Alfonso Peccatiello - Global Macro Series - May 3rd, 2023

[00:00:07] Alfonso

I think this speaks to the power of a true global macro mind. There are two things to consider. When I say global macro, people generally think US equities, US rates, credits, maybe European equities, credits and commodities, FX, and that’s it. The reality is there is a lot more. Investors need to become more acquainted with looking at the world, and the world isn’t the US and Europe only. It’s everything else.

[00:00:39] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

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Here’s your host, veteran hedge fund manager, Niels Kaastrup-Larsen.

[00:01:35] Niels

Welcome and welcome back to another edition of our Global Macro Series where today, as usual, I’m joined by my co-host, Cem Karsan, as well as a returning guest to the show, namely, Alfonso Peccatiello, whom we spoke to last about a year ago. Welcome back, Alfonso, and thank you so much for joining Cem and I today for what promises to be a lively and unpredictable conversation as part of our Global Macro Series. How are you doing? Spring, has that arrived in the Netherlands?

[00:02:02] Alfonso

Well, unfortunately for me, it’s my turn to be in the Netherlands where it’s going to be 3 Celsius degrees tomorrow. So the answer is no. Very nice to see you guys. I am a regular listener of Top Traders Unplugged, super good podcast so super happy to be on the seat. Let’s see if I can keep up with the level.

[00:02:19] Niels

Oh, I’m sure you can. Cem, how are things with you? What about summer? Is that where you find yourself in the Windy City?

[00:02:27] Cem

The spring here is about a month and a half and we’re entering it now. It’ll be summer soon. But things are good right now.

[00:02:35] Niels

Fair enough. All right. Okay. Now, I would like to kick off like we did last year just to hear your current big-picture macro framework, Alf, and just to see what you’re thinking today, what may have changed from last time. If you can’t remember when we last spoke, I can summarize it very easily for you because you were pretty bearish on everything; bonds via BTPs, stocks, credit spreads. I’m sure a few things have changed since then. So I’ll let you do that and then we’ll dive into some specifics.

[00:03:10] Alfonso

Okay. I think that the Fed will cut interest rates to 0% to 1% in 2024. It’s probably my most controversial take, and that will be the result of the massive tightening in monetary and fiscal policy that we have gone through in 2022 and 2023. The tightening will keep applying through a much tighter fiscal policy ahead of the elections for sure and then a tighter for longer Fed Funds above equilibrium until something effectively breaks.

When you have that combined tight monetary policy, monetary policy and fiscal policy stance for a while, you’re basically waiting for an accident to happen. The Silicon Valley Bank or First Republic Bank, now, episodes are not in that camp. Those are idiosyncratic liquidity pool risk management banking issues. So we haven’t gotten to that stage yet, but we will.

When we get there, I don’t think the Federal Reserve will have the chance to accommodate with 100 or 200 basis point cuts. As in every recession, in every credit deleveraging episode, the Fed will need to cut way below neutral levels, which means 0% to 1% Fed Funds.

[00:04:35] Niels

Great. Good stuff. Cem, do you want to dive in first and then we’ll see where we go?

[00:04:41] Cem

Yeah. I’ve read a bunch of your stuff, and obviously, we’ve talked several times, Alfonso. I think very highly of your work. It doesn’t mean I agree with all of it. But that doesn’t mean I don’t at least dive quite deep. A lot of it is a masterclass on cyclical effects of credit on economies, how cycles come and go. My view is that yes, I agree with a lot of the cyclical effects that you’re talking about, the lags that they operate under and what we’re seeing in real-time.

My disagreements tend to focus on their lack of looking at it outside of what’s the last 30, 40 years, where it was a very two-dimensional cyclical world. It’s the secular effects that I most worry about. You’ve heard me talk about this before, but I’d love to start and go back to the last time we saw inflation, 1968 to 1982, and really ask you how you believe whether or not this time is similar or different than that time, and then we’ll take it from there.

I’d love to walk through and understand how you think about where we might be secularly, not just cyclically.

[00:06:03] Alfonso

Yeah, excellent way to steer the conversation. So the economy of the ’70s was materially different than today, highly industrialized. Wage growth was a big driver of nominal spending. That was also because the share of labor, let’s say, the share of importance, as one of the factors for total economic growth was much larger than capital. So labor was beating capital in terms of scarcity, in terms of effect on economic growth. It was a highly industrial labor-intensive economy, the one of the ’70s. But also, unions had a lot of power. That is something that is materially different from today.

One statistic is that to generate the same million dollar of sales, a US company today needs about 1/10th of the employees it needed in the ‘70s. So employees were important. Wage growth was an important driver of nominal spending. Now, that’s the first difference. The second was obviously related to this one, which is demographics. We were coming after the Second World War, with the post-Second World War demographic boom, we had all these guys turning 20, 30, joining the labor force. So labor force growth was pretty solid. Actually, we had labor force growth and productivity growth, which combined together were roughly in the 3.5% area.

That means, Cem and Niels, that the US could grow structurally 3.5% per annum without the use of any leverage, nothing, which means total debt level in the economy were much lower. There was no need to lever up and push economic growth through the use of leverage because structural growth was so strong. It was also an economy which was highly industrialized and dependent on labor. So this is where we started.

We had inflationary episodes during that era that were much harder to fight, Cem (and I think that’s where you want to go), because they were so rooted and so easy to corroborate by the structural factors. When you have an inflationary episode and you have labor being such an important driver of nominal spending, it’s easy to see how an inflationary episode brings people to ask for higher wage growth and how you can cause a wage price spiral because there is scarcity, let’s say, of labor in an economy which is highly dependent on that labor and on that wage growth.

So you have these wage price spirals that happened in the ’70s and the economy was structurally different than it is today. Forward to today, you have, of course, a much more capital-intensive economy, let’s say, so where capital beats labor, where demographics is what it is, where you had the Chinese workforce and Asian workforce expanding rapidly providing cheap labor to a globalized economy. This will change over the next 20 years with the Chinese workforce shrinking by 30% over the next 30 years. That’s quite something.

You’re not going to have that cheap supply of labor back again. But for the next five years, you’re probably still going to look at an economy which is not so much driven by labor, where capital still dwarfs labor, where technology plays a large role, where demographic it’s what it is, at least for the next three to five years. Those are the major differences I see between the ’70s and today.

[00:09:45] Cem

Like I said, a masterclass. I love it. So let’s push back on three of those ideas. I agree about the 1970s. Particularly if you start looking at the late 1970s, that’s kind of where things were. The problem is we’re not really in ’68 as much as we are in ’65 in my opinion. We are early on in this cycle and it’s different. It’s always a bit different. But we are in a position where deglobalization is moving forward and it’s for a lot of the same reasons that we saw in 1965.

