We Study Billionaires - The Investor’s Podcast Network - TIP262: REPO Markets - What it is & What's happening (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we have a really hot topic that many people in the finance industry are talking about, and that's the strange events happening in the $100 billion overnight repo markets. Our guest, Luke Roman, is a TIP fan favorite that's one of the smartest guys in the industry, and we are so excited to cover this topic with him this week. Throughout the episode, we help people understand the basics of the repo market, what the stress is that we're currently seeing, and whether this means that there's more QE on the way.

Starting point is 00:00:28 Finally, we talk about how this might impact the stock market and other macro themes. So without further delay, here's our chat with Luke Groman. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Hey, everyone, welcome to The Investors podcast. I'm your host, Preston Pishon. As always, I'm accompanied by my co-host, Stig Broderson. And today, we have brought back the one and only Luke Groh.

Starting point is 00:01:09 Roman, welcome back to the Investors podcast. I have no idea how many times we've had you on, but every single time we have you back, you're a crowd favorite, and we always learn so much. And so, Luke, welcome back to the show. Thanks for having to be back on, guys. It's great to be back. So we're talking about a hot topic today. And I mean, you can't get this word said enough in the news right now. And for people that are listening to this in the future, here we are the 25th of September in 2019 and the big word that we're talking about is repo. Everyone is talking about repo. I would argue very few understand what repo is. What we really want to kind of accomplish

Starting point is 00:01:50 here is like let's start off with the basics. Let's define terminology. Let's talk about the basic mechanics of the repo market. How would you explain this to if you were going to a high school class and you were talking to some kids, how would you describe the repo market? I would describe it in brief that it is basically the plumbing that makes the financial system run. The key is that it's the plumbing to the system. You know, in a repo transaction is just, you know, a dealer lends securities, gets back cash at a small haircut and whether that's an overnight transaction. It says, and it's just a means of cheap and safe financing for other positions. And that's why it's so important and why it's such a big, you know, why it's.

Starting point is 00:02:37 It's the plumbing, in essence. So let's just take, for example, let's say that you're sitting on a bunch of bonds and I'm another bank. Say you're a bank and I'm a bank. You're sitting on a bunch of bonds. I have a bunch of cash. I basically take possession of your bonds. I provide you the cash that I was holding.

Starting point is 00:02:53 We already have, when we do that deal, we have it structured that tomorrow morning. We're going to then swap back. You're going to pay me a little bit of interest on that. And the interest should be between the federal funds rate, which right now is 1.75 and 2%. And so we pay a little bit of interest on that exchange and then I take possession on my cash again and you take possession of your bonds and that's the end of the deal. But that term was that one day term or whether it's a two-week term is established before that trade between the two of us occurs. Am I describing it appropriately there? Yeah, that's, I think,

Starting point is 00:03:28 a fair description. And so I think it's important for people to understand that you have basically two different markets here. You have the federal funds, you have the Fed funds where banks can conduct this exchange with a central bank and it's uncollateralized interbank loans. But then whenever you get into repo where it's between two banks, that's when it becomes securitized between the two parties. So if I'm providing some type of asset to Luke, there's a redeemability to that. It's almost like when somebody has a house, the bank can take repossession of the the house to make it securitized. So these repos that are happening between banks are securitized when they're happening between a bank and the central bank. That's whenever they're

Starting point is 00:04:12 uncollateralized obligations between the two of them in the repo market. So just to kind of get some of that terminology out of the way. Let's talk about what in the world's happening. So here on this, or I'm sorry, on the 16th of September, the overnight general collateral repo traded as high as 8%, which is 6% higher than the 1.7%. to 2% range. And just to kind of give people an idea of how ludicrous this is, since 2006, this has never happened. In fact, that much of a move beyond what is what we'd call a normal deviation of how

Starting point is 00:04:50 much of a premium people would pay over this federal funds rate, this would be described as I think like a 42 standard deviation event is how far off the variance we are with this. I mean, this is just a total break that happened on the 16th of September. So you were on our show. And when was this, Luke? This was probably June 25th. I was looking at the notes. 25th of June.

