The Pomp Podcast - #1354 Darius Dale | Presidential Election Could Make Assets EXPLODE

Episode Date: May 1, 2024

Darius Dale is the Founder & CEO of 42Macro. In this conversation, we talk about Secretary Yellen’s hawkish tone on quarterly refunding announcement, liquidity dynamics, impact of decision to flood the market with bills, rising inflation, asset prices, and future macroeconomic outlook leading up to the election.  ======================= Introducing Espresso - the world’s most interactive portable display. They have a portable screen that is incredibly light, comes with a nice stand, and the user interface is very easy. Anyone who listens to this podcast can go to ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠us.espres.so/pomp⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. They have a brand new offer waiting for you.  ======================= Meanwhile is the world’s first licensed and regulated life insurance company built for the Bitcoin economy. Protect your loved ones with sound money built to manage life’s uncertainty and a broken financial system. Their BTC-denominated Whole Life Insurance policies allow HODLers to pass more BTC on to their loved ones and a tax-advantaged way to access BTC for liquidity during their lifetime. Visit their website at https://meanwhile.bm/ to join the waitlist for a policy and to learn more. ======================= Pomp writes a daily letter to over 265,000+ investors about business, technology, and finance. He breaks down complex topics into easy-to-understand language while sharing opinions on various aspects of each industry. You can subscribe at https://pomp.substack.com/ ======================= View 10k+ open startup jobs: ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠https://dreamstartupjob.com/⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ Enroll in my Crypto Academy: https://www.thecryptoacademy.io/

What's up everyone? This is Anthony Pompliano. Many of you know me as Pomp. You're listening to the Pomp Podcast, which is my effort to find the most interesting people in the world and sit with them for hours while I ask questions in an effort to learn. So it would mean the world to me if you would subscribe to the show on your favorite audio platform, watch episodes on YouTube, and tell your friends and family about the podcast. My goal is to help millions learn from the world's most interesting people. So let's get into today's episode. Today's episode is with Darius Dale, the co-founder and CEO of 42 Macro. In this conversation, we talk about Secretary Yellen's hawkish tone on quarterly refunding announcements,

liquidity dynamics, the impact of decisions to flood the market with bills, how rising inflation is affecting asset prices, and future macroeconomic outlooks leading up to the election. This conversation was fascinating. There's tons to unpack in here. Darius brings charts, graphs, and insights that will definitely make you think differently about how you allocate capital. Here is my conversation with Darius Dale. Anthony Pompliano runs Pomp Investments. All views of him and the guests on his podcast are solely their opinions and do not reflect the opinions of Pomp Investments. You should not treat any opinion expressed by Pomp or his guests as a specific inducement to make a particular investment or follow a particular strategy,

but only as an expression of his personal opinion. This podcast is for informational purposes only. Today's episode is brought to you by Espresso, the maker of the world's thinnest portable display. Now listen up. If you're like me, you feel like you are at a command center when you sit down at your desk. I got a gazillion tabs open

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um let's just dive into q2 quarterly refunding announcement and what does that mean and why is she doing this yeah appreciate your problem thanks for having me back on the show man it's always good to be here so um let's just start by explaining what the quarterly refunding announcement is for investors who may not be familiar uh that's when the treasury outlines its net financing uh estimates uh for the uh current and upcoming quarter and then they also provide their projections for things like the Treasury General Account Balance, which is essentially the Fed's checking account, or sorry, the Treasury's checking account at the Federal Reserve. And then there's a lot of other information in there as well. But the things that matter most

to market participants are here on slide one, are one of the things that matters most is here on slide one. And that's the data that we get on Wednesday or Monday afternoon in the QRA, which is the privately held net marketable borrowing totals for the current quarter and the next quarter, and then the end of quarter Treasury General Account Balance total. So So for the current quarter, they're forecasting having to borrow $243 billion of net marketable borrowing from the private sector. That's up $41 billion from where they projected Q2 to be in the Q1 quarterly funding announcement. And then what I thought was pretty hawkish is when you look at the next quarter estimates for privately held net marketable borrowing, They skyrocket $604 billion to $847 billion, and that increased $847 billion is going simultaneously alongside a $100 billion increase in the Treasury general account balance.