When Kennedy was assassinated, his view of this Great Society program of fiscal spending became reality very quickly under LBJ. There was bi-partisan support here in the United States and we had a fiscal wave, nothing compared to the fiscal wave we’ve had now. That really kicked off this inflationary push. As inflation went higher, we began to see resource scarcity. There was a lot of protectionism at the time (similar to what we’re beginning to see now), which led to the beginning of a Cold War, eventually, the beginning of a Hot War in Vietnam, and a very, very, similar set of effects that we’re seeing now.

Resource scarcity, deglobalization, ultimately constrain the availability of labor, whether we are an industrialized economy or not, we can argue. But constraining labor supply to the borders of a country dramatically (I think we can all agree) increases inflation. Those are the key similarities. Here in the US and even in Europe, service is 75% of the economy. It’s still very labor-intensive.

I don’t think this argument of industrial versus non-industrial is as relevant. Part of the reason we’ve become here so untied to the effects of labor is because, as you mentioned, we’ve been able to export it to China. That’s not, in my opinion, going to be happening as much going forward for several reasons. So labor importance (and there’s lots of metrics I can point to) is significantly on the rise in the last 5 to 10 years.

Demographics, let’s talk about demographics. I agree demographics is destiny. The millennial generation is the biggest demographic bubble since the baby boomers. As baby boomers are falling off and they have not been the core source of demand because they’ve been out past their family generating years, we are now getting a millennial generation that is at 40% of the wealth creation, and importantly, household formation that baby boomers were at this part of their generation.

So you have a millennial bubble which is at 40% of the household creation that has now entered those years and is demanding, across the world, not just in the United States, globally, help in building those households. Guess what? That’s politics. If you want to get people who are trying to create a family and who have kids to vote, there’s only one solution. It’s to help them in their pocketbooks. That’s what has shocked people in the last year, despite that huge fiscal wave two years ago, three years ago, that we’ve continued to see significant fiscal moves.

To your 2024 argument of zero rates, what do you think happens if we do get an economic pullback into what is a 2024 election season here in the United States? You better believe we get more fiscal. So this is again, just to be polemical. I’d love to kind of hear your rhetoric and thoughts. Otherwise, I do believe we’re very similar. Maybe we can find common ground too.

We are on a very similar trajectory in the sense that fiscal global strife, beginning of what you could argue is a Cold War or Hot War, and then resource scarcity entities like OPEC and whatnot, are now trying to flex their muscles, whether it’s via currency battles, whether it’s via resource battles, economic battles. We’re seeing that across the board, and again, those things rhyme with the last time we had inflation.

[00:14:22] Alfonso

So Cem, when it comes to being polemic, we’re both market people so there is no market unless two people disagree on what should be the price to trade something. So same with opinions, let’s say. I have no problem with that. I’m happy to hear another side of the story. Actually, I don’t think that we are that much far away. What I always hear, from my clients as well, is that there tends to be confusion in macro between cycles and trends.

We are now debating, in the last part of the conversation, what will be the inflation trend or long-term average over the next 10 to 20 years. Is it going to be the 1.5% that we saw in the last 20 years or is it going to be 3% or 4%? That’s a macro trend, right? I don’t know where your vote is. Actually, let me answer that question. I think the probability that inflation will turn to be higher structurally over the next 20 years is not negligible at all. It’s not.

So the tail of the distribution has to be fatter on the right end than it was 10 years ago and exactly for the reasons you’re mentioning. I would add a couple of them. The global supply chain has proved to be not particularly resilient to all sorts of problems and many businesses, including Germany, Germany Inc as a country, basically has made sure that the on-time global supply chain was one of the main features that was underpinning their economic growth. When you realize that it can get broken, you need to do something about it. It could be onshoring.

Now, I don’t expect all German car manufacturing jobs to be onshored back in Germany, but even on a marginal basis, if you want to find labor within your own boundaries of the country, you have to pay up. So that makes sense. That component of wage growth will be something relevant to observe. The availability of cheap labor elsewhere will be shrinking, as we discussed. There are more reasons why to believe inflation might actually be higher on average than it was over the last 20 years.

What I always tell my clients is, it’s going to take five or 10 years for that to play out. It’s a long-term trend, which means the distribution will be probably moving a bit to the right, but you’re talking 5 years, 10 years, decades.

Cycles are a different thing because people tend to confuse, maybe they have a strong view that inflation will turn to be higher over the next decade. That doesn’t mean inflation can’t be 0% in 2024. In the cycle, temporarily speaking, that can still happen even if your long-term average moves up to 4%. So one thing is an inflation cycle, the other is an inflation trend.

On inflation trend, I think we agree more than you think overall. On the cycle itself, I do believe that. as in any recession over the last 100 years, if you are to get one, especially a recession that involves some deleveraging in some corners of the credit market, any of these recessionary episodes over the last 100 years have brought inflation down by on average 6.8 percentage points since the peak. That’s quite a lot in 16 months on average.

Every recession has managed to bring down inflation. There has not been any disinflationary recession episodes over the last 100 years, and there are good reasons why a recession is disinflationary in the first place. So when it comes to the cycle, I think we have tightened fiscal and monetary a lot for a long period of time. We’ll keep doing that because the mandate of the Fed is to do that until they actually see core inflation trending down to 2%. They’ll probably be a bit too late.

The moment you are there, core inflation doesn’t stop at 2% or 3% annualized, but it probably moves down because of the deleveraging episode.

[00:18:23] Cem

Yeah, so I think you’re right. I think we do tend to agree more on the distribution. I like that you’re talking about the distributions of potential outcomes longer term. I would differentiate my view in that I don’t see secular inflation going 2% to 3%. I see it going to 5% plus, maybe 7% or 8%. I would also differentiate our cyclical view in that I agree. We’re clearly going into some type of cyclical downturn.

The effects of monetary policy have a direct effect, as does fiscal, on that cyclical story. But it is, I think, a much stickier demand equation, much like we saw in the ’60s and ’70s. I think we’re more likely to see a dramatic earnings recession in the next four, five years than we are to see an actual deep recession, because we are in a very demand-push economy. I think very much people lose sight of that difference.

We are still at record or close to record price to sales, record profit margins. These are assumed to be structural realities by most people, that we live in a new technological age where profits are structurally higher. I take a great exception to that fact. I think they are a structural effect of historically low interest rates and the globalization that causes, the profit-seeking in growth investment that causes, and ultimately the technological innovation that drives.

When those things start going in reverse, and labor costs increase, and we’re dealt a world that there is a limited sphere to which to expand in, the economic realities set back in. I do believe we’re going to have dramatic margin compression in the next 5 to 10 years. So I would argue that in ’68 to ’82, we did get three recessions, three, that’s a lot in 12, 14 years. The reality is that short-term Fed Funds did come down, and each one significantly 10% (I’m looking at the numbers now), back down to 3.5% in the first one, in the second recession 14% down to 6%, in the last one, 20% down to 10%.

