Odd Lots - Volatility Suppression Turned The Entire Economy Into One Big Carry Trade

Episode Date: October 1, 2020

In a carry trade, an investor borrows money cheaply to buy an asset that yields more. As long as nothing changes overall, the investors get to pocket the spread. In our latest episode, our guests argue that more and more aspects of the economy resemble this trade, and that the culprit is the policymaker suppression of volatility. We speak with Tim Lee, Jamie Lee, and Kevin Coldiron, the authors of the new book “The Rise Of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis”.See omnystudio.com/listener for privacy information.

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And I'm Tracy Allaway. So Tracy, one of the things that we've been talking about lately, and we really sort of drove at home in the last episode, was this idea of the entire market kind of implicitly looking like it's one trade. So many things seem to go up and down together that while you sort of think that, Okay, investing should be some search for interesting individualized opportunities. Everything kind of looks like it all trades as one. Yeah, that's exactly right.

And I think there's been quite a lot of discussion at this point, including on that last episode about how the market is being generally driven by interest rates, aka the central banks. Right. So the story that multiple guests have told us is that, well, we get into this situation. in which growth is slow, perhaps due to income inequality. That means that asset prices rather than sort of actual demand becomes a key vehicle of what drives the economy. That means the central bank then ends up becoming more sensitive to asset prices when it comes to easing policy that further fuels asset values, that further exacerbates the inequality problem, that further causes weakness and growth, that further causes weakness and growth, that further causes.

is the central banks to then act, and that we're like in this spiral that, you know, by some accounts, maybe it has gone on four decades. And if that's the story, then I would say, you know, it really feels like COVID right now is sort of an accelerant of that whole process. Yeah, I think that's right. And I think it gets to a theme that we keep coming back to in all these episodes, which is if we are slowly recognizing that the financialization of the economy is not a good thing and we're trapped in this sort of endless cycle, then how do you actually break out of it? And we've had so many of those discussions now with proposed solutions ranging from fiscal stimulus to full employment policies and that sort of thing. Right. And you know,

it sort of gets to this idea or it's like, okay, if you know that every time there's going to be a crisis, you know, like I were saying before the crisis, and this is something that you and I talked about a lot, And you've written about it a lot, the rise of private sector debt, particularly corporate debt, share buybacks, corporate leverage, private equity leverage. You know, like people are like, okay, but this is all fine. But if there's a downturn, then this all explode. But of course, if the, you know, central banks expand credit, start buying bonds directly, then you can have an economic downturn in theory without the financial market exploding. And that's kind of what we saw happen in March and then through now. Yeah, exactly. And I think, I mean, this is one of the reasons why we're talking about this, right? People intuitively feel a little bit uncomfortable about the real economy being in a terrible state while financial assets are booming. Well, well, they, oh, never mind.

Oh, were you going to say that they were booming up until a few weeks ago? Yeah, I was. I'm trying to caveat just in case the market crashes further over the next few days. Well, we are recording this on Thursday, September 24th. I think the episode will be out in a week. So who knows, either we may have had a crash since then or we may be back to all-time highs on the S&P 500. But hopefully whichever way it is, or maybe it will be flat, hopefully whichever way it is, I suspect that the conversation will still be useful. Still be relevant. I agree. I think so. So today we are joined by three guests who are all the co-authors of a new book. It's called The Rise of Carry, the dangerous consequences of volatility suppression and the new financial order of decaying growth and recurring crisis.

That last line, decaying growth and recurring crisis certainly feels like a theme. And I'll do a quick bio, a quick intro of our guests. So we're going to be the three authors are Tim Lee. He's the founder of Pi Economics and has a longtime study of the field. Jamie Lee, he works for Jeremy Grantham, also a longtime expert, also in environmental research and volatility trading. And then Kevin Koldairn, a lecturer in financial engineering at UC Berkeley's Ha School of Business. So we're going to see how this goes. We're going to see what the rise of Kerry is all about.

Before we bring them in, I was just reading the dust jacket again. And the questions at the beginning feel like the questions that I really do think are on everyone's mind. Why have markets risen and crashed so spectacularly over the past 25 years? Why is the stock market outpacing the growth of the economy? Why do companies buy back stocks? And this is a really big one. We should probably question ourselves this a lot at the media. Why do traders take every utterance of central banks as the word of God?