So this is a Treasury that, in our opinion, Jenny Yellen is using the Q2 quarterly refunding announcement, at least the first day of it. We'll get another update on Wednesday. But the first day of that, she's using it to send a hawkish signal to market participants. Now, is the signal working? yeah i mean in recent weeks right like so if you go uh if you look at slide two in this chart where we show we unpack the different uh dynamics of our net liquidity model which is essentially everyone's net liquidity model now we invented this model a few years ago uh this is uh it's the trip a fed balance sheet uh the total assets on the fatality minus the treasury general account

balance and the reverse equal facility balance and uh you know subtracting those two balances uh gives us a clearer indication of uh where you know that liquidity is on the fed balance sheet as it pertains to bank reserves and so uh up until you know really for throughout most of 2023 uh the the the treasury is doing things from a net financing standpoint uh that was specifically and expressly designed to tap into the excess of funds that were fully stored on the best balance sheet in the form of the first reboot facility balance and the reverse equal facility balance which the fed uses uh to mop up excess liquidity in the financial system uh in order to maintain the floor on the policy rate corridor. That balance has declined from about $2.5 trillion

at the beginning of 2023 to only $506 billion currently as a function of the policy that Jenny Yellen and her cronies at the Treasury were implementing. And that was a boost to liquidity, is a boost to asset markets throughout that time period. Well, if you see over the past kind of week or so, or really, really since the beginning of April, we've seen both the RRP and the TGA balance, treasury general account balance, move in a direction that is less supportive for liquidity that drains liquidity, i.e. both balances have gone up. We're now at $506 billion in terms of the R&P, and we're up at $910 billion from the beside of the TGA. Got it. And then when we go, we take a look at the market liquidity. I guess one story that you and I have talked about over

the last couple of months is China was putting a ton of liquidity in the market. America was trying to drain. There was this like back and forth battle between it. It seems like now and on slide three, you have Secretary Yellen's decision to flood the market with bills was a contributing factor to this declines. Like talk a little bit as to how that plays into some of this. Yeah, absolutely. So this is, you know, again, so if you go back and think about the types of funds that are you being that actually allocate to the reversible facility, it's typically money market funds. It's money market funds that are the safety of the Fed's balance sheet or the overnight liquidity relative to T-bill instrument, that those are the

treasury securities that mature in under a one-year time horizon. And so if you go and you sort of look at the composition of net marketable borrowing over the last 12 months, through Q1, the 69% of total net marketable borrowing was financed in the bill market, which is very anomalous relative to history because only if you look at total net marketable borrowing across the $27 trillion that the treasury has borrowed thus far from the private sector, only 23% of that thus far is in the T-bill market. And so for her to supply 70% of total net market borrowing in the bill market, in our opinion, is an explicit signal that she was trying to create both liquidity and spread

dynamics that would cause funds to flow off the RRP. And she was quite successful at doing that. Yeah. And then investors, they were concerned. Are they still concerned? Yeah. Yeah, so what we show on slide four is the composition of nominal net marketable borrowing. And so we show, again, the bills, the blue bars and the red bars are the coupon issuance.

And we see that bills were projected to decline by $245 billion here in Q2. And this is largely as a function. We typically see that in the second quarter of the year. That's typically a function of the Treasury expecting to get a significant amount of tax receipts. And so they typically cause bills to go down in Q2. But what was quite concerning, and investors were right to be concerned about that, because ultimately what it means is that the decline in the RP that has been a positive tailwind for asset markets since this early part of 2023 was likely to stall out. And we've seen it stall out in recent weeks. And perhaps more

importantly, we saw coupons actually increase to $447 billion. So on a net basis, when you think about treasury net financing policy, it creates essentially a crowding out effect for broader asset markets. The US dollar, you and I talked about this a few years ago, the US treasury is at the very top of the global capital structure. When the treasury issues debt, everyone, we all have to make room to absorb that debt because it is the world's reserve currency and the world's reserve liquidity management, preferred liquidity management tool. And so whenever they issue coupons, which are interest-bearing securities that have a duration and that increase the overall portfolio risk for any investor that's onboarding those securities, then that's when you start to