Starting point is 00:05:16 And I remember the conversation because you kept bringing this up. And you kept saying, you know, this is not normal. This is, this is broke. And this is going to be a story. And sure enough, here we are by September. I mean, you nailed it. I mean, you saw this months before. before this became a thing. So tell people what you were seeing back then and then describe this

Starting point is 00:05:39 interest on excess reserves versus the federal funds rate and how that works. If we go back in time, you know, to five years ago, foreign central banks stopped growing their holdings of treasury bonds. And that was a big moment, number one. And so when that happened, you saw moves in the U.S. and abroad to begin to shift the financing of U.S. government deficits onto the global private sector. And so you saw that begin to crowd out global Euro dollar markets. Libre began rising. You saw the U.S. take regulatory steps such as regulating banks into buying more treasury bonds with HQLA. 1516. You saw the regulation of money market funds into buying a lot more treasury bonds and keep that one in mind because that's going to come back to be important in the

Starting point is 00:06:27 repo story. And I think going forward as well, this process of basically shifting. the financing of the U.S. government from global central banks to the global private sector took place from 3Q14 and then sort of, I would say, came to a head last year in the third quarter of 2018 when due to regulatory changes, banks stopped growing as fast or stopped growing at all, depending on who you talk to, their FX swap books. And that's when FX hedged treasury yields went negative for the first time in, I think ever, but the punchline was basically that was a moment where the foreign private sector began being paid effectively not to buy treasuries on a hedged basis. And so that began to weaken the marginal foreign private sector bid for

Starting point is 00:07:18 treasuries and pushed more of that onto the domestic sector entirely, and in particular the U.S. banking sector. And so fourth quarter of 2018, excuse me, you saw. U.S. primary dealers buy treasuries at about a $600 billion annual rate in the fourth quarter, which is a lot. And that continued into the first quarter of this year in terms of them buying more and more and more of the U.S. government's debts that's being financed by the domestic private sector. And that came to a head in March where Fed funds rates went over interest on excess reserves and stayed there. Now, interestingly, back in March, it was said by some people, you know, that really, you know, are really in deep in these markets, that it was just a technical. It was a short-term, temporary, technical, that there are ways for the Fed to fix this. You know, at the time we said, yeah, there are ways for them to fix it, but that's ignoring the bigger picture. And so you fast forward, three months, we had two cuts to interest on excess reserves. You've had two Fed funds rates cuts. And they still never, they still haven't gotten fed funds rates below. interest on excess reserves. And our whole case this whole time was that what you're seeing is the

Starting point is 00:08:30 accelerating crowding out with Fed funds rates over IEOR was a symptom of the accelerated, the acceleration of the crowding out of the U.S. private sector that really began five years ago and came to, you know, really accelerate in the 3Q18 with FX hedge treasury yields going negative, negative, excuse me, and then, you know, accelerated further in March. And what I think ultimately we're seeing now with What happened in repo last week is I think another important acceleration or this U.S. fiscal crisis, for lack of a better word, andcipient fiscal crisis perhaps more, more apt, is accelerating further. It's getting more acute. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer.

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Starting point is 00:13:14 All right. back to the show. Luke, you were talking about the transition there at the end of 2018 where international banks, especially in Europe, stopped buying U.S. debt, which meant that the primary bias here in the U.S. were forced by law due to the changes of basically what happened in 2008 financial crisis, is the requirement to purchase really what's causing the drain in liquidity that's driving so much of the repo problems? that way you described it is is fair that ultimately that transition and again foreign private sector is not stopped buying but they've stopped buying enough and you know they deficits are rising

Starting point is 00:13:57 faster than their appetite to grow them because they're the you know right now you know when I talk to you in June at the end of June I want to say the FX hedged yield on a 10 year treasury for a yen investor was like negative 60 basis points. And for a euro investor, negative 85, and those numbers are now negative 100 basis points and negative 125, respectively, you know, ballparkish. So, you know, before today's, before the last week or so, it's moved. So they've gotten more negative. In other words, there's more incentive to either not buy, not roll treasuries, or take the dollar risk on yourself, which you can do on the margin, but you simply can't do that for really big books. And so that by nature forces more of the financing of U.S. deficits onto the

Starting point is 00:14:44 U.S. private sector. Now, everyone's been talking about the banks, and, you know, there's been several, you know, really three primary dealers that have bought, you know, this is per Zoltan Posar's work, about $200 billion in treasuries over the last 15 months. And that's a substantial portion of the U.S.'s deficit over that time. But not as many people are talking about just the general absorption of U.S. economic liquidity when, you know, there was an article in the Wall Street Journal in early July, noting that for the first time and a long time, maybe ever, a majority of the U.S. long-term debt was being purchased by U.S. individual retail investors. So, you know, to the extent that I have a finite balance sheet and I want to own 10-year treasuries, yes, they're marketable,