But growth, GDP growth, not just nominally, in real terms, throughout that 14-year period was above trend in real terms, again, with very hot inflation, much higher than it has been in the last 20 years. I think that’s the big important takeaway. Demand will continue to be sticky, structural inflation will continue to work higher. Even if we have cyclical downturns like I believe we agree we’re going into, I believe they will be much shallower than people expect and the effects will be felt on short-term interest rates.

But I will actually argue, and this is where we connect the Top Traders Unplugged, the trade will ultimately be to bet on the secular increase of interest rates, and at the longer end of the curve, will continue to remain sticky into recessions and will actually work its way out.

[00:21:54] Alfonso

When it comes to the long end of the bond market, Cem, I want to stress out a couple of things. The curve has inverted in overnight index swaps curve for the first time in March 2022. So it’s been over a year. That 5, 10 is in OIS, not in the treasury, but OIS, so merely reflecting the term structure of Fed Funds, that curve has inverted already for more than a year as we speak.

You can basically call it a protest, I should say, from long-term bond investors saying, you know guys, if you hike above whatever we deem to be equilibrium, Cem, let’s say 3%, if you hike above that, we’ll assume that the damage you do to long-term inflation and growth is quite something. So we’ll make sure that once we are past the 5 and 10-year term structure for Fed Funds, we’ll price in some weaker growth, weaker inflation, some long-term damage because of the short-term tightening cycle.

This has been, basically, a relentless feature of the bond market for the last 13 months. Now, if you believe that inflation is something structural that is going to reprise to 4% or 5%, there are a million macro trades out there where you can try and make money out of it. So the term premium in the bond market is basically non-existent. Not at all. So there are basically investors who don’t want to be compensated to take duration risk, rather than just roll their T bills at 5%. They could just decide to do that.

Instead, they are happy to buy 30-year bonds or receive 30-year OIS swaps 100 basis points through where Fed funds will be, basically, at least for the next three to four to six months. So there is no required compensation from long-only investors. If you look at optionality, which is something you look at pretty often, I’m sure, can we talk for a second about bond volatility because it’s been quite an interesting phenomenon?

[00:23:58] Cem

Absolutely.

[00:24:00] Alfonso

Many of my hedge fund clients, when the higher for longer narrative was prevalent in February, they were basically looking for ways to fund their trades, as every hedge fund manager does, not to pay carry on the trades too much. One of the ways to fund these trades was to sell calls on gold, on bonds, on bond prices. The idea was the Fed is just not going to cut. The hurdle to cut rate is so high I can just sell that optionality away, use the premium and fund my trades.

Then the banking crisis happened, and at that moment, you’re basically caught completely off guard, both because you sold vol and also you’re on the wrong side of the delta. So you’re wrong in two cases. You sold optionality the wrong way. So you have to cover it up, right? Basically, a couple of hedge funds blew up as well, as we saw it reported effectively in the results, by selling optionality and being forced to cover it.

What that also caused was that from then, bond market vol remained extremely high as seen in three months, five years swaptions. Three months, two years swaption vol was like 170 basis points unrealized. I can’t make the square root on top of my head to calculate what the daily move is but it’s a gigantic number. You have to have 10 basis points daily move into US treasuries, I think, to get a breakeven. Just ridiculous.

Look, bond market volatility is really important for overall risk-taking because fixed income is such a large and systemically important part of all institutional portfolios that when it ends up bringing more vol to your overall portfolio volatility, you just don’t have any budget to add anything else. It loses all its properties of diversification and low vol and stable income. All of that is lost temporarily. When it comes in as well, when it reduces itself and it normalizes back, then generally (Niels is looking at me there) all the CTAs and all the systematic investors generally get some renewed budget to get back into their trades.

But long and bond vol, the reason why I’m making all this story is that even during the hysterical moments of the banking crisis in March, vol on long-dated bonds didn’t really explode at all. So that’s another signal from investors. We can talk about the cycle in interest rates, the cycle in inflation, that there is literally almost nothing priced and no term premium, no risk premium, no optionality premium, nothing is priced in for structural inflation at the moment. So, Cem, I’m saying if you are really believing in your thesis, there is so much out there to trade.

[00:26:58] Cem

So I think you’d agree a year and a half ago when this, or a year and so ago when this first decline began and the move in interest rates began, there was a well-held understanding that inflation was transitory. Markets very much were pricing that inflation was transitory. The vol across the board in bonds, in FX, in VIX, and across the board were incredibly low. Yet, we saw a significant move both in vol and in long end of the curve and had incredibly profitable trades despite how the market was priced.

So I want to be careful looking at the bond market and saying, hey, the bond market is always right. If a trade is there, then then it must not be real. Now, you are very much right that there are structural reflexive effects, as we both know, that are critically important to the way things move based on how markets are priced. But that does not mean the secular realities don’t exist.

Actually, the greatest opportunities are when you can find, and they happen and they have happened in the last several years and I believe they will continue to happen. It’s about riding the wave of the cyclical effects and the positioning effects versus that secular reality that’s going to make you very wealthy. That’s what made people wealthy in the last 30 years is driving that secular trend. If you had that secular trend in interest rates, that simple trend, and all the things that meant for equity multiples, for growth versus value, you go across the board, you are inordinately wealthy.

So if you understand the secular trend, if you can pick to it and have conviction in it and don’t get lost in the cyclical trends, use them as opportunities when narrative changes, when people turn to that deflationary argument or whatnot, that is what will ultimately lead to great success in these markets. I think people get too caught in the cyclical and miss out in the big picture.

[00:29:18] Alfonso

Yes, I took the other stance before saying people confuse cycles and trends. The other approach is to not get lost in the weeds of cycles and focus on structural trends. Obviously, it’s about trying to find trades with a positive expected value over time and find good risk-reward. Talking about that, I think Europe deserves a couple of words too from my end. Given my Italian accent, people maybe might want to know something about Europe from me.

So look, I am watching this banking situation unfold and I think people confused a liquidity crisis with a credit crisis, and the liquidity crisis can be fixed by central banks. They have tools to make sure that the value of the collateral, in this case, treasuries and mortgage-backed securities, effectively is backstopped at 100 cents on the dollar, and that’s what they did.

So walking back for a second, regulation in 2013, Basel III, high-quality liquid assets, liquidity coverage ratio, all these things I was subjected to myself as well when trading for a bank, these effectively meant that banks could buy treasuries and the regulators would consider treasuries and government bonds exactly the same as cash, or I should say, the same as reserves at the central bank. So there will be no liquidity haircut.