These are the questions that their book purports to answer. So I think if we can answer all of these questions in the next 30 minutes on this podcast, listeners will have found a lot of value from that. So Tim, Jamie and Kevin, thank you so much for joining us. Thanks for inviting us. Our pleasure. Thanks. So why do we take central bankers' words as the voice of God? That's a great question. That I think sometimes our listeners and viewers of TV, they're like, oh, you guys sort of make such a big deal of every random utterance from Jay Powell or a regional Fed president. What's the deal with that?

So we're arguing in the book that the main transmission mechanism of central bank policy has really been through, at least over the last 20, 25 years has really been much more through their actions in suppressing financial volatility. And Joe, you've already kind of said quite a few things that we would agree with in the book, that we seem to be trapped in this sort of circle, a vicious cycle of markets that rise for long periods, the economy seems to be rather asset price dependent, and then you get these crashes and central banks are sort of scrambling to support markets, and when we go into a new cycle. And we're agreeing with that, really. And in the book, we're sort of saying that

is taking us into this, what we call it a carry regime, whereby markets have become increasingly disconnected with the real economy. And I think we've seen that kind of spectacularly this year, which is, you know, since we finish the book. But we're saying it's much less to do really with the kind of traditional idea that central banks are pumping money into the markets and kind of creating the surplus of liquidity that can only go into asset markets. It's much more to do with the fact that we've come into this, what we call a carry regime,

where a lot of financial structures, transactions, actions, trades across the board, really, even including things like private equity, but certainly including things like buy to rent property or various types of structured finance, currency carry trades, which is where we start the board, because that's a more common type of carry trades. These kind of trades, which are essentially short volatility trades, have come to dominate markets and really be the primary drivers of asset prices, even if we don't, you know, see that in an obvious way they are. And then so that's associated with more debt and more leverage, which kind of requires these

kind of trades because they're liquidity providing in these structures. They provide liquidity to a system that needs liquidity. But at some point, you end up there's too much leverage and there's too great to disconnect, if you like, and then you get a rapid crash and central banks step in with all the measures that they do which suppress volatility again and encourage a renewed growth in those same sorts of carry trades. So we're sort of in this carry regime where the markets become disconnected from the economy. And we argue further that, as you've already touched on, you were talking, I think,

about how all asset prices could have become, seem to be rather the same thing. We say in the book that really it's changing the nature of money itself and that that low levels of volatility of a lot of financial assets that should really be considered risky assets in a normal world. They're included in ETFs and things like that. They suddenly seem to be, to many people, much more money-like because the central bank is standing behind them. In some sense, a lot of financial assets have effectively become contingent liabilities

of the central bank, not just money being a liability. And so we've had this carry regime has been associated with a kind of whole range of financial assets appearing more money-like. And then in the crashes, those crashes appear as a kind of complete evaporation of liquidity across the board and mean that central banks feel they have no option but to take even more drastic measures than the last time around. This is really interesting. But I mean, the argument here is basically, as I understand it, the growth of carry generates easier financial conditions because financial assets become more liquid and more credit becomes available. And then when the whole thing starts to reverse, you see financial conditions tighten and that's what sparks or what encourages central banks to step in and prop up the market because they don't want to see credit and liquidity drying up for the real economy. I'm wondering, could you maybe give us a concrete example of how you see a particular carry trade generating liquidity and credit in the real economy? Sort of walk us through the steps of how you see it working.

Yeah. So currency carry trades are the most obvious case because the currency carry trader is borrowing in a very liquid funding market, say, well, in the case of the dollar funded carry trade, which has become the dominant one, I don't. low interest rate and then providing those funds, in a sense, Turkey would be the obvious example now because Turkey is kind of liquidity deficient, if you like. They've been in a continuing kind of rolling crisis, provides that liquidity to the higher interest rate economy. But, I mean, we touch on in the book how, you know, it's hard to distinguish sometimes between liquidity in the sense that economists use it and liquidity in the sense that economists use it, and liquidity in the sense that financial market participants use it, meaning, you know,

the ease of transacting in a financial asset. And carry trades are particularly important, I think, for that latter case. And in the book, we have quite a lot on volatility selling trades in the stock market, say, which those kind of trades, a simple one would just be writing put options, but or, you know, you have shorting Vick's futures. or a whole variety of ways that you can short volatility in the stock market. They essentially provide, or buying the dip, as we say, to which they're equivalent. They essentially kind of like market-making trades.