Starting point is 00:15:30 but once I buy those treasuries, I can buy a car, or I can't use that treasury, and I can't use that treasury is collateral for something else per se. And so I think there's sort of two portions of this sucking out of liquidity. It's what's happening at the primary dealer level. But then I also think there's a less discussed topic of we're financing our own deficits for the first time really in 70 years. And so there's actually sort of classic crowding out taking place. So what is driving that shift of why other countries are not buying U.S. debt? I think it's a couple things. I think, you know, mechanically for the private sector, I think they are apolitical and just, you know, the profit motivated. And so it's that FX hedge treasury yields going

Starting point is 00:16:15 negative begins to change their economics. And the way you fix that is either a much weaker dollar to normalize FX hedged yields that you need a much weaker dollar or you need much higher rates. But I think away from that, which we already touched on, I think it's two things. I think it's number one, when you hear slowing trade, when you hear China's current account surplus is vanishing for secular reasons as they become more consumer and less export driven, you know, we hear about that a lot as it's negative for China or as it's a change for China. And what we never hear about is that the flip side of that coin, which is they don't have the dollars to reinvest back into treasuries. Similarly, what we've seen in oil, where we hear on, you know, the U.S. is becoming

Starting point is 00:17:00 self-sufficient in oil, shale has capped oil prices, shale has taken power from OPEC, all true. But we rarely hear the flip side of that, which is at $55 a barrel, OPEC doesn't have a lot of dollar surpluses to reinvest into treasuries like they used to. So some of it is secular current account surplus deterioration, call it, amongst the big creditor nations in the world, which are really, you know, China, Germany, South Korea, and then it falls off pretty sharply there, depending where you are in the oil cycle, it's OPEC. And then I think there's geopolitical reasons as well. Of course, you've seen with Russia, China, others as well, but to the extent that we are spending ignored an amount of times trying

Starting point is 00:17:45 to sanction a lot of people will say, you know, I think that that doesn't help make the case for redeploying any surpluses that they do have, which are shrinking into treasuries. I'm sure the typical listener hearing this conversation is just saying, well, how in the world are interest rates over in Europe all negative? No matter where you go, they're negative. Here in the U.S., the 10-year treasuries still positive by quite a bit. And when I say quite a bit, I mean like higher than 1.5% on the tenure, which is, I guess, laughable. But in comparison, that doesn't add up. So they're saying, well, you would think that the capital over in Europe, for example, would absolutely be buying up U.S. debt if they've got a positive yield. So explain to the audience why that's happening. Yeah, I think a lot of it has to do with what after FX hedging costs yields are doing. And what that means is you can buy treasury bonds and, you know, in the 10-year at, say, whatever, 1.8% today, 1.75% today. You can buy those and there seems to be an easy pickup in yield, but you're absorbing the risk of the dollar falling against the euro. And so if you look

Starting point is 00:19:02 back to 2017, the dollar or the DXY fell about 12% in 12 months. And so, you know, the risk of the dollar may not seem like much, but if you're running a 50 or $100 billion portfolio and you're unhedged and the dollar falls 12% in 12 months again, or there's a plaza accord like we had in 85, where it falls 25 or 30 percent, you're going to be out of a job, best case. And so you need to hedge those, the FX risk. And once you go to do that, historically, for a long period of time, that had been positive, which suffice it to say it was positive, up until third quarter of 18, borrow money in Euro, put money into treasuries, hedge the dollar risk, and still pay the insurance, that's basically an insurance premium, the FX hedge, and still earn a positive carry, still earn a positive

Starting point is 00:19:50 carry, still earn a positive yield after that cost. And after 3Q18, the cost of ensuring a fall in the dollar got so expensive that you could no longer afford to borrow money in euros, buy U.S. treasuries, hedge out the dollar risk, and earn a positive yield. And so the opposite is also true. And so, you know, as the U.S. dollar investors, you and I could in theory buy euro debt and sell euro forward and the hedging cost pickup to us American investors, we could earn more doing that trade than we could just buying 10-year treasury at 1.75% today. So considering the drop-off of buying happening in Q4 2018, we do hear arguments for some of the players that if you're a European banker, the dollar needs to devalue against other currencies,