see some indigestion in asset markets as investors have to create that space, if you will, to absorb those coupons. Got it. And then on this last slide that you've got here, this net marketable borrowing and the TGA, explain this a little bit more because I probably don't understand this nearly as well as you do. Yeah, absolutely. So going back to the discussion, you know, so, you know, we'll go back to slide three really quickly, where we showed that, you know, the yellow was explicitly targeting the bill market in order, in our opinion, to release funds, track funds from the RP into asset markets and into the economy. Well, that's been the spark call, because if you look at on slide five, where we show the spread between market observer rates

and the weighted average interest rate on the various segments of the treasury market. And so the spread gives you an indication of, okay, where is it most expensive and least expensive for the treasury to issue debt? And so at the top, we show the seven-year treasury yield minus the weighted average interest rate on all marketable debt. And the seven-year treasury sort of corresponds to the weighted average maturity of all marketable debt. That's a little bit over six years. So that plus 93 basis point spread suggests that, hey, if the treasury was just to issue a six and a half year treasury instrument, they'd be paying roughly 93 basis points higher today than they would on their existing portfolio of treasuries.

When you go and you look at that same spread across the various segments of the treasury market, it's pretty clear to see that the bill market is where she's getting the most, did most of the largest discount, really the only discount, minus 35 basis points. If you look at the spread between observed rates in the notes market relative to the five-year treasury yield, that's 180 basis points positive spread. So they would cost them money. It would raise the overall weighted average effective interest rate on their notes portfolio. If you look at a 10-year rated average interest rate on bonds, that was 108 basis points positive. So that would raise the weighted average effective interest rate on their bond portfolio. Same dynamic with

tips market as well. That's about 114 basis points. So that minus 35 basis points we see there suggests to us that, hey, Treasury Secretary Yellen, when she outlines the composition of the net marketable borrowing for Q2 or for Q3, really, and then tomorrow morning's part two of the QRA, she should, it makes the most economic sense to continue targeting the bill market because that's where the discount is. However, if we see an increase in coupon supply and or an increase in bond supply, in our opinion, that would be a very explicit signal that she's actually trying to create a duration risk in global investor portfolios, because ultimately that would tighten financial conditions. And a tightening of financial conditions is likely

to slow inflation. And that's exactly what President Biden needs. If you look at the most recent polls going back to last week, you know, he he had a narrow lead in a lot of swing states, but that has evaporated. And I want to say he's only leading in Michigan. And the reason for that, at least as what's been cited broadly by political strategists, is that inflation continues to be the real big issue for him on the economic front. And so, you know, rather than continue to goose asset markets by creating net financing policy that causes, you know, more money to flow into asset markets and more money to flow into the economy, it may be the case that here in Q2 and in Q3, the Treasury Department is actually shifting their net

financing policy in a way that tightens financial conditions and actually has a depressing impact on inflation, which could potentially help save Biden his election bid, re-election bid. How should we expect this stuff to impact asset prices? Obviously, inflation is kind of one component of it. We're going into an election year. I think a lot of people are looking at all the geopolitical conflict and they're saying to themselves, how do I position my portfolio to just protect myself, to be prepared for the maybe unknown, understanding some of these dynamics that are playing out. Yeah, 100%, man. So in our opinion, it's always about understanding what the dominant driver's markets are in the context of the positioning cycle. Those are, in my opinion,

if you're trying to make median term calls on asset allocations in terms of getting more bullish or bearish or taking up your gross exposure or net exposure to a particular asset class or taking that down, you need to understand the evolution of the dominant drivers of asset markets at any given time, particularly relative to the dominant drivers of the positioning cycle at any given time and and right now we kind of look at survey the global macro landscape and that's something that obviously we do at a very high level for our clients here our institutional and retail clients here according to macro which is help them understand all the moving parts with the full distribution of probably economic outcomes looks like and from a modal outcome perspective uh we

continue to see uh continue to get confidence in our resilient u.s economy think that thing's been active uh since uh middle 20 summer 2022 uh that was the thing we offered back then uh and then with respect to the right-tail risk, things that are still active are green shoots globally theme. We continue to see positive dynamics out of the global economy from a leading indicator perspective. Our China front-loading stimulus state, we continue to receive sort of confirmation from leading and then coincident indicators from China that suggest BBOC is likely to continue supplying liquidity over the medium term. But what is new and has suddenly become a dominant driver of asset prices and ultimately the positioning cycle that could cause asset

