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FRA: Hi welcome to FRA’s Roundtable Insight. Today we have Yra Harris and Peter Boockvar. Yra is an independent trader, a successful hedge fund manager; global macro consultant trading foreign currencies, bonds commodities in equities for over 40 years. He was also CME director from 1997 to 2003. And Peter is the Chief Investment Officer for the Bleakley Financial Group and Advisory and he has a newsletter product called The Boock Report. BoockReport.com. It offers great macroeconomic insight and perspective with lots of updates on economic indicators. Welcome gentlemen.

Yra Harris and Peter Boockvar: Thanks, Richard.

FRA: Great! I thought we’d do a view on your thoughts on 2018 in general; where markets are heading, what the trends are, if you see any geopolitical events happening; effects on financial markets and the economy. And so, maybe we begin with the current rally in equities. Do you think it is sustainable? What are causes of this? Where do you see it going? Maybe start with Peter?

Peter Boockvar: So, what we have is enthusiasm, of course, post-US tax reform combined with optimism about global growth. Generally speaking, that is overwhelmed any concerns with central banks and the tightening or less easing of monetary policy. We went from “Don’t fight the FEDs, don’t fight Central Banks” to “who cares about Central Banks” because everything is fine in the economy and there is disbelief that we’re making the transition from a reliance on monetary policy to the benefits of a fiscal policy and synchronized growth. That is what the market currently believes. I think, this year, that thesis will be tested as monetary policy usually dominates fiscal policy in terms of its impact on markets and the economy because interest rates are such a strong lever and in a highly indebted global economy, that becomes even more so the case.

FRA: And Yra, your thoughts?

Yra: I have to stop and say that things Peter and I have done a lot with you Richard and so much of what we discuss is really coming to fruition. In fact, today is the most important day coming out of Davos (World Economic Forum) I hate this time of the year because I’m just not a big fan of what goes on in Davos. I found it, actually, kind of despicable to tell you the truth that these people gather and there’s so many political powerful people that are from central bankers to treasury secretaries to finance ministers discussing things and it’s an expensive ticket. I think its $650,000 to $700,000 and just what are you paying for? And it’s only going to be my problem and of course, there’s a day like today. We got a double blast; from Wilbur Ross and Steve Mnuchin. Mnuchin is a secretary and was talking about “if the dollar goes down, it’s actually good for U.S trade and Wilbur Ross, found to be more incendiary because he said,” …well, there’s trade wars every day. What was the exact phrase that he used? “Now we’re sending soldiers to the rampart”. Well, that’s a very, very incendiary phrase and I was truly bothered by that. So, everything we just talked about, everything Peter speaks to, this is going on. You know, Richard, I think that the 10-year will close out the year at 3.4%. I heard Richard Fisher today pushing about poor rate increases. Maybe. The more I hear what these people or what this administration are talking about, the more concerned I get as to where this is all going. I think I understand why Mnuchin and why they chose Davos to make these statements. That’ll be an issue for other people to think about. It’s very problematic and it does raise some serious issues for the Fed. It’s going to put Jerome Powell in a very difficult position especially if they keep the dollar down. I think we’d probably agree. The reason they keep it down. If you’re going to attack the Trump administration for starting a trade war, the only other alternative is to mark the dollar down. So, it now becomes open season, as far as I am concerned, on the dollar. So, why not? Richard, today you’re talking to two people. I know Peter has certainly been bearish, for what, $1.08 on the euro?

Peter: Yeah, $1.05.

Yra: Yeah, at $1.05 for sure. So I know these discussions have been going on for almost a year. And, Richard you know the many conversations that we’ve had in fact, I know Peter and I totally found commonalities when Mark Fields came out of the White House and talked about currency manipulation being the mother of all trade barriers. So it’s almost like this administration has adopted to that and said,” Hey, you want to go this route? We can play this game too,” and that’s where that leaves us to today.

Peter: It’s a very dangerous slippery slope. Steve Mnuchin is obviously trying to help the manufacturing sector but that’s 10% of the U.S economy. We are a consumer-based economy. So, damaging the purchasing power of a consumer-based economy is very dangerous. You have potential for rising input prices and certainly higher interest rates and I think that will swamp any benefit to multi-nationals. You have commodity prices, say CRB index, which is at the highest level in about two and a half years have rising inflationary pressure, generally speaking, particularly in wages. Now you have the threat of rising interest rates that will only be exacerbated by a weaker dollar. We import more than we export; highly inflationary. Foreigners own a lot more of our assets than we own of their assets and we rely heavily, particularly in the U.S treasury market on foreign buying of our bonds. If you look at last year, one year ago, a European buyer that wanted to pick up some yield bought a U.S treasury; 10-yr at 2.45%. A year later, not only did they lose some principal, since prices are lower, but they lost 15% by owning the dollar. So this is a very dangerous game. The administration should be focused more on currency and dollar stability, not the basement. There’s a very negative slippery slope.

