09/08/2017 - The Roundtable Insight – Yra Harris: Central Banks Fear Deflation More Than Inflation

FRA: Hi, welcome to FRA’s Roundtable Insight. Today we have Yra Harris. Yra is an independent floor trader, successful hedge fund manager, a global macro consultant trading foreign currencies, bonds, commodities and equities for over 40 years. Also he was the CME Director from 1997-2003. Welcome Yra.

YRA HARRIS: Richard, thanks for having me back again.

FRA: I thought we’d begin today with a discussion of your interview with Rick Santelli back in February of 2016. At that time you mentioned gold and bonds are better plays than the Chinese Yuan. Since then, I think you referenced gold at being 18% higher and also referenced a shift in asset classes taking place – that would be great to get your insight on that.

YRA HARRIS: This is always a cautious zone for me to do this. Sometimes you just have to go back and look at things you said to weed out all the noise that crowds the world of finance and the discussion that takes place. So yes, on February 1st 2016 I had done a hit which you can find HERE. And it was the Monday after a weekend – I mean it was a scheduled interview, and what took place over that weekend is what I call the four horsemen of the global macro world. People I hold very high regard for their analytical ability: David Tepper, Ian Horton, Kyle Bass and George Soros – These guys came out and made comments over that weekend, it got a lot of media play, that they expected a 30% depreciation in the Chinese Yuan because of all the debt issues in China and other things that were taking place. On that Monday morning with Santelli I discussed that that’s a difficult trade for a lot of people to make .. I said I would rather be long bonds, all kinds of bonds all over the world, sovereign debt not corporate, and gold. It raised Rick’s eyebrows and he said, “Why?” I said, well, because if the Chinese Yuan, and at that time it was trading at about 6.58, which was an okay level, it has certainly weakened over a period of time where it was down to 6.10, so I said if you’re looking for a 30% depreciation from these levels, the impact on the globe will be massive deflation because if the Chinese were depreciating that much that means they would be shoving exports out as fast as they could and it would really put downward pressure on prices all over the world and we already know we had too much slack in the global economy, and that would be the impact. And I would own the gold because it’s deflation that will force the hand of central banks to panic. We are now at zero to negative interest rates. People say they fear inflation; no they don’t, not at this point in time. We go back to Ben Bernanke talking about the lessons of 1937 and that’s the fear of deflation. Central banks fear what happened in Japan for the last 20 years. The fear of deflation weighs upon them, so then, from a hard money perspective, it’s more the issue of what you do in response to that deflation. And that’s why I said gold would be a better play, a safer play and an easier play for most investors and traders to make. So I went back the other day to review it and the Yuan had actually dropped. Right now, it is through the level it was on that weekend and right now it’s trading at 6.48.  So that’s moved where the Yuan is actually higher from that date, but gold is up now 18-19% from then and the bonds are basically steady, maybe they are now 10 basis points higher than they were. But that was the purpose of that trade because again it’s to put the light that central banks fear deflation far more than they fear inflation at this point in time. Now will that change? Well, the Fed hopes it changes, but it’s not changing. And we heard Mario Draghi this morning; he’s much more worried about hitting his inflation targets on the upside than anything else. So that was my point of that. I just wanted to go and revisit that for people who follow my blog and just to put perspective to things.

FRA: Great. And what about your current thoughts on the 2/10 U.S. yield curve? I think you had some concerns that it might be breaching the 73 basis points level.