Starting point is 00:20:44 including the euro, and that is why it's happening. The way the markets are pricing, that's a fair statement, but I don't know that that's what they are saying per se. Because really what drove it was a balance sheet constraint. What was happening is largely U.S. banks were growing their swap books infinitely and basically taking on the risk of a falling dollar. And by that happening, that was allowing the global private sector to buy treasuries, hedged, and still make a positive carry. So basically, the U.S. banking system through the swap books were absorbing the risk of a fall in the dollar. And starting last fall, basically for regulatory reasons, and I still don't know which regulator, why. I don't know if it was Basel or if it was Dodd-Frank, whatever reason, a balance sheet constraint hit where they basically just,

Starting point is 00:21:37 discourage the infinite growth of those FX swap books at that point. And once that happened, then you began to see, you know, market forces where suddenly, you know, if you can't hedge and the price of the hedge has, or if you can't grow the hedge book, the price of the hedge goes up. And once the price of the hedge goes up, you know, so basically once the price of that hedge begins to go up without the growth of that balance sheet, to be clear, I don't know that the bankers over there are saying, okay, we think the dollar screwed. So this is something, this is a bet we want to make.

Starting point is 00:22:07 I think it's the way the balance sheet regulations are playing through or effectively, you can infer that from those movements. So let's talk a little bit more about this 8% blowout that happened here in September 16th. So if you've got the central bank willing to provide liquidity at this 2% rate, right? And all of a sudden, you have people saying, hey, I'll pay 4%. I'll pay 5%. Just give me some cash. I'll pay 6%. I'll pay 8%. And this is an overnight. It's based on an annual rate. But for something that was normally 2% to blow out clear up to 8%. And historically, I think the deviation was like 0.02 or something like that. That's totally crazy. That tells you that there was no cash to provide this person who's wanting to take on the position.

Starting point is 00:23:04 So, I mean, that's kind of crazy. And you weren't seeing this in the international markets. You were just seeing this in the U.S. Talk to us about that specific event. Look, I think there are, you know, I think there are near-term technical factors, short-term factors at play. And then I think there's the overriding theme, right? So within that you had, when I say the short-term technical factors, I think the people that have been talking about those things, I think, are absolutely right. And by that, I mean, you're coming up on quarter end, and so there's liquidity requirements, window dressing that banks want to do. That happens every quarter. You had a corporate tax payments due, so that's also draining cash out of the system. That was known ahead of time. It still happens. I think those two factors should come and go. You had the Saudi attack on that Saturday, and there were, you know, credible rumblings that the Saudis and the aftermath of that were in the markets on Monday and Tuesday draining cash to make payments to fund whatever they need to do. Obviously, they have dollar needs to fund the kingdom. And if half the oil is down or half the oil production capabilities are

Starting point is 00:24:17 down, you'd expect their cash burn rate to possibly be fairly substantial. And so you would expect to see them draining that. So I think you had a number of our confluence of short-term facts. some expected, some unexpected, but all short-term technical drivers. And I think a lot of the narrative around what happened last Monday and Tuesday have been focused on these things. And that's not to say they aren't correct. Some of the things we were talking about in June would have happened regardless, but I think some of these short-term technical factors probably brought it to a head sooner and maybe more explosively. Like I said, the short-term is where we're seeing. the narrative really focused on, and there just is not a lot of discussion going on around,

Starting point is 00:25:04 this is the first time we're having to finance our own deficits in 70 years. And, you know, between the liquidity coverage ratios, the requirements of primary dealers to bid at auctions and deficits which are simply not slowing down, and that's assuming we don't get into a recession, there's not a lot of discussion still around that portion of what drove last week. So look, in Europe, they're working with a model where more money is going out than is going in. And you have people here in the U.S. who are seeing the effects of those policies, and they're saying that they don't want to go there. How do you see the policies here in the U.S. being influenced by European Central Banking? I think the repo programs they put in place by them time.