FRA: Could other central banks, outside of the Federal Reserve, take reaction to this? Could there be currency depreciation intentionally done by other central banks? Do you see that?

Peter: We’ll find out tomorrow when we hear from Draghi.

Yra:  There’s a lot of people short Yen or long dollar/Yen here who have been comfortable. That is not a comfortable position that you should be in because if there is somebody out there with a target on their back, it’s the Japanese. The BoJ (Bank of Japan) should’ve ended this policy. That doesn’t mean you have to start tightening and I know they’re not buying as much as they say and as the market thinks that they are because they don’t have to. There’s not that much to sell so whatever you have to clean up to keep that yield curve at that position is certainly not nearly as much as it was a year ago. You don’t really know the full amount of buying but with whatever they want to do they step into the equity market anyway people are buying but whatever they want to do. They step into the equity market anyway. It’s a very slippery slope and I think we’re going to hear from Peter’s executive director or from ECB (European Central Bank) about the strength in the euro. Now in some ways, the strength of the euro helps Draghi because it keeps the Germans at bay. It’s interesting that Jens Weidmann, now all of a sudden started talking more and more. So it does give Draghi some leverage. He could certainly go,” Well, we can afford to be more patient.” It’ll be interesting to see in his press conference how much he discusses the recent strength of the euro.

Peter: I actually think in this counter-intuitive that the strength in the euro actually gives Draghi some license to back away from his policy because inflation pressures are building in Europe as well. What the central bankers want, they have to be very careful as with, because if they achieve the inflation they want, interest rates are not going to be where they are. If Draghi gets us 2% inflation, the German 10-yr is not going to be a basis point, it’s going to be multiples of that. We saw in the market data today, talking about prices pressures intensifying. I want to bring up Japan and I’m going to quote Reid from this press release today from market on Japanese manufacturing. It said,” Strikingly output price inflation accelerated to the fastest rate since October 2008 an inch sharper rise to input cost. With a low rate in unemployment and sustained growth in official GDP data, inflation pressures should continue to mount.” Just imagine if they get the inflation they are hoping for, what’s going to happen to these bond markets? So, by having a little rebound in our currency, they can maybe moderate the inflation pressures. At the same time, giving the central banks an out. Now, of course central banks won’t look at it that way. I’m sure Draghi is going to whine about the stronger dollar is making it difficult for him but I think this is a window that’ll give them the opportunity to back away from their policies because I have to believe that they see the same inflation pressures that we do, particularly in the commodity side, with prices continuing to go up every day seemingly.

FRA: So, for this year, do you see a trend towards quantitative tightening by major central banks?

Peter: Well, the Fed is certainly initiating that. The ECB (European Central Bank) and the BoJ are just buying less but buying less is still a form of tightening. If you blow less air in a balloon, there’s still air going in but less air means a contraction of that balloon.

FRA: And Yra?

Yra: Peter and I have little bit of a different view on this because I still think that Draghi is operating, not just prior to his mandate, his self-declared mandate; is of course the preservation of the euro. I still think that his end game is to put so much debt on those books. Not that he doesn’t have it already, he does. He’s going to push for the creation of a Euro bond. Merkel (Angela Merkel), I can’t tell you what she’s thinking right now. She has got some serious issues. She was chirping about some stuff today about globalization, what they need to get done are they going to divide banking authority. There’s a lot of things in the platter in Europe. It’s just not a straight path and I really think that if inflation takes off in Germany, Draghi and a lot of bosses will be happy because it’s a way for them to punish the Germans for being so intransigent towards Greece, Spain and Portugal. And pushing for fiscal austerity even when unemployment is over 20%. You’re going to have to endure this because right now, the most ridiculously priced asset in the world is certainly German debt. It’s preposterous. Peter keeps pushing it and he’s a 100% right. Right now, the interest by any practical measure, the interest should be about 4 %.

Peter: Yeah

Yra: Right.

Peter: Which should be in line with nominal GDP there.

Yra: Yeah. Maybe 4.5%. It is so preposterous. Let alone all the others but nobody acknowledges that. They all look for reasons. Germany is a land of savers. Every bit as much as the Chinese savers. That’s why the current account surplus is so huge. It’s the largest in the world because Germany saves. They save a lot of money and these savers are being punished because the people who are wrong are not Germans who are investing in the DAX or anything, it’s German pension funds and insurance companies but it’s not individual Germans. They got beat up so bad in the market back in 1999 and 2000. They’re not that invested here. So, most of their money is in fixed income type of instruments — they’re getting killed. We’re speaking on the Financial Repression Authority (FRA), nobody is being as much financially repressed as the German population and that has political notifications.