They make it easier for lever traders or those who are a bit overexposed to exit the trades. And you could say the same, you know, I'm sitting in the UK where, you know, buy-to-rent property or buy-to-letters, we call it here, has been such a big factor in the property market, and buy to let investors in the property market, that's a carry trade too, because they make it easier for properties, people don't want to sell to sell their property. I'm Francine Lacqua, an award-winning journalist, and I've got a new podcast, leaders with Francine Lacqua from Bloomberg Podcasts. I've interviewed everyone from Heads of State to fashion icons about the news of the moment, but I've always been curious who are these people as leaders. I don't think there's one right way to be a leader.

decisions. A poor decision is always better than no decision. Listen to new episodes every other Monday. Follow leaders with Francine Lacquois wherever you get your podcasts. Just zooming back for one second and for people who maybe aren't familiar with the terminology, how would you, to an average person, define what a carry trade is? And then, you know, I still think it's probably not intuitive to people how, say, buying the dip in the stock market is sort of economically equivalent to buying a house with the intention of renting it out to someone. So explain what carry is and then how sort of economic, you know, sort of the logistics of how that ends up being the same, the same trade, so to speak. So one definition we give in the book,

which maybe is a bit out of the ordinary, but we think it's quite useful, is that carry trades are trades that use liquidity to provide liquidity. And so a buy to rent house is, a very good example. I mean, anyone who does buy-to-all, almost anyone, is almost certainly going to be taking out a mortgage to do it because there are enormous taxed ones doing it, and because house is too expensive to buy without leverage now. So you're using leverage, but you're doing so to become an active participant who will be able to provide liquidity to future house traders, as Tim was saying. And also, you know, you're converting the extremely long-duration house into a bunch of one-month or one-year-old.

short term, these assets. Either way, you're liquefying the market, but in the process of doing so, you're taking on liquidity risk yourself. You could even think of it in a much more simpler way where it's a trade that makes money when nothing happens, right? So the classic example that we've talked about is, you know, you borrow a yen to finance a position in the Australian dollar. That's a positive yield trade. If the currency doesn't change, that makes money. And the same thing of, you know, if you're like an insurance type of trade where you're selling puts, that has an income, a premium income. And as long as the market doesn't change as long as the world stays pretty much the same, your, the trade's profitable. So carry trades in all forms generate kind of this consistent income.

And then there's these occasional sharp drawdowns. And that's quite important because what we're saying is as these trades kind of. work their way across the financial system, the stock market and the overall economy is starting to basically show the same characteristics of carry trades, which are steady profits, but occasional crashes. So it's no accident that we've had these big crashes over the last 10 years. It's because the underlying nature of the risk is kind of mirroring carry trades. Right. So this is kind of the picking up pennies in front of a steam roller. idea. And the example that jumps out to me is what happened in the treasury market in March of this

year, where we had a bunch of hedge funds that were arbitraging these tiny differences between cash treasuries and the futures contract for treasuries funded in overnight market. So they were basically borrowing liquidity. And the trade worked really well as long as nothing happened in the treasury market. But then in March, we got a bunch of volatility. Everything went haywire. And some of these hedge funds suffered really big losses. If one of the hallmarks of carry trades is this idea of steady profits and then a big blow up, what does it actually mean for investors and players in the market? Does it mean that the people who are able to continuously survive those blowups and continuously keep tapping liquidity are going to be the ones that keep going?

So we actually talk about that in the book. And there are some people. I mean, ideally, without, you know, in a kind of totally free market, it would be the people with the very strong balance sheets who would, you know, be natural providers of carry. And some level of carry is important, as Jamie said, to liquefine markets. Part of what we're arguing is that when central banks, you know, because of their role, let's say, lender of last resort, come in and truncate volatility. They truncate the left-hand side of the distribution. They truncate losses. That does two things. One, it kind of makes the balance sheet of the people who were natural carry traders even stronger.