Starting point is 00:25:51 Look, if I was them, I think they've handled this as best as best they could, really. They're in an unwinnable situation because the reality is, is the political side has been irresponsible to varying degrees or wanting to kick the, you know, kick the can for that irresponsibility for 80 years. And so nobody wanted to, you know, basically it's fallen onto the fed's lap. It's accelerated under Trump. So now, I think, you know, given all of that, I think they've done not that bad. I think they've done what they could, which is to say, if I them, you know, I put this repo program in the place. I say it's temporary. I extend it out around quarter end. And this, you know, this buys me three or four weeks. And now I can start

Starting point is 00:26:37 to change messaging. And, you know, because realistically, you can't go from we're going to do three or four more cuts to, you know, we're going to do $100 billion a month in QE until further notice, right? Because that could create more problems than it solves. You've got to allow, you know, the levered plays and the markets to begin to sort of go. We got $16 trillion. negative interest rate debt that's on the wrong side of the boat, in my opinion, because they're going to go to QE. I mean, it's, and maybe you're starting to see it today with the long end of the curve backing up pretty pronounced real rates turning higher. Yeah, their next step, I think, is they're going to have to do QE because, again, people said, well, this is just temporary.

Starting point is 00:27:14 I said it's just temporary. Fine, step away from the money markets. Let them go back to eight because the deficits are going away. And at negative 100 basis points, the Europeans aren't going to be buying, you know, private section, not going to be buying enough treasures. So step away. and let's see what happens for a month at 8% repo. Talk to the audience about what a standing repo facility is and what kind of function that could play in all of this. It would do a lot toward liquidity, as I understand. I mean, it's effectively a wand you could wave and magically turn treasuries on bank balance sheets into cash whenever you need it, which is very powerful, very liquefying.

Starting point is 00:27:52 It effectively amounts to, again, financing the fiscal authority. authority through the banking system via, you know, by the monetary authority. So let's transition back to the discussion about Europe. Because regardless of what is happening in the U.S., Europe has these banks that are just too big to fail. So if the policy is to do more QE and drive down interest rates even more, how can that possess? Yeah, you know, there's some interesting things going on with Europe.

Starting point is 00:28:25 There's, I would say three things. So there's this tiered structure that they just laid out, which I'm trying to read as much as I can. There is, call it, the implications for the dollar and for the treasury, you know, treasury market of a rise in long-term rates in Europe and particularly the boon as a potential carry trade is unwound. And then there's what they've been doing in energy, which is interesting as well and could buy them room. So I'll touch on each quickly. So the tiered system that they began discussing or rolling out or drogue proposed, what, last week or 10 days ago, you know, people that are really deep in the weeds on this think it's a really big deal in terms of just the amount of liquidity it could drive. That it could be a real game changer in terms of asking that question, you know, how much more QE can they do that, you know, doesn't hurt the banks? This might, and, you know, basically, my understanding is they're basically paying the banks to make loans.

Starting point is 00:29:24 effectively. So to your point, the question at this point is political, it seems like more. There seems to be some pushback on that, as well as on the fiscal side, which ties into the second point, which is you've actually started to hear even, you know, some of the Germans say we need to do more fiscal stimulus and take advantage of, you know, basically, you know, hit this, hit this bid in the bond market and do some fiscal stimulus. We'll see politically. And to me, the question, too, is if you have a backup up in boon rates, you know, does that lead to an unwind you've seen? Has there been a carry trade of some description put on where you're short boons and long dollars, long treasuries? What does that do to the global financial system, setting aside any of the FX hedging

Starting point is 00:30:10 that stuff we talked about before? And then the last part, I think, too, within Europe has been what we've seen since late June regarding energy, where the Europeans have been, you know, for lack of a better word, they've shown surprising backbone vis-a-vis the United States over the last three months in regards to Iran, in regards to setting up this SPV, the special purpose vehicle to buy oil from Iran in euros. And, you know, last fall, three, they're the world's biggest energy importer. They spent $300 billion, or $300 billion a year with 85% of that being spent in dollars, which makes no sense to them. And so if they were able to convert that entire, bill into euro, it's basically a $250 billion increase to their current account surplus instantly,

Starting point is 00:31:00 which you can then redeploy. It buys them time at the very least. And you can talk about how you can spend it. Can they get out of their own way politically in terms of deciding what to do with it? But the bottom line is their current account surplus would rise by, you know, $250 billion right off the bat, which then would allow them to say, hey, China, or hey, US, will weaken, or excuse me, will strengthen the Euro X because we know we have the breathing room with this $250 billion we're picking up over here. So those are the three things I'm looking at with Europe. So let's quickly talk about how do you position yourself through all this? Because this is, this is some crazy stuff. The last time we talked, you had brought up gold, you brought up Bitcoin.