Treasuries, government bonds are Level 1 HQLA assets. They have no liquidity. They’re the same as reserves for the liquidity coverage ratio calculation and they have no capital requirements, nothing. So if you buy treasuries, you don’t need to attach any capital at all to your purchase. Basically, it means regulators consider government bonds the same as reserves at the central bank. Now, guess what?

When it’s government bonds and the value of these treasuries and its collateral, the very reason why the banking system should experience a systemic crisis, I’m sorry, but they will not make this happen. It is paramount important to make sure that the value of this collateral remains pristine. They did so basically, with the BTFP and the other tools that they came up with. The fears also spread to Europe at that point.

In Europe, we do a lot of things sub-optimally, but on regulation, we’re much tighter than the US. I’ve been buried on the regulation myself for years working for a European bank. There is a thing in Europe which is called the supervisory outlier test on interest rate risk. So European banks are subject to a stress test that stresses all their assets and liabilities, not only held-to-maturity bonds, but people are obsessing about that which represents 5% of the balance sheet of a bank, roughly.

You look at the entire interest rate risk on assets and liabilities and the hedging derivatives as well of a bank and the ECB forces European banks to stress test this net risk that they run. So I had to look at it and the ECB says, okay, move up the interest rate by 200 basis points and flatten the curve. So the most negative possible scenario for a bank. How much is your capital going to draw down because of that? The median European bank takes a capital drawdown of 6% on the entire capital base.

The entire capital base goes down by 6%, which means the core tier one ratio goes down by what, 60, 70 basis points. Is that a hit? Yes. Does that mean the bank goes belly up? No, not nearly. Why? Because the stress test exists and so banks have done their homework and they’ve hedged their interest rate exposure as they would normally do. In the US, there is no supervisory outlier test. There is nothing like that, which meant even a large bank in principle could act like cowboy when it comes to interest rate risks on their balance sheet.

But if you look deeper, JP Morgan willingly publishes the result of this potential test and they will get the 5% capital drawdown. So again, people I think have over-emphasized the nature of this risk but European banks are instead more exposed to commercial real estate on the margin and to real estate in general than US banks are. Why? In Europe, people have forgotten already but we’ve got negative interest rates for something like six to seven years and negative real rates for almost 10 years in Europe.

So if you were a European bank or a pension fund or an asset manager, dude, you had to find a way to make returns. Laws in Europe made sure you couldn’t pass through negative interest rates to your customers for years and years on end. So the only way to maintain your net interest margin was to generate returns on your assets. So you ended up doing that by taking risks in securities and in sectors which delivered some returns and the real estate market, because of leveraged securities, could deliver some of these returns.

So the exposure which sits in commercial real estate, in leveraged real estate securities on the European banking balance sheets is actually pretty large. European commercial real estate prices are already experiencing severe drawdowns because of structural problems with the office space and the vacancies and all of that. So that is a credit problem. If it unfolds further, that’s a credit problem.

The ECB can do anything to backstop the value of the collateral, can’t beat up a vacant office in Germany to make sure that the value of the collateral for a German bank remains good. It can’t do that. So I think that is where people should focus their attention more if they’re looking for banking stress, particularly in Europe, rather than a liquidity crisis.

[00:35:16] Cem

Wonderful, wonderful points. Actually, this is something we agree on. I do think the banking problems that we have recently seen are grossly overdone. There was always a tail on banks, it’s structurally how banks are built. The leverage within banks defines that if there is a run on the bank, that there will be a problem. But that simple fact does not mean we have a banking problem, and it is one that is well understood. That regulation, as you mentioned, globally, domestically as well, have come dramatically since 2008 to prepare for. So I do think the focus there has been over-exaggerated.

That said, I do think what we saw is a canary in the coal mine, in the sense that there is a lag to monetary policy and interest rates going from zero to five, a significant one. You can argue nine months, you could argue 18 months, based on how you look at it. That is because (I’ve mentioned this before) there are 450 trillion in assets, 350 of those are not equities, and most of those rerate very slowly. On top of that, even equities buybacks, drive a major source of demand in equities and there is a significant lag there.

We’re in Q1, still close to record buybacks for equities despite in the last year and before that a 5% increase. You look forward Q2, Q3, Q4, it’s a cliff. You start to see a dramatic fall off. So what the banking runs tell us, again, it’s about that unknown risk underneath the hood of these effects and how they build up until that Minsky moment. So there are signs now that little pockets of sand are collapsing under what is a hollowing internal mountain of sand.

I think we’ve yet to reach that grain of sand where things really collapse, but that is a clue of what is out there and I think that’s really how we should be looking at it, not as the core driver of what’s happening here. So we do definitely agree on that regard.

[00:37:41] Alfonso

Yeah. I was just looking at the risk-reward of the stock market as well in different sectors recently and we have gotten to a point where people are very happy to bid for downside in banks, to a point where puts were pretty expensive over the last two, three years in a percentile ranking.

But that has faded away, I think, over the last few weeks, because I think you tweeted it out or you said in an interview as well, when nothing happens and people are pricing a lot to happen, then naturally, you need to unwind these trades where you spend a lot of insurance premium to protect you against nothing because nothing is happening, then you unwind the trades and people get sucked in basically to reallocate or to re-leverage back up. That’s what we have seen, I should say.

[00:38:31] Cem

Absolutely. It’s true for equities as well. It’s across the board. The event vol that eventually creeps into markets is fuel. If you get a narrative where you also have shorter positioning on top of that, it can be a pretty powerful combination. But that’s why often you get first moves and then it’s the second move that gets you, which is what we should be looking for at this point.

[00:38:58] Alfonso

So then I look at where we stand today. If you just try to standardize measures of downside protection in the S&P 500, so let me say one takes a 25 delta put on the S&P 500 with a three-month expiry. Let’s say right now, that would mean roughly 7% to 10% decline for people to understand in terms of moneyness. Three to six months out, it’s priced basically at the 90th percentile in terms of cheapness over the last two to three years. It is relatively cheap to try and buy some downside optionality.

Now, the problem is that even last year, we haven’t seen any jump risk. We haven’t seen anything that makes you materialize that kind of expression. So people are I think a bit not in love anymore with put options. It has been pretty expensive as a way to express a theme which was correct, which was this low grind down in equity markets.

So people might debate, well, if we move from 4100 and there is some serious credit stress banking, stress, a recession, anything of that sort, and we move back to 3600, 3700 but we move there without jump risk, then are you sure that buying put options is the right way to express the trade?

I think that’s been a debate that has resurfaced recently. Because in the past, we were used to the opposite. We were used to nothing happening. When you had let’s say a drawdown in equities, it came with a jump. It came with it. People were busy selling vol the whole time. When the rarer episodes where the stock market actually had a drawdown, put options could work.