So sort of reinforces their existing advantage. And two, it encourages people who maybe don't have the balance sheet, like the hedge funds you referenced earlier, to enter the trade. And therefore, the carry regime, as we've talked about it, expands over time because carry looks more profitable than it probably should have been, given the fact that central banks kind of truncated the volatility. They suppressed it. They stopped some of the losses. So that's not necessarily blaming central banks. They're acting to backstop the markets, but it has this kind quite important second order effect of encouraging the growth of carry trades through time. So, you know, one of the things that people have pointed out, and I think there's a corollary between

the sort of real economy on the market here, which is that we used to have like sort of recessions where there'd be some inventory cycle and the economy would go in a downturn and then companies would maybe lay off workers and sell through their recession, sell through their inventory and then over time maybe they would need to build it back and rehire workers, then we'd come out of a recession. And we also used to have bear markets where maybe the market would just trade sideways or down for a few years and then there'd be some new regime. And it feels like maybe since 2001 or so in the last few downturns, we don't really seem to have recessions or arguably even bear markets anymore. We just seem to have crashes.

And I'm curious if sort of what we saw with the great financial crisis and then sort of what we saw very briefly is sort of the new model as long as we're in this regime, that we don't have these sort of slow rolling downturns. It's just a crash because the moment the income starts to draw up or the moment the asset prices start to go down, everything unravels until very, very quickly under the carry regime until the sort of central bank steps in. Yeah, I mean, that's what we're saying. I think perhaps the point we haven't emphasized enough so far is that the way we define carry trades in the book is that their liquidity providing, as we've said, but also they're levered. They're always levered. They involve leverage. If they don't involve leverage, if they don't involve. They're not really carry trades under our definition. And they have that, they kind of make money if nothing changes. If nothing, you know, if you don't have a lot of volatility, you don't have a problem, they make money, then you do have a problem. They suddenly lose.

And I think they also, a carry trade always has a kind of target asset at the back of it, a currency carry trade, obviously, if you kind of borrow US dollars now and put it into a Turkish lira bond or something, your target assets, a Turkish lira and the bond. And you're saying, you know, buy to let property I was talking about earlier. here. Although they're aimed ostensibly at extracting income, the yield pickup or the premium

for the volatility short, writing insurance too also is another form of carry trade, credit default swaps, these kinds of things. The primary aim is to pick up the income, but there's an effect on the asset price, which will rise generally. And

then the rise in the asset price creates as an economist, I would call imbalances. You know, Turkey was a very good example of that, which we discuss in the book, where you had capital flows going into Turkey that were lever to some extent, and often those were actually Turkish entities, you know, Turkish businesses, borrowing dollars overseas to invest locally rather than hedge funds or something. But that made the Turkish lira become progressively overvalued over time,

and so Turkey had a huge current account deficit. Once you have that deficit between, spending an income, you need continued carry trades to keep the whole thing going. So you get the double effect of imbalances very often and also the growth in leverage. And at some point, that becomes unsustainable. And then you get the, you know, what you might call the margin call effect. Yeah, as Tracy said, picking up pennies in front of steamrollers, the steamroller arrives and everyone has to get out at the same time.

And as we, you know, we try to explain that the liquefying nature of carry trades, When you get that, the crash, it means liquidity evaporates. And asset prices crash, liquidity evaporates. All asset prices seem to become highly correlated. They all seem to become the same thing. And because the economy, the U.S. economy, particularly but British economy, other economists, too, have become very asset price dependent. You then end up with an economic crash too.

That's what we argue that, I think Kevin said, that the pattern of the economy has become like the pattern of the classic carry trade pattern of the sore tooth pattern of the steady rise and then the sudden crash. But over time it's still being profitable, partly because central banks have, you know, truncated the crashes. And so carry traders over time have the crash wipes out quite a few carry traders, but central banks rescue a lot of them, and particularly the big guys, and they make money over time. But there's also an awareness of the risk. So you kind of get, the carry trade itself becomes sort of higher risk and high return. Because the carry trader, the carry trader not only provides liquidity is levered and provides

liquidity, but the carry trader has to accept the crash risk to some degree and relies ultimately on the central banks. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Moscow here to tell you about our new on-de-beams. Man News Report, delivered right to your podcast feed. Bloomberg News Now is a short five-minute audio report on the day's top stories. Episodes are published throughout the day with the latest information and data to keep you informed. Yes, there are other products like this from a variety of news