Starting point is 00:31:44 I mean, where do people position themselves, particularly if you're a baby boomer and you're in a position where you just can't have an appetite for a lot of volatility. What in the world do you do? Yeah, it's hard. To me, the one thing that is crystal clear to me is that we are moving towards QE or MMT or capping of yields at the long term or all of the above. The bottom line is that it is. is a matter of national security for the U.S. and other Western social democracies, if you will,

Starting point is 00:32:20 for their bonds to be certificates of confiscation on a real basis. And so if I'm a baby boomer or somebody who's retiring or retired, the way I'm thinking about it in terms of my long-term assets, that's sort of like for the wheels to not completely come off the cart and for you to need, you know, spam and gold and guns and, you know, K-rations, sovereign bonds have to yield negative on a real basis for an extended period of time. It's just where we are with debt levels, that's how it's worked out. So understanding that, to me, I think everybody needs to have an allocation of, you know, physical gold, five to 10 percent, more if you really understand gold markets and really feel like you understand what's happening here. I still like equities

Starting point is 00:33:07 relative to debt. But I ultimately think, again, tying back to this on the real basis, the debt has to lose on a real basis to be for sort of everything to kind of hold together. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up. And customers now expect proof of security just to do business. That's why VANTA is a game changer.

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Starting point is 00:36:41 All right, back to the show. So let's imagine that the Fed comes out and they say that we need to do QE. Our past experience have resulted in assets going up in price in a major way. But given that we talked about, do you think, A melt up or meltdown is most likely to occur? I feel like a meltup is a much more likely scenario than a meltdown. A, positioning, right? You've got $16 trillion in negative interest rate debt.

Starting point is 00:37:07 And it's been interesting. I think, you know, if I was sitting in negative interest rate debt, seeing what the Fed did would scare me to death. Because to me, the message of last Monday and Tuesday, if you look at overriding, the dollar shortage came home. the U.S. money markets broke before China did. And when push came to shove, right, when we talked in June, I said our bet, you know, consensus that the Fed will stand aside for a while and let people twist in the wind on risk.

Starting point is 00:37:36 And we saw Fed fund where we saw repo go to eight, that didn't let anybody twist in the wind. How long did it take them? It didn't take them 24 hours. It took them 12 hours to respond. And now we've seen two or three upsizings to that, the addition of a two-week term repo. and a doubling of that. I don't know if you saw that today, but they took the term repo from $30 billion to $60 billion,

Starting point is 00:37:57 the $75 billion overnight to $100 billion. I was asked earlier this year, you know, if you're wrong or what were the signs you'll be looking for if you're wrong that, you know, that the meltup isn't the right scenario. And one of the things I said was, look, when push comes to shove and if the Fed stands aside and lets people twist in the wind, that I'll have to completely revisit this. and Monday, Tuesday, boom, Fed was there. Fed's got your back.

Starting point is 00:38:24 There's $16 trillion in negative interest rate debt going, which came to shove, and the Fed was there in 12 hours to fix the problem. So you got billionaire Ray Dalio basically wrote his big piece probably like two months ago, a month and a half ago. And at the end of it, he was basically like saying, hey, gold is the place to be. But if you go through a scenario, and I'm really just trying to play devil's advocate here, Let's say that we go through a massive QE, we have a meld up.

Starting point is 00:38:52 Would high-quality businesses outperform gold at that point? And does it make more sense to be positioned that way? I think it could. You know, if you look at how gold and, you know, the correlation between gold and negative interest rate debt totals that we've seen, you know, I'm sure you've seen those charts, I think gold right now is very popular. And I think it's very popular as both a safety trade.

Starting point is 00:39:16 and it's popular as a long duration in a negative interest rate environment trade, right? And there's a fair number of tourists there. And so if I'm right that we get an equity melt up and that basically what we, you know, temporarily temporary open market operations turn into permanent open market operations or permanent temporary operate, however they structure it and you start to see the long end of the curve back up, I think you could see gold sell off for a bit. I think that will, that could continue for a time until there is sort of, you know, and that might even be good for the dollar. So like you look at what happened today.