FRA: Will interest rates tend to rise this year necessarily at different points in the yield curve for yield curves across the major economies? Peter?

Peter: I believe that’s where we’re headed. In the U.S, they keep talking about rising commodity prices and rising wage pressures that are clearly evident everywhere will see whether productivity can offset that or not. The Fed is obviously going to be buying less. You have an enormous amount of supply coming our way as debts and deficits continue to rise. We could have a trillion dollar budget deficit next year. Now, I know the relationships between deficits and interest rates that are somewhat squishy but that was the case in a bull market in bonds. If we’re no longer a bull market in bonds, then the U.S treasury market maybe become more sensitive to U.S debts and deficits. Then you throw in the weaker dollar which can impact foreign purchasing of U.S assets. So I think that interest rates here will continue higher. I think they’ll surprise to the upside. In Europe, I think, interest rates there have only one way to go and that is higher as the ECB will likely end QE (quantitative easing) in September. As they’re currently buying less, or 50% of what they were buying in December and Japan is obviously the wildcard. Actually, before I get to Japan, let’s get back to Europe because this is what bondholders in Europe have to look forward to. Not only do we have a situation where QE is shrinking and going away, but after that they have the end of negative interest rates to look forward to afterwards. So, you had the Riksbank today saying that we’re going to start the path out of negative interest rates even before the ECB starts doing it. So, we are now looking at the barrel of the end of negative interest rates over the next two years. With seven or eight trillion of negative yielding interest rates, there’s going to be a lot of money lost in just getting negative interest rates back to zero. I see only higher interest rates under many different scenarios out of the next couple of years globally.

Yra: I agree wholeheartedly with Peter. I think the 10-yr yield, Peter and I have not discussed targets and I hate choosing targets but when I got pinned down I said,” The 10-yr will be at 3.4% at the end of December of this year. I think I’m going to be low. I think the curve will be back between 130 and 150. I really believe that. If they keep bringing the dollar down, it’s going to come harder and faster as Peter talked about that slippery slope. So, I’m a 100% in agreement and at 2.63 on the 10-year it’s a nice technical level. We could go a lot farther, especially if we have the central bank step back and are not there buying as much.

FRA: Now, one of the economists at Davos we mentioned earlier is Bill White, the former Chief Economist for BIS (Bank for International Settlements). He is now the Head of OECD Review Board. Just wondering on your thoughts, he mentioned because of this rising trend in interest rates, there could be some problems on the horizon due to the problems in servicing debt. So there could be a Central Bank debt trap if you will. Your thoughts on that, Peter?

Peter: Over the last few years, the average duration of credit around the world has gotten to record highs. Which means we’re hugely sensitive to small changes in interest rates. I would have to agree with that. I’ve read some chart from Deutsche Bank saying that,” considering the amount of global debt for every hundred basis points of rise in interest expense or in interest rates, can lead to a loss of 1.2 trillion dollars on paper. We’ve been addicted and accustomed to extraordinarily low interest rates that has dictated behaviour whether it’s the behavior of lending money to a junk credit with almost no covenance to keeping zombie companies alive to buying expensive paintings and hundred million apartments in New York City or buying the S&P 500 at historic valuations compared to 1929 and 2000. Changes in interest rates are higher and it doesn’t have to be a lot higher. It could have dramatic effects on the pricing of a lot of different things because the cost of money is the important price in input to a lot of these things. I think the markets are way too nonchalant with this move in interest rates and this change in behaviour with respect to central banks.

FRA: And Yra?

Yra: You can’t say it better than that. Bill White, whom I have great respect for, as I call him Mr. Lean or Clean because in 2006, he wrote that wonderful paper for BIS talking about the role of central banks and should they be in the business of leaning into spectated bubbles or should they just wait and just clean. He was warning what was coming. We are addicted to this. We’re so addicted to just taking on more debt, more debt, and more debt. What are they using the debt for? To buy back stocks and pay dividends. This is so classic. Ray Dalio, whom I certainly respect as a thinker. I’ve been reading him for almost 35 years and Jeremy Grant also. But it seems to me they’re doing a lot of what I call “chirping” on issues that ought not be discussing such as: if you’re holding cash, you’re going to be sorry. Ok, maybe. But as I think by the time I was down with you, I did something a few weeks ago that I haven’t done in nine years. I took the free cash which is out of my trading account and bought T-bills (Treasury Bills) as my security. My daughter called me and said,” Dad, ninety-day T-bills are 138 basis points.” What am I thinking about? I’m moving and I’m not the only one because Warren Buffett said he’s got a one hundred million in T-bills. These are interesting moments here. I’m not as convinced of this great melt-up as everybody else. I think Peter is getting to where, as usual, things started getting called. We’re very sorry you own a $150 million dollar painting.