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given that it's gone on for quite some time at this point? And if anything, seems to be intensifying in 2020. We're a bit pessimistic in the book, really. We need answers. We need solutions. We kind of suggest at the end that maybe we've gone, you know, we've gone past the point of no return. And ultimately, we will see the demise of central banking. And we'll one way or another, either a crash that cannot be contained, like sort of 2008, but even worse, or MMT type measures, which perhaps we could argue have already been happening, that will ultimately create a lot of inflation and lead to the kind of demise of fiat money and then the appearance of alternative forms of money. And, you know, perhaps some people point to cryptocurrencies,

we argue that current cryptocurrencies, we only touch on them briefly and not really, not really kind of legitimate enough perhaps to become a new form of money now, but something similar or some improved form could become a new form of money. So we could just be going to, we may not, there may not be a solution other than the end of the monetary regime that we've become used to. Just on the MMT thing, we've been, as we've been saying, obviously massive deficits and a lot of inflation fears, at least in market commentary, if not in the markets themselves. We, you know, we explicitly identify the carrier regime with deflationary pressure. for various reasons. But the one I like most is to do with the linking of options selling

strategies and market making as the kind of basic form of carrying. You know, a world in which, which was inflating very heavily is a world in which there's tons of cash on the sidelines in which people are willing to sit on the bid and ask and willing to sell options for free or less than free. So in a highly inflationary world, volatility buyers rather than sellers would systematically make money. Of course, perhaps we've already been saying the last couple of years. Talk a little bit about this further. Let's say from the perspective of a financial professional or someone who's a trader,

how has the rise of the carry regime just changed, say, the day-to-day nature of the job, of an investor, of a trader? How is this sort of the way this is version sort of essentially change the way people have to approach their roles? One thing it's done. And I actually would want this kind of goes back to a question that Tracy asked earlier, like what are the implications for investors? It's made it very clear that there's much more skewness in asset prices, asset returns than people expected. So and there's what we're saying in the book is there's compensation for that skewness. that skewness risk is compensated.

So one of the reasons the S&P has done so well is that you're kind of collecting some of this liquidity premium that's built into it. But at the same time, you have to accept this skewness risk. And that probably should mean that people allocate less to the S&P 500 than they kind of normally would so that they can survive. I think it's also increased the demand for protection,

which is why the skew in auction prices has gotten more extreme over time. And again, you know, like I ran a levered hedge fund strategy for many years. And that skewness and that liquidity risk should mean that kind of overall leverage levels, you know, should be lower. But I don't actually think that's happened. I think people have just relied more on kind of dynamically managing their risk in portfolios, which kind of actually reinforces the demand on the other side for liquidity provision. So I think that that's why you get these much more sudden drawdowns in hedge fund strategies than we saw before.

So instead of running it kind of structurally lower leverage, they're managing their leverage much more aggressively day to day, which puts more prices on people who are on the other side of that trade or pressure on people on the other side of that trade. So I forget which one of you mentioned it before, but it's sort of a common dictum in markets that in crisis, all correlations go to one. Things are bad. You've got to sell everything, whether it's the chair that you're sitting on or a stock or a bond, whatever. Are we in the carry regime, are we seeing the same thing apply except to booms where essentially in the good times, all correlations go to one in the same way, in a way that wasn't really the case in previous upcycle? you know, part of the suppression of volatility. We're arguing that central bank suppressing volatility is the kind of ultimate driving force of some of these increasingly strange features we're seeing. But one of the ways in which you can get market-wide volatility down is by

increasing dispersion, by decreasing correlation. It should be the case that the boom periods of extremely low volatility are marked by relatively low correlation most of the time. So I have a weird question, but every once in a while I see analysts make the connection between suppressed volatility in markets and social instability or discontent in wider society. So this idea of chaos and populist anger and things like that. And I think it was a week or two ago, there was a Deutsche Bank note where they touched on this topic and I actually have it in front of me because I thought it was relatively. to this conversation, they wrote that, quote, asset price volatility is a powerful energy, and when it is suppressed in the market due to central bank liquidity or buybacks, it needs to find a home, and that can be outside the market in society, especially in a very

iniquitable society. The vicious loop can then turn back into asset prices. So I remember when that note out, quite a few people were making fun of it saying it's crazy how central banks get blamed for everything nowadays, even populist discontent and things like that. But I'd be curious to get your take on this. Can the suppression of volatility in financial markets and financial asset prices have an impact not just on the broader economy, but society as a whole? Yeah, well, maybe I'll start on that. I think we probably could all speak on that. But I mean, we very much say that in the book. I mean, the last part of the book is on that topic. We're very much in agreement with that, that this whole, we call carry regime that we're describing