Starting point is 00:39:52 You have the markets up, you know, risk or equities up. You had the dollar up. You had yields up pretty sharply. You had gold down a bunch. I could see that for a bit as that sort of $16 trillion, oh God, the world's ending trade goes the other way. And now, ultimately, I think there is a holy cow moment coming where it is almost. my God, the monetary authority is financing the fiscal authority. And it's never going to stop until the dollar falls 10 or 15 or 20 percent relative to these other currencies. And that means

Starting point is 00:40:25 so when I look out, it comes down, you know, I think you could see gold underperform high quality equities for a bit. I ultimately think, you know, gold trades with a different numeral in the front of it, you know, in, you know, a couple, couple three years out. I think yields can back up for a bit. But to me, the way I'm looking at the world, I think you can see a two-stage rocket for the melt-up, right? So I think stage one for an equity market melt-up is, oh, gosh, this isn't temporary, this is permanent OMO, and they're financing the deficits effectively. Boom. Okay, I'm on the wrong side of the boat, 16-trillion, some portion of 16 trillion has to move into equities. That's point one.

Starting point is 00:41:02 And as that happens, you start to see a backup in yields. If that backup and yields gets disorderly, we know what the Fed's going to do. They just did it to repo. Repo got disorderly, it was eight. The market said repo was eight, and Fed said, no, no, no, it's two. And it's, well, here's 50 billion. Here's 75 billion. Here's 100 billion.

Starting point is 00:41:20 And I think that's exact stage two of the equity meltup rocket, I think is, yeah, you get the long end, you know, selling off on this first day, this realization of, oh, God, they're financing and they're financing the deficits and it's not going to stop. The equity yields back up. And Lael Brainer talked about this earlier this year. Claretta talked about this earlier this year. if push comes to shove, we'll cap long-term yields like we did during World War II. And I think that's stage two, where you go from, oh, God, I've got to get out of 16 trillion

Starting point is 00:41:49 into equities and yields back up a bit. And if yields get sloppy, then the Fed says, well, in addition to the front end of the curve, repo, we're also going to cap the long end of the curve at whatever politically tenable rate or politically expedient rate we're required to do that at. And that's, I think, stage two of an equity meltup. And I just don't think it's fascinating. I don't think people think it's possible. And I think it's highly likely. It's where we are.

Starting point is 00:42:16 There's nowhere else to finance these deficits. They are what they are. And it's interesting. Someone said to me before that we're in this deflationary stage, you know, in terms of where, you know, where pressures are. And I said, well, you have to understand. We had an equity bubble. We kicked it up to the banking system and the housing market. And then we had that bubble.

Starting point is 00:42:36 We kicked it upstairs. Sovere, it's been 100 years since you've had a bubble burst at the sovereign level. And the roadmap for sovereign bubble burst is very, very different. Now, you want to know what it looks like. You'll look at the Latin America, you know, Latin America, other emerging markets in the 80s and 90s, which is in hard currency, everything falls. Well, the only hard currency relative to the dollar is gold. And in local currency, risk assets. I mean, look at Venezuela.

Starting point is 00:43:01 On a percentage basis, Venezuela has killed every market in the world for, you know, five, six, seven years in a row. Now, it hasn't gotten anything on a real basis. And so when I think about, you know, back to your original question of where do you put your money, I think you have to have some money in the hardest, in the hardest currency, which is gold. And then I think, you know, after that, it's basically a hierarchy of, you know, when you do monetary financing of the fiscal authority, okay, stocks do better than bonds, bonds turn into certificates of confiscation. If I have to own bonds, I'd rather own, you know, Apple bonds than I would U.S. treasuries. Fascinating stuff. Luke, tell our audience where they can find you. I'm sure they're

Starting point is 00:43:44 going to be looking you up after this discussion. So I'm just so thrilled to have you on. I really enjoy these conversations. I always learned so much. So thanks for coming on the show and tell people where they can learn more about you. Absolutely. No, it's probably the easiest place to find us at our website, FFTT Frank Frank TomTom dash LLC.com. Always updates there on what we're up to and find out some more about our different research product offerings there. I've also got a very active Twitter feed at at Luke Gromon, L-U-K-E-G-R-O-M-E-N. Luke, thank you so much for come on this show. What a pleasure.

Starting point is 00:44:21 Thanks for having me on. It's always great. I really enjoyed talking. All right, guys. That was all the Preston and I had for this week's episode of the Ambassadors podcast. We see each other again next week. Thank you for listening to TIP. To access our show notes, courses or forums, go to theinvestorspodcast.com.

Starting point is 00:44:40 This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permissions must be granted before syndication or rebroadcasting.

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