Last year, the stock market was in a drawdown the entire year long, and actually, I think that buying puts for the entire year and rolling them over lost money. But correct me if I’m wrong, in 2022.

[00:41:02] Cem

You are absolutely right about the effects and what’s happening. This is my bread and butter. This is another opportunity to talk about cyclical versus secular effects, in a different way, not in terms of equity markets but in terms of vol. If I were to give you a history of the last eight years in the last minute in vol world, it would be as follows.

August 2015, Yuan devaluation, vol explodes relative to the equity market move. You have a 5x vol reaction relative to normal, vol markets go dark. Anybody who’s short vol gets blown out, anybody who’s long it makes an incredible killing. Everybody piles into vol, short sellers are gone.

Six months later, you get Fed 2016, oil goes to 20, and credit high yield starts to blow out. The world grabs what’s a really cheap vol assuming that vol will perform again and vol gets decimated into that decline. Everybody who owns vol is like why would you ever own vol if it’s not going to perform into the biggest decline since 2008, which is what that was, a 12% decline bigger than the yuan devaluation decline of 9%.

So people start losing faith, and stop investing in puts, and start selling puts, and put sellers make a lot of money for about a year and a half, two years. 2017, vol collapses. Everybody leaves the vol space. Reflexively, the vol selling leads to the lowest implied and realized vol in history, in 125 years, which leads to the Volpocalypse, a massive vol event. You’re starting to see this sine curve in action. ’18, everybody who was short vol blows out, everybody who was long vol made a killing. Everybody piles into vol.

October to December 2018, we get the biggest now decline, again, since 2008. Vol gets decimated into that decline. Step, step, step, three and a half months of absolute vol decimation. What proceeds? Everybody slowly moves out of the vol space and says why would you ever own vol if vol doesn’t seem to work into a decline. Enter March 2020, a year and a half later, vol explosion, market explosion, and reflexively, one of the biggest vol events we’ve had. So what does everybody expect? Better own vol.

So 2020 comes along, two years later, right on clockwork, and what doesn’t work? We had record skew. Record vol hedging people see that train coming. It’s going to work. We’re ready. We’re all lined up. Decimation. So tell me, where are we in this cycle? It’s not confusing to me where we are cyclically. We have had a complete abandonment of vol hedges because it hasn’t worked. We’re at a point where the secular risks are still there. As I mentioned, the best opportunity is when the secular opportunities there, but the positioning and the cyclical realities start to line up.

So I would caution people to say, oh, look at what happened the last year and a half. Why would you own puts? I don’t know. Look at the positioning, look at what’s happening underneath the hood, and you very much had a complete loss of conviction. By the way, this zero DTE business, everybody’s talking about it, but nobody really expresses. Everybody is talking about that massive increase in zero DTE trade. Nobody’s talking about that. There’s been a dramatic increase and equally as large decrease in actually 30-day vol trading.

Volume hasn’t gone up on total, it’s just shifted to zero DTEs because vega has not worked, optionality has not worked. What’s worked is just realized move if you’re kind of playing direction with it and using it for convexity. So people have replaced real vol with short term bets to cover themselves. They’re band aids, they work for a day, but what they don’t do is expose you to a secular move and a structural move that can really hedge you in a time the structural weakness.

So anyway, I’ll get off my soapbox. But that’s the history. That’s the cyclical realities of where we are. Now, we could go into arguments about secular, even further secular. What does inflation mean for downside vol and what does it mean for hedging? Generally poor actually for equities; very good for FX, interest rates, dollars, gold, a lot of these things that, again, you look at, there are secular opportunities in vol there.

So we’re actually in a very interesting time if you believe in that inflationary thesis, as you mentioned, to particularly bet on cross asset vol because they are all not connected as much as they were in the last 30 years in many ways when you’re in inflation. I’ll cede the floor to our guest, but yeah, the vol story is so important.

Last point, in the ’60s and ’70s, we didn’t have options, we didn’t have vol. So we are in a unique situation. We’re really going into an inflationary environment with a whole host of new products that didn’t exist back then which equals a very potentially dangerous, but also, no data to tell us what exactly should happen.

[00:46:38] Alfonso

Well, I knew I would trigger you talking about 25 delta puts and vol and realized stuff. So we went there, and it’s always a pleasure to discuss these corners of the market with you.

Look, the other thing which is on my radar here, geographically speaking, unlike macro, really overall, are two things. One is Japan, which is quite an interesting case right now. Because of my previous job at a large bank, I could speak to these Japanese real money investors, and they are really important in the overall capital flow landscape of markets.

Japan is the largest exporter of capital in the world, literally, they have accumulated a large amount of savings over the last 20 years and they basically have no good investment opportunities domestically, so they try to export their capital as much as they can. They’re large investors in US treasuries, in European government bonds, but also in equities, also in Australia. They are international investors to a large extent.

Why am I saying this is because during periods of slower economic growth, normally speaking, they are very process-driven, risk-averse investors in my experience. So they basically smell trouble and they tend to de-risk. With Europe and with their European flows, it is extremely funny that anytime there was any smell of a political risk anywhere, so let’s say an election in France, and is it Macron or Le Pen or is there some referendum in Italy, they just flee the market.

There is no flow anymore for a couple of months until they have the certainty that things have calmed down. Even if they lose a bunch of 20, 30, 50 basis points in credit spreads, they’ll stay out just to make sure their process is respected. So in periods of uncertainty, they tend to stay away effectively, and this historically has benefited the yen. Why? Pretty simple. They unwind a normal trade where they will sell yen, buy dollar or euros to go and buy out these government bonds or equities or whatever they buy. Now they do the reverse. They stop the flow.

So on the margin, they actually even sell euros and dollars and buy back yen or any way they stop the counter flow that leads to the Japanese yen strengthening. That’s in normal periods of uncertainty. This time, you’re coupling this with, for the first time in 30 years, wage growth in Japan at 4%, services inflation at 4% annualized. So you’re looking at some inflationary pressures in Japan. Can we conclude definitely that this is a new inflationary wave in Japan? Not yet. But the situation has definitely changed, but at least it poses questions and it does pose question to a new governor of the Bank of Japan, which is also an important change.

We have somebody else at the helm. We’re now debating whether if curve control is the right way to go in Japan or not. So any marginal change away from that monetary policy will lead to higher domestic interest rates, higher risk-free rates. So basically, an alternative for Japanese investors that would make repatriating cash back into Japan even more attractive because of domestically higher interest rates. I’m saying all of this because the Japanese yen is something to look at.