is associated with rising inequality and deteriorating real growth. So the wealthy benefit at the expense of those who are not. And that does translate into, we say in the book, I think at the very beginning, undermining the social fabric, you know. But the question is, we do lean towards blaming central banks, but we rather say that in some sense, it's really all about the structure of power in society, and central banks, put it in its simplest form, central banks are really agents of that structure of power. So we are, I'd say, but we are basically saying that central banks, put it very bluntly, may think they're actually,

on behalf of America or Britain or wherever they are, but they're really not. They're acting on behalf of the wealthy and the powerful and the influential. It's curious. We think that the CARE regime, yeah, it's inherently in equalizing because the wealthy benefit from it much, much more. They have the balance sheets which enable them do things like buy-by-to-let properties or short volatility. You know, just one last thing or what, you know, one last sort of thought I have that I'm curious about is sort of when I listen to this discussion, particularly when people think about housing or when people think about, say, make buying the dip in the stock market, people don't

think of themselves as like participating in a carry trade per se. They don't think of themselves as doing the same thing as, say, someone borrowing yen and investing in Turkish lira or Australian dollars. And sort of, I'm curious of like, you know, thinking about like the millions of sort of unwilling or carry traders that don't know it and the way like to the degree to which asset prices become a societal value because so many people livelihoods and lives essentially become more tied to asset values than than their income. Yeah, exactly. And we try to towards the end of the book also, we try to discuss that to kind of the kind of evolutionary aspects, if you like in a financial sense of the carry regime, the fact that it's sort of changed the way that really people think a

little bit, if you, you know, compared to, say, 40 years ago, that we've become used to, you know, particularly here in the UK again, where buy-to-let property is such a big thing, buy-to-rent property is such a big thing. People assume that house prices will always be rising over time. And, you know, they don't really, yeah, they don't see themselves as being, doing a similar thing to people who write put options or do things in, you know, credit default swap market or something, they don't. But it's, and, and we, we argued that really the way that even financial analysts or those involved in, you know, the financial industry think has been changed, because this has changed

to kind of accommodate this idea of the carry regime, becoming the sort of normal, the way things are, the sort of the norm. I think that we see that in, you know, a much greater acceptance in the conventional wisdom in financial markets, you know, much greater acceptance of a large-scale intervention than there would have been, you know, 30, 40 years ago. I mean, I remember very well when I, in my formative period, the 1980s, when the dollar, at the beginning of the 1980s, when the dollar was in a big bubble, you know, the dollar was getting overly strong.

And the Bundesbank, you know, tried to do a bit of intervention. And I was kind of learning that, learning at that time. And I think they were kind of intervening in a scale of like two to three billion. seemed a lot, you know, and I remember being told by my mentors that, you know, it's hopeless they can't defeat the market. The markets are much more powerful than any central bank. But, you know, people then were thinking in terms of central banks, yeah, being a little part of the market and being kind of trivial in that respect in the bigger picture.

Now there's a kind of the conventional wisdom is really that central banks pretty much control the market if they want to. It's a very, very different mindset that people who are involved in markets, or I would say beyond that and generally have. And I think that is this kind of, this rise, you know, the book's called The Rise of Carry. The rise of Carrie has changed the way that people think without people even realizing it. And it goes beyond financial markets. I mean, that's a big part of what we're trying to say at the end of the book. To step back a little. I mean, obviously the world is a lot older than before, at least in the West. There are a lot more people who are at retirement or

near retirement and dependent on their assets for the living than they ever have been in the past. Joe, if you're looking for an example of just how far buying the dip has spread, I've got a 16-year-old son. And a couple months ago, it's at 11.30 a night ago into his room, I say, you know, time to go to bed. And he said, well, just one second, I got to put my limit orders in for tomorrow morning. Wow. And I was like, you're what? He said, yeah, limit orders. Yeah, I've got a couple of core positions, but, you know, if they fall a couple percent, I buy the dip. And, you know, I'd never told them that. I don't know where he figured it out. You know, buying the dip,

you asked this earlier. And, you know, if I've got a levered position in the market, right, and the market falls, then I need to adjust my position or else, you know, my leverage gets away from me. So people who are buying the dip, they're providing liquidity to levered traders. And so So that's why we draw the equivalence of buying the dip as being like a, you know, capturing some of the short volatility premium being like a carry trade. By delta hedging arguments, we argue that, you know, all forms, whether you're short fixed futures, short options, or even yes, just physically, say, buying the S&P every time it's down over the last 24 hours, all of these trades are highly analogous and highly correlated to actually