prices to unwind from the current trends is the fact that sticky inflation is now a dominant theme here in the u.s economy and the outcome of sticky inflation is causing uh some indigestion with respect to uh u.s and global liquidity and the reason it's doing that is because the dollar is really starting to break out the dollar has broken out uh it's now bullish from the perspective of our volatility so momentum signal and one of the most important things investors need to know is that the dollar is one of the most uh a counter-cyclical one that has the highest inverse correlation on a coincident basis uh to global liquidity uh has a very high inverse correlation or sorry a bond market volatility and currency market volatility

which the dollar tends to be positively correlated with also have a very high uh inverse correlations uh to uh global liquidity on a coincident basis so what we're seeing now is sort of put the piece the pieces of the puzzle together we're saying some of the things that have been bullish for asset markets, particularly on the economic front and on the stimulus front out of Asia, are becoming less important to markets. And what's becoming more important to markets is stickiness of inflation in the US and ultimately how the Fed and Treasury are either going to respond to that, which we just talked about with respect to the Treasury, or going to ignore it and actually be forced to do nothing about it. Because right now, we're moving from

a condition where both the Fed and Treasury's policies on a net financing basis and on a forward guidance basis were explicitly dovish for much of the past six months. And we are now moving into a period where they're perhaps going to be explicitly hawkish or at the bare minimum, just hawkish at the margins, which is a much less bullish backdrop for asset markets. And when you kind of look through this, should we expect this stuff to change or are we already in the like what I'm going to call like the election playbook, right? And that doesn't necessarily mean that the Treasury or the Federal Reserve is like actually

looking at the election, but just like it does feel like there's these four-year cycles. It does feel like there's people starting to talk about this stuff. They are paying attention. There is, you know, at least the accusation of if you don't start cutting now, you're going to wait till you're closer towards the election. It does have an impact, whatever. Like, are we already kind of whatever is in motion now, we should continue to expect to be in motion by November?

or do you think that there are like a pivot point where we could go from hey we've got one kind of approach today end of summer we could pivot and be in a whole different regime by election time yeah that's uh that's that's that's very much could be the case i mean in our opinion going back to that you know they're trying to play this from a game theory perspective start by thinking okay what does president biden want because he's going to have some influence over how the treasury chooses to enact policy right the treasury has you know the treasury knows the budget deficit's to be generally speaking but how they choose to finance the budget deficit it are you know sort of uh you know discretionary uh choices by by nature and so they can do things that are i guess

more supportive for what the administrators objectives are less supportive uh depending on the relationship there and obviously ellen has a very positive relationship with joe biden and so in our opinion you know when you think about this from the perspective of just isolating the election you know typically elections are actually quite bullish uh stocks typically perform well into presidential elections, you know, if you look at it, so we're right around, you know, let's call it six months out of the election or six months out before the election, you know, the six months leading up to an election with data going back to the 1948 election, the median return for the S&P is plus 4% with an 84% positive ratio. And then if you have a

Democratic incumbent running, the median return doubles to about plus 8%. And this is a six-month return prior to the election. And so that's the baseline. We're not saying you have to expect the baseline, but any statistic, any backtest with such a high percent positive ratio tells you that there are underlying and structural and more importantly, stable market forces that are causing that. And so in our opinion, I think it doesn't necessarily pay to be a bear heading into election unless you have very specific high probability catalysts on the bear side that are likely to materialize and become dominant drivers of asset markets before the election. And one of the things that we're doing a tremendous amount of research on is trying

to understand the interplay between sticky inflation and what the Treasury Fed's policy responses are likely to be to the advent of sticky inflation as a dominant market date. And really, we're kind of very much in that debate process. But the early indications of that debate process are certainly moving in a hawkish direction, as we highlighted in previous slots. Where can we send people to find you or find out more about 42 Macro? I appreciate you for having me, man. Thanks again, as always. So if you guys like staying on the right side of market risk, if you like making money in bull markets and protecting gains in bear markets, then definitely come check us out at 42macro.com. I'm on Twitter at DariusDale42. So if your goal

is to just be educated, we're happy to do that as well. So come check us out on Twitter as well. So we appreciate you guys. I learn something every time we talk, my friend, and I always appreciate how much time and effort you put into not only the charts, but also the insights. So we'll definitely do it again in the future. I appreciate you, brother. Thank you for all that you do as well, man.