YRA HARRIS: Yeah, we’re down here again. This 73 basis point level has been an important level for me. I’ve written about it for 4 years and we’ve bounced out of this area several times, but here we are back visiting it so we are getting some flattening in the curve. Now as I warned last night in my blog, this is a critical level for me and it sends a very important message to the banks because this curve ought not to be flattening. If the Fed embarks upon, as our beloved Peter Boockvar calls: Quantitative Tightening (QT), which is a wonderful phrase, but if they begin shrinking their balance sheet that should unleash more supply in the long-run in the market & the curve ought to steepen. But, if the curve chooses not to, I think the Fed will have received a message. We saw the Bank of Canada tighten after we saw the response of the currency which rallied quite a bit because it caught the market off guard because the consensus was that they weren’t expecting a tightening. So we saw that action and this plays right into Lael Brainard’s speech back in June. What Lael Brainard said recently is that she doesn’t want the Fed’s Funds Rate to go up, that the Fed Funds rate is high enough to embark upon quantitative tightening. And with more supply it’s going to be a trickle effect to begin with, just as Janet Yellen has famously said that the quantitative tightening will be like watching paint dry. Peter Boockvar doesn’t believe that, nor do I, once this starts going, but this curve is very interesting. Now, as I warned, and I’m not being a two-fisted economist here, but with the impact from the Bank of Japan and from the ECB still actively involved in quantitative easing programs and because we believe in the global macro world that money is fungible, it might push the long-run US curve lower and lower. And this is really going to cause a problem for the Fed. They’re going to have to sit up here and take note of it because they cannot afford in all their designs for whatever they want to do, for this curve to start flattening more dramatically.

FRA: And that’s what you think would likely happen if the 2/10 reaches 73 basis points then…

YRA HARRIS: Yes, especially if it closes on a weekly basis. In today’s world we can get all kinds of erratic movement, but it closed on a more long-term technical level like a weekly close, that would give me a warning sign. My history of studying this has been that when you get flattening curves, especially in the US dollar, which is of course the most significant part because they are the world’s reserve currency  – That your currency ought, and I emphasize ought, first of all to rally .. now that may seem counter-intuitive but that’s what does happen. I don’t know what the time lag is but the currency does rally. And it’s not good for metals because what does it reflect? It reflects a coming slow-down in the global economies. That’s what flattening yield curves project, that’s historical .. And that’s why historically they have been great predictors of economic and financial outcomes. But, in this world of massive QE, we don’t know that. Again, as we’ve stressed, and I’ve been on with you I think for 3 years on and off – the signalling mechanism has been so badly broken. And this may be one of those times, but it certainly sends a warning sign. And the warning sign this time will be interesting because if I’m right, this time the dollar will not rally and the gold will not break. It may have an initial effect, but there won’t be any significant damage done to these prices levels because the Fed will be in a very difficult situation as to how to respond to this because with interest rates at 1.25% it’s not like they have much latitude on that end. So this gets very interesting. We are at very interesting pivotal points and we’re going to wait to see how this unfolds. But, the market dynamics are telling us that we’re at very precarious points.

FRA: Yeah, and we also talked yesterday on the program show in terms of what’s happening in China on the Silk Road and the rally of base metals over the last 1 year period or so. So in the old world, base metals and precious metals could fall, but now because of all the distortions and new factors such as China’s development, we could still see that trend of rising base metals and precious metals?

YRA HARRIS: Well, yeah. I mean we are still trying to figure this out as we’ve watched copper rally. And I’ve been suspect about the copper rally, but now between the Hurricane Harvey and Irma there is going to be a lot of rebuilding and the copper prices were already moving higher, so we might see some of that fall off from that. With China’s Silk Road initiative it certainly has had some impact, but the way the Chinese securitize some of their debt is with commodities which I’m a big fan of. I think that there should be gold-backed bonds. How this hasn’t taken place is beyond me and I know my friend Bosko up in Canada has been working on this because he trades – he makes markets for people’s gold coins and he has been very interested in this. But this is significant. These are significant events that are taking place here and part of the reality may be that the Chinese are securitizing a lot of commodities and that puts a floor on the pricing and keeps them in demand. The problem is that when you use commodities as securitization, if you haven’t priced them, meaning: if you pledge me 100 ounces of gold and you’ve given too big of a haircut on it, then I’m not really protected if gold prices collapse. But if you figure out the right ratios it does work. Are we embarking upon this? I don’t know as of yet, but we are certainly seeing some interesting responses to all of this.

FRA: As you mentioned earlier about the central bank policies of Europe and Japan factoring into this thinking, do you still see their monetary policies as staying the same like the current program of 60 billion Euros per month by Europe? Do you see that changing?