market making, actually running a continuous high frequency trade. market making trust you well you know that was a fascinating conversation tim jamie and kevin really appreciate the three of you coming on one thing i just want to say before you guys uh go is that you know one thing that's really interesting to me is how much what some of you uh the themes of what you're talking about they're not that different in in a sense from a lot of the sort of mt friendly uh people that we often have on this podcast about the sort of destructive uh nature of an economy that's so driven by asset prices, so need for central bank. So, you know, there's some, there's some synthesis out there that, like,

between the sort of slightly more like fiscally oriented view and this view, you know, we'll find it between these conversations. There's, I believe that there is less daylight than perhaps people think from your framework. And I really enjoyed listening to it. Thanks. Thanks a lot. Okay. Okay. Thanks.

You know, like I said there at the end, I, you know, I think that this sort of description, volatility, suppression, sort of bottling up a potential crisis, it's a different way of talking about a problem that I think a lot of people are recognizing even who come at the market from multiple angles. Yeah, I think that's right. And I think our previous guest, Jared Woodard, he spoke about this as well. But it's that notion that when you are in a sluggish growth environment, you kind of have to engineer profits in different or more creative ways. And I think that's often where the carry trades

come in. The other thing I was thinking about was the mention of or the discussion of the change in investor behavior, which I think is really striking. So we spoke about buy the dip or this idea that whenever stocks go down, people eventually come in and start buying on the assumption that the central bank is going to come in and stabilize everything. But I was also thinking about, remember that other saying from around the same time, which was bad news is good news. Bad news is good news meant that whenever you had bad economic news, the central bank was going to step in with additional liquidity. So actually, if you had bad economic data, sometimes you'd see risk assets go up. And if you think about it, it's just such a perverse way of looking at the overall economy and the financial

markets relationship to it. The fact that people are thinking that that bad news can be good news, bad economic news can be good news for risk assets. That should be a huge red flag. That something is off in that relationship, I think. It's super interesting to exactly that coming from the perspective of like, say, even the U.S. homeowner, they were talking about by the last, and the idea of buying a house with the idea of immediately turning it into a rental property. But think about like, okay, in the U.S., for decades, we've prized homeownership as being really important, right? And, you know, the implication of that is, like, obviously as mortgage rates go down, which tends to happen every time there's an economic downturn with this sort of ongoing multi-decade decline of mortgage, you know, people can refinance their mortgages. and that sort of like turns into a win for them in some sense.

Like there are a lot of people who like, it's been a massive year for refis or the last several years. So, you know, I think there is like this sort of like very weird thing where we turn a bunch of people into economic actors. One of the big things that will sort of drive their economic well-being is the decline of interest rate. Right. Absolutely. And of course, we haven't seen significant wage growth either. So you're basically telling people that one of the few ways to get wealthy at the moment is to invest in the stock market or some sort of financial asset like a house purchase that you would expect to go up in value. And again, it seems to me it's almost inevitable that that impacts how policymakers think and how they view the real economy, this idea that maybe the stock market is the economy, at least for people who have a significant proportion of their wealth tied up.

in financial assets. Yeah, totally. No, I think, you know, there's a lot here in this sort of question of, is there a way out maybe through more aggressive fiscal policy, probably the best hope, but something like that to sort of get out of this cycle in which not only is policy super sensitive, it seems, to financial assets, but each cycle sort of perpetuates the cycle, and it gets bigger. Yeah, fiscal policy or I guess in this case, after this particular discussion, you could also be thinking about macro prudential policy and ways to clamp down on particular carry trading behavior in the market, right? That's sort of what they were getting at with the market structure argument. But yes, really interesting discussion, I think. Okay, shall we

leave it there? Yep. This has been another episode of the Oddlots podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Allaway. And I'm Jill Weizantel. You can follow me on Twitter at the stalwart. And check out our guest's book, The Rise of Carey, the dangerous consequences of volatility suppression and the new financial order of decaying growth and recurring crises. The authors, our guests were Tim Lee, Jamie Lee, and Kevin Koldiron. And be sure to follow our producer, Laura Carlson, at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levy at Francesca Today. And check out all of our podcasts at Bloomberg onto the handle at podcasts. Thanks for listening.

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