What Japanese investors do, overall, is definitely something to look at because it also impacts global equities, global fixed income. It is definitely something to look at. We have a Bank of Japan meeting on Friday this week. I’m not sure when the podcast goes out. On the 28th of April, we have a Bank of Japan meeting. I like the Japanese yen. I think there is an asymmetry in the trade.

If you expect the global economy to slow down anyway like I do, generally speaking, interest rate differentials tend to close and Japanese yen tends to benefit from it. This time, you also have an idiosyncratic tailwind potentially behind due to domestic inflationary pressures and changing monetary policy.

[00:50:42] Cem

Do you see a tail risk coming out of that? What is your view in the next call it six to nine months given that effect?

[00:50:50] Alfonso

Yeah, well, from a communication perspective, nobody knows this new guy, Ueda. This will be the first chance this week he has. My take would have been that he has only one chance to make a first impression, which is when he shows up for the first time in front of global investors and tells us what’s happening in Japan. We have services inflation at 4%. What are we going to do about it?

Kuroda, his predecessor, had a history in surprising investors. He did it multiple times and I remember that very vividly. Sometimes, I also got burned by Mr. Kuroda myself. I’m not sure whether Ueda will be the same, Cem. I don’t know. But I can see why somebody might want to own upside in the yen, which, to be honest, is not cheap anymore. The skew is there, people are aware that there is this risk, but I can see the role that the yen could play also in a diversified portfolio over the next six months. It’s an interesting thing to look at.

The other one, the exact opposite of that, is carry trades. Because, look, again, I have traded basically one of the lowest average volatility periods, between 2013 and 2021, for a bank. I remember at some point in 2017, it got depressing. You would look at does this trade carry and roll down three basis point a quarter. Yes, I need that please, because there is no vol so I’d rather take those three basis points levered up and hope that nothing happens in the meantime. It got that bad, really.

But we are now hearing again about carry, or at least I am hearing a lot about carry again, in the form of Brazilian real, Mexican peso, Polish zloty, Hungarian forint of recent, anything that has embedded carry into it a good roll down and possibly not devastating volatility. Now, Latin America has been great for that in 2022 and early 2023, because also realized vol has been pretty low. So people have gotten this carry in Brazil and in Mexico, double-digit yearly carry, I mean, serious good stuff there, and they’ve benefited from it but to the point where I think today, it’s getting a bit extreme.

It might get a bit rooted in the investor mindset that you can get exposure to EMs, you can get the carry, nothing happens, there is nothing to be worried about. Poland or Hungary or Brazil become safe havens, good carry trades. I think there is something to consider there because Japan has no carry obviously, and people are hesitant whether to have it in the portfolio or they’re very happy to keep adding positions that generate carry.

Again, it’s a matter of positioning and investors shifting a bit their stance and I would be very, very careful about that at this stage of the cycle.

[00:53:52] Cem

That’s very interesting. I, a year ago, started talking about some of these things. The problem is it always takes a bit longer than you expect. You look at ’96 to ’99, all the emerging market crises we saw, all the Russian ruble the Asian flu, everything that came out of the interest rate hiking cycle then. There’s plenty other examples other than that, but that’s a classic example that I lived through.

You can’t help but wonder when is that again, that Minsky moment, when do things break? Because we are having a lot of those pressures building and building and building. Question is, when will it happen? I agree. It’s something very important to watch on, April 28th.

[00:54:46] Niels

Guys, I hate to interrupt this conversation. I’m still here and enjoying it immensely, as I’m sure all our listeners are. But I do want to throw a couple of things at both of you really just to shift gears a little bit. I know we’ve talked about both sides of the coin, so to speak. I can see, I wouldn’t say a case for both, but I can see some of your scenarios play out in an odd way.

But one of the things that I’m sitting left with is this thing that we are comparing a lot of these things that might happen in the future to things that’s happened in the past. I’m of the belief that maybe things won’t actually happen exactly as it’s happened in the past.

I couldn’t help noticing Ray Dalio’s latest piece on LinkedIn a couple of days ago, where he talks about these five forces that he’s written about for a long time. So the big debt cycle, conflicts within countries, conflicts between countries. Then he also talks about acts of nature, which of course we don’t control, and then technology. I think what he’s saying is that he sees that all of these forces, of course, some of them are a little bit unpredictable, but he sees all of these forces coming to a pass right now like they did last time in the ’30s to 1945. I don’t necessarily need you to comment on this but this is just something where I’m thinking that maybe we will end up being surprised.

Maybe Alf is right that the Fed will be forced to take rates to zero, but maybe the bonds will actually take that as a negative and bond yields will go to 10. Who knows? Maybe inflation will be a lot stickier than what it might do or what it should do compared to the fact that we’re slowing down the economy, and so on and so forth. I think there’s room for many surprises.

But where I do want to go to just to change things a little bit, I want to talk a little bit about the US dollar, because suddenly, this de-dollarization has really come to the forefront. I couldn’t help noticing I think yesterday in the Financial Times that Stanley Druckenmiller (and I think when he speaks, I’m definitely paying attention), saying that that is his high-conviction trade right now, the only one, and that is short dollar. He bases that on the fact that he sees problems with the US policymaking.

He also believes by the way that currency trends, maybe like you do Alf as well, will last usually for two to three years. He does sound a little bit like a trend follower if I was going to be honest here. But at the same time, I’m also thinking yeah, okay. But there are other dirty shirts in the laundry basket. That doesn’t necessarily mean that the dollar is going to take the full brunt. Then I’m going to throw something further at you just to pack it all in.

The change on the global stage. Cem and I obviously have talked to a lot of people about geopolitics, and suddenly in the last few months, even today, we’re seeing things happening where China is kind of taking center stage, Saudi Arabia is taking center stage. They’re the ones making the peace deals. Now I just see on Bloomberg right now on the internet on Bloomberg, that Xi speaks to Zelensky for the first time during the war. Things are happening, there’s stuff going on that definitely is changing below the surface.

So I’d love to hear your thoughts about this. Maybe we can throw in oil, we can throw in gold, central banks buying gold, we can throw in the whole thing in the last 10, 15 minutes we have together today. I’d just love to hear how all of these things play into your playbook so to speak.

[00:58:45] Alfonso

We have done it all, I think, from equities to vol to fixed income, now we missed the dollar and commodities and geopolitics, I think, so let’s do that. Why not? So the dollar. Okay, Stanley Druckenmiller is telling us that he’s in the hard landing camp but is short the dollar. Interesting. Very interesting, I think. Because look, I’ve had a look at what happens to the dollar in periods where tight monetary and fiscal policy led to a recession or very slow growth and there is no immediate conclusion to what happens. It really depends from the form of recession you’ll get. What do I mean there?