YRA HARRIS: Well, I think about that. Peter and I have actually disagreed because he thought we were going to see an earlier statement from quantitative tightening, but he was dead right on target in saying that it will probably come in October after it shifted a little bit after Jackson Hole. And from what Draghi talked about today in his press conference, recalibrating the October meeting which fits Peter Boockvar’s timetable now. I don’t know; I think it depends on many things. Number one, I think that Mario Draghi is hoping, he’s fervently hoping, that Merkel does very well in this election because it will give him more latitude because Merkel has been running protection for Mario Draghi in his whole quantitative easing plan since day one. So the stronger she is, the more comfortable he is. So we will see the way this election comes out and we’ll play upon that. I still say that Mario Draghi nets me my premise and I’m sticking to it. He has a far different agenda than the Fed or the Bank of Japan does because he has a political agenda and his political agenda is how to craft a Eurozone bond because it will take a Eurozone bond to create a truly unified European financial system and therefore the bigger he builds that ECB balance sheet, the higher the chance that he is going to be able to synthetically create a Eurozone bond.

FRA: And to continue building that balance sheet if the ECB is running out of bonds to purchase, could it expand or broaden to include German equities?

YRA HARRIS: Well, that’s a very good question. Mario Draghi was actually asked that question today and he danced like he was afraid to answer, he really didn’t give an answer. Could he? – He said they haven’t discussed it – Baloney they haven’t discussed it. They are very aware because this is going to become a legal issue regardless. And if the AFD, the Alternative for Deutschland Party, actually does better in the election than some think, it will for certain become a major legal contention because they are already violating the whole basis of the Maastricht deal to begin with, but everybody has looked beyond that because Mario Draghi’s real mandate is preservation of the Euro. He said that in July of 2012. He keeps talking about inflation, but he has taken that upon himself to be the preserver of the entire EU project regardless of costs. So, we can’t answer that question, we really can’t, until we see certain things start to play out. Everybody is going to develop their own hypothesis and some are going to prove right and some are going to belong in the trash heap of ideas, or as Max Planck would say, science advances one funeral at a time; same with trading.

FRA: The last question is on the Euro. Where do you see that going? We’ve seen a lot of volatility, today for example after Mario Draghi’s speech and also the ECB releasing forecasts on foreign exchange.

YRA HARRIS: In fact, Rick Santelli had John Coulter on and Santelli asked him a great question at the end. Rick asked him about the Euro and he asked would he be buying Euros and Coulter of course dodged the question just as Mario Draghi dodged the question, he dances one with great ability. It’s interesting that he cited the 1.18 Euro level as the number that they use in their projections. So he was being nailed down to that, but he didn’t give it that much credibility. My view on this is that he likes Euro here because it helps Merkel because it quiets the Germans. He wouldn’t come out and say this, but if I was there I would have certainly asked the question: Does the strong Euro represent the successful policies of the ECB? Which of course is what Draghi would say if asked .. I’m not sure where it goes here, but I’ll tell you this, and I’m going to blog about it tonight: so far today in the cash Euro market the high has been 1.2059. This is a real critical area because if you go back to July 2012, and especially July 23rd when Draghi delivered his famous comments of whatever it takes – Meaning to preserve the Euro. The low that week, when he made that comment, was 1.2042. Then over the next year and a half the Euro proceeds to rally all the way back to 1.40. Now during that time is when the United States when in full quantitative easing mode. And then 2014 when the United States began tapering, the dollar starts to rally and the Euro drops over the next few years from 1.40 to 1.05. So these areas that we’re in are very important and we’ll see what happens.

FRA: Great insight, lots of volatility and moving parts today. How can our listeners learn more about your work Yra?

YRA HARRIS: You can follow me on my blog, “Notes From Underground” at YraGHarris.com. You can register for it; it’s free. You will get a real-time into what I am thinking about

FRA: Great excellent. Thank you very much Yra.

YRA HARRIS: Thanks Richard – I appreciate it.

Transcript by: Daniel Valentin <daniel.valentin@ryerson.ca>

LINK HERE to get the MP3 Podcast

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