to mean, it's going to mean smarter selection and easier ways to find liquidity in the marketplace. People and relationships are not going away. Not going away at all. They're not going away. So, and I made a joke about the Bob Pisani AI.

You know, I want to trade bonds. Could you find me the most efficient way to buy this one-year treasury? at the lowest price, they'll be able to find. Back to William Goldman. Nobody knows anything. These things evolve differently than we expect. People and the relationship side of this business are not going to go away.

It's sort of like, in a way, the Bob Pisani AI is going to, if I want to say, find me the cheapest flight to Paris, is sort of the same thing as finding me the most efficient way to buy a one-year treasury. It's just a routing question. How do I do this? It's a routing question.

That being said, as the trade routes, the relationship on the other side matters. And that gets back to my point around finding liquidity in the sophisticated marketplaces. Now, again, the most common question I keep getting asked is how can I get my own personal digital assistant to trade stocks and bonds so we can make a fortune? And it always seems to me if everyone has access to the same information, none of this is going to matter that much. But do you have a different perspective? Is the Bob and the AI going to be... We would like to have Bob as the AI on our platform.

platform. We would like to onboard your sister and your mom. That being said, the market has always sort of grown up in fixed income in a little bit of a bifurcated way where different clients receive different liquidity. Billy Holt, thank you very much for joining us. Billy Holt is the CEO of Trade Web everybody. Thank you for joining the EPA podcast. InvescoQQQQ believes new innovations create new opportunities. Become an agent of innovation. Invesco QQQ, Invesco Distributors, Inc.