If you get a recession without deleveraging, without credit stress, without massive deleveraging episodes, then it’s not a given that the dollar appreciates. If you get a recession with a credit deleveraging event, it always ends up appreciating. So let me explain for a second how the system really works. It’s pretty simple. So we have built a system that is based on debt and credit, domestically, in the US, but also a system that is based on debt and credit denominated in dollars issued by entities that have no organic access to the dollar.

So a Brazilian corporate that sells soybeans in dollars will need to lever up their balance sheet and they will issue debt in dollars. Now, how do they pay coupons? How do they service that in dollar? It’s by selling soybeans in dollars, so by global trades, and they have no organic access to the dollars apart from this trade growth. If trade growth comes down, then obviously they have to deleverage to make sure that they can get their hands on the dollars and pay back their liabilities.

So what then happens is the denominator of the system appreciates. When you deleverage a system, it’s the denominator of the system, the dollar itself that actually gets a bid. You’re basically compressing the system on itself and so the dollar benefits. Any deleveraging event leads to a mechanical appreciation of the dollar. It’s just how the system is built. But if you get a recession, even a hard landing, let’s call it like that, without a major credit deleveraging event, well, then it’s other things that drive the dollar.

Is it, for instance, Fed policy? So if the Fed slashes rates at 0%, and other central banks around the world are maybe not in the same camp yet, then you get the euro going to 130, 140 against the dollar. We have seen it already. We have seen it partially happening before the great financial crisis. We’ve seen it happening in 2011 and 2012. It tends to happen. So it’s not that clear cut, I think, what happens to the dollar during a recession. It depends from which shape a recession takes. Cem, what do you say?

[01:01:43] Cem

Yeah, I agree it’s not clear. What is clear to me and what I like to think about on these things is distribution. What’s clear to me, and again is true historically as well, is that volatility during periods of inflation in the dollar, in FX in general, trends significantly higher, and there is more vol to the vol as well. So the next derivative of vol is also even more leptokurtic.

The trade, in my opinion, is not to take a direction on it, but it’s actually to buy vol in that space. It has already increased significantly, as you’ve noted, but historically, it’s still not expensive, and particularly the vol of vol, the most convex moment of the distribution, is cheap. I agree with Druckenmiller on his 10-year stagnation thesis for a lot of the same reasons. My view, however, is, I’ll tell you a little quick story.

I just went in for a TSA PreCheck, the Global Entry interview yesterday. The woman who interviewed me was supposed to be interviewing me on my qualifications of whether or not to get this. Instead, it became a conversation about the weakness of the US dollar and how she believed the dollar was in secular decline. A customs agent, I’m hearing this everywhere.

Usually, if I’m hearing it from my customs agent, that’s reason for it to take the other side of the trade. Have at that anecdotally what you will. But the reality is, I do think there’s a lot of that out there. I think the death of the US dollar is much exaggerated. I believe you were hearing a lot of that right before it ran to local highs last year into the last decline in markets and deleveraging. So if we’re talking about a coming potential decline in markets, not just the mechanical effects that Alf talks about, but I do think the positioning is actually not in your favor either.

Yes, there is a lot of movements in India and movements in Saudi Arabia and movements away from the dollar, and there’s a lot of agitation and fear not to mention schadenfreude. There are a lot of people outside the US who would love to see the strength of the US dollar fade. But the structural realities are (again, this is not an egocentric American view, I want to be clear), this is the biggest economy in the world (maybe not the strongest), biggest military in the world, and the rule of law here is decentralized much more than any other autocratic, and that’s probably the most important place.

There’s a belief at least, right or wrong, that your money is safer here than in China, than in Europe, or other places. There’s a reason for those beliefs. We’ll see if they continue. It doesn’t mean we can’t get volatility along the way. Broadly, I would believe we’re in a structurally inflationary place where if you continue to have the exorbitant privilege of the US dollar (it’s a big if), but I think the odds are in the favor that that is not going to change overnight.

If you have the exorbitant privilege of the US dollar, you have the ability to export inflation, the Fed has control, and ultimately it is in the Feds best interest to have a strong dollar during periods of inflation. So I would be betting in that direction.

[01:05:19] Alfonso

The exorbitant privilege of the dollar is one side of the coin, and I’m going to make now the argument that it is also very hard as a task to be the dollar, to have that role, to fulfill it really, because what you need, you are the denominator of most global trades, most global invoices, most FX transactions in the world, which means Saudi Arabia sells oil denominated in dollar, gets back what? Dollars.

So the first question you need to be able to assess and to answer is, can you provide an outlet where I can recycle these dollars in a liquid, deep, repo-backed market that you continue to supply with and increase in size over time, because global trade grows, the economy grows. Saudi Arabia sells more oil, they get more dollars. So can you give me a big, liquid, deep and ever-increasing market where to allocate back these dollars? It’s not easy.

Europe can’t provide you with that because we don’t have a very large AAA market in Europe. We have a very small AAA market in Europe, like safe bond market is really small compared to the size of Europe. Japan can’t provide you with that. The central bank is about 60% of the market. This market doesn’t trade for days in a row. So I’m sorry, but it doesn’t fulfill the criteria of liquid, deep, repo-backed market.

Where else do you want to go and look at? China, Russia? You’re lucky if they don’t lock up your money and the rule of law is not necessarily very strong over there. So it is an exorbitant privilege, Cem, you’re right. But it is also difficult to fulfill the role to be the dollar. On top of it, the other side of the equation, that $12 trillion of dollar-denominated liabilities sitting outside the United States. Entities, corporates have levered up in dollars. So transitioning away from such a leveraged system where leverage sits outside the United States is not an orderly process. It’s a very messy one.

So when people tell me, we’re going to de-dollarize, my first question is, well, good luck with that. It’s going to be very hard and very chaotic as well. In the past, every attempt at moving the global reserve currency either into another one or changing the system, maybe a gold-based system, for example, it’s been very painful. It’s nothing to be super excited about, to say the least, if it ever happens, and then the alternatives, both on the asset side and on the liability side, because I said there are $12 trillion of debt, can you imagine issuing that in renminbi? Can you imagine issuing that in Russian ruble? What is the alternative really? It’s really hard to say.

[01:05:44] Niels

All right. Let’s just tackle the last two then. Commodities, what are your thoughts on what’s going on there?

[01:08:23] Cem

I will say the following. We had a 40-year period where the Fed had ultimate control. Their dual mandate of price stability and maximum employment were aligned because they had secular deflation they could come in and stimulate and the Fed put was therefore dominant. We had a two-dimensional system where only cyclicality really mattered. We reached our natural state of inequality.

There are other effects that are now driving things the other way and the Fed is now in a box where they have dual mandates which are in conflict, which opens up much more dimensionality. This similar to other inflationary periods, creates a situation of again more dimensionality and more global conflict. There’s an ability for other entities to push back and there’s a reason to given some of the populism and things like that. These things are connected.

When that happens, you begin to see other sources of strength, think OPEC, other places where people are flexing their muscles to get the benefit of the strength that they have. Much like the Fed has used the exorbitant privilege of the US dollar to its benefit, other entities begin to use their strengths to their benefits. There is a group of countries that have one major benefit, which is they have the lion’s share of commodities. In the ’60s and ’70s, again, people think of these as unconnected events.

When you think about inflation in the ’60s and ’70s, google it online and people will be like fiscal spending align weirdly with all of this OPEC crisis and global conflict. My view is they’re all very much connected. So I think we’re entering a period of less of a Fed put. The Fed is going to be less likely to be able to control so this is part of why I disagree with the Fed going to 0% again, because I don’t think they’ll be able to.

But I also believe what that means is OPEC and other entities that have control over commodities and broad resources, whatever those resources may be, will flex their muscles and put puts on those things. I’ve been talking about this, Niels and I have been talking about this for some time, I talked about last quarter again before OPEC stepped back in and put a put back on the market again.

So I think you can expect to see that in the next decade, not just the next year or two. That should underpin much like the Fed underpinned equity values and increased multiples, that should underpin commodity prices and reduce industrial commodity volatility. Ironically, the volatility increases that I’ve been talking about, which are dollar, FX, gold, which has been mispriced, I think until more recently, and we talked about that, all of those things should increase.

But ironically, long-term volatility in equities and industrial commodities and other products where there is an ability to flex muscles and write puts by bigger, stronger entities will decrease. So that’s my broad view on industrial commodities and where we’re going in the near future.

[01:11:32] Alfonso

The volatility of inflation will be higher over the next 10 years. Not only the trend, the long-term average might move higher, but the volatility around this trend will be higher, which means commodities have an important role in a macro portfolio. Because in periods of high inflation and not necessarily super strong growth, it is hard to find diversifiers. Niels can provide you with some CTA trend following diversifiers in those periods, they work very well.

For more traditional, let’s say, asset classes, commodities, industrial commodities tend to perform pretty well when inflation vol is pretty high, especially on the way up, obviously, where inflation is increasing rapidly, where the momentum is increasing rapidly. So I think they deserve a role in macro portfolios that is much more important than it was over the last 10 to 20 years where people had just forgotten about the asset class.

It didn’t do much. It didn’t provide you with any major diversification or I should say there was no major inflation momentum on the upside and that’s why they actually fell out of fashion. I think they deserve a better role and a larger role in macro portfolios going forward.

[01:12:47] Cem

Agreed. We’re only agreeing on things.

[01:12:51] Alfonso

Cem, I told you. I think we agree more than you think.

[01:12:54] Cem

For sure. I just had to make it interesting at the beginning. We had to talk about what we don’t agree.

[01:12:59] Niels

This is how we bring people together on this little podcast. We start from opposite sides and we get closer and closer. Before we get to the final question and point I wanted to discuss, which is geopolitics, I will just add to what you kindly said, Alfonso, that, yes, not only do CTAs have some added value when commodities are in a, you could say, high volatile environment, but actually also in a year like last year, where commodities sold off pretty strongly against most people’s expectation following the Ukraine invasion, they also did pretty well. So yeah.

Now, geopolitics, last point. I think it’s such an important part. It kind of ties into everything we’ve spoken about today. There are things that are changing, it’s changing rapidly as far as I can tell. So I’d just love to hear your thoughts on what’s going on when we not necessarily look at markets, but look at countries and policies and people. Maybe Alf, I could start with you just to get your perspective on where the world is heading.

[01:14:14] Alfonso

Well, I think it’s undeniable that the bipolarity is getting stronger. That you have Lagarde coming out and making a speech talking about how important it is to keep basically the Western powers aligned, and then you have on the other end Lula showing up at a basically BRICS kind of conference asking these questions very loudly. Why do we need to have the dollar? Why do we need to be tied to the dollar? Can’t a BRICS central bank issue a currency where we use that as a denominator to trade against each other?

So, yeah, the world is becoming more bipolar, I think. Nobody can deny that. When it comes to investments, not to be too philosophical and to be more practical, I think this speaks to the power of a true global macro mind. There are two things to consider. When I say global macro, people generally think US equities, US rates, credits, maybe European equities, credits and commodities, FX, and that’s it. The reality is there is a lot more.

So when the Chinese reopening was, actually, one can almost call it a geopolitical event, the decision to reopen the second largest economy in the world, the trades that were available, the best ones were in Thailand, in Vietnam, in Myanmar. Those are places that obviously if you don’t care about politics and geopolitics at the global level, you’re not going to look at.

But sometimes, you can widen your horizons and take a broader perspective and actually be able to generate some interesting returns in those places. So I think investors need to become more acquainted with looking at the world. The world isn’t the US and Europe only. It’s everything else.

[01:16:03] Cem

Yeah, I’ll jump in with one last point. How do we know or why do we think that this trend will continue? I agree with Alf. It’s a simple fact that populism, which is demographically tied to this younger generation, is by definition local. People live in countries and they care about their families and the people they live with. Fiscal policy drives populism and nationalism. Monetary policy drives money to corporations and capital, and capital is international, and tends to be correlated with globalization.

So we are approaching a period, if we are going to continue to see populist trends, which are, again, alive and strong in every country I visited in the last year, and every millennial on down that I talked to, it’s more fervent than ever. So as long as that remains the trend, expect global conflict in all its forms, which is not just war, it’s economic conflict, it’s resource conflict, it is real politics in every form.

So if that’s where we live and that’s where we are, there is particularly on the turn, which is where we are, we’re on a macro turn from monetary to fiscal, we’re on the macro turn from capitalism to populism. If you believe that, not only are there immense opportunities, but there are asymmetric opportunities available at this juncture. They’re likely to be not one-year, two-year opportunities, but decade-plus long opportunities.

[01:17:57] Niels

Very good. Well, gentlemen, this was illuminating, it was unpredictable at times. It was fun all the time, and very enjoyable. Thanks so much, both of you really, for an awesome conversation with a lot of knowledge being shared between you. I want to encourage everyone to go and follow both Cem and Alfonso. Well, you have SubStack, of course, Alf, and both of you have very engaging Twitter feeds. You’re incredibly generous both of you in terms of what you share and explain.

As people can probably tell from today’s conversation, we do live in a very global macro-driven world now and it is truly important to stay well-informed. Those two gentlemen that you just heard, they are the ones to follow here. From Cem and me, thanks ever so much for listening. We look forward to being back with you as we continue our Global Macro Series. In the meantime, as usual, take care of yourself and take care of each other.

[01:19:00] Ending

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