FRA: Could there be a slow-down in asset inflation due to the quantitative tightening trend?

Peter: It should. It certainly hasn’t happened yet. The sixty-four thousand dollar question is “when does it matter” and none of us know but I think we’re more confident that it will definitely will matter. I just have to be able to understand that risks are dramatically rising when you have such extreme valuations at the same time you have rising interest rates and a tightening of monetary policy. But again, the question is when does it matter and we won’t know until it does.

Yra: Yeah, and that’s right. People say, if they listen to Peter and I talk, you guys are just crying because you missed it. I have more money in stocks than I ever had. Before the market was at its highest, just by good fortune, started peeling back more. So I’m peeling back into this because I missed the last five percent. I’m not going to be upset because when the break comes, it’s not going to be a five percent break. It may be 15 or even a 20% break. Everybody says,” well that puts you in a bear market.” I don’t know that these rules people really hold in the realm of these Bernanke terminology; zero bond interest rates. I don’t know if any of these old rules hold but we’re going to find out.

FRA: Yeah, exactly.

Peter: We will find out.

FRA: Yeah. If this would’ve happened if they were a significant and fast fall in asset values of asset pricing, could there be a reverse in course by central banks from tightening back to quantitative easing?

Peter: Here is where it gets really difficult for the Fed because they went so extreme and were so slow in removing that accommodation, they left themselves with very little wiggle room. So in the past recessions, they obviously have a lot of bulls to respond. If this selloff is precipitated by higher interest rates, weaker dollar and higher inflation and the Fed decided to start cutting rates that would be a further mess for the U.S dollar and potentially even more inflationary and could lead to even higher long-term interest rates. So then what the Fed is going to do is, they’re potentially really screwed and it also ties hands with QE that could weaken the dollar even more. That gets back to the original discussion on the dollar and the administration wanting a weaker one. It really creates a difficult situation for the Fed if the dollar weakness continues because it completely ties their hands in responding to the next down term here. Because imagine them cutting interest rates with and already weaker dollar, that would be a real mess.

Yra: You know what, if you look at the last the curve steepened out over 180 or 200 baseline, I’m talking about the 210, that was when the second QE2 and everybody was convinced. Now we’re really going to get inflation. So the Fed, of course, wasn’t moving on the long end even though they were buying more. People were selling thinking inflation was really going to take hold. People are smug about the stock market breaking or possibly being negative. The other side of the coin has been where people say,” Where is the inflation?” They started talking about gold but gold is not going to go up because of inflation. Gold is going to go up because the central banks in the world capitulate to the deflationary scare because that is when gold went up the first time. There was no inflation. They would do anything and I mean anything to prevent deflation setting in and that’s what Peter was talking about. If they had to back track here now, look out!

FRA: Did that prompt them to go into extreme negative nominal interest rates so we get real nominal interest rates going into negative territory to an extreme level as if they’re cutting the interest rates on the low end to the same extent they did on the first financial crisis?

Yra: No, that view will certainly have “good friend” on the Fed.

Peter: Yes, no pun intended.

Yra: Pun totally intended. Thank you, Peter

Peter: I’m not convinced we go to negative interest rates. I think you’d blow up the U.S money market industry. I think the banks would go bananas so I don’t see that being a possibility in there. I think that the experiment with Japan and Europe with what they did to the profitability of the banks there. I think there’s a part of negative interest rates that’s been repudiated as a good policy. As the reserve currency of the world, having a negative interest rates, what a disaster that potentially could be.

Yra: I totally agree. I think that point was so well taken. I think Japanese stocks is a safe hiding place for many years. I still hold them. They’re finally starting to move now and they’ve been terrible. It’s like the European banks. Every time I hear people talk about European banks, what Deutsche Bank is trading 19.50? Big deal. They haven’t really responded well. Yeah, they’re well off their lows but that was because there was a question of their sovereignty. Now we’ve got beyond sovereignty at least for a minute until one of the European countries who really have a lot of sovereign debt becomes an issue and our sovereign bond is going to be zero risk rating forever but we’ll get to that question later.

FRA: What are your thoughts on geopolitical risk to the financial markets in the economy, Peter?

Peter: I’m less worried about geopolitical risk. It’s usually more news worthy than economic or market worthy. I don’t think we’re going to war with North Korea. I put that on the backburner, it may happen a day here or a day there. I’m less worried the geopolitics than I am of central banks really screwing this thing up.

FRA: And Yra?

Yra: I couldn’t agree more. To me North Korea, I had trip of my own to North Korea because my son who really knows Japan well. He said,” Look it, as long as the United States isn’t sending air transports and take people out of Seoul, you don’t have to worry about anything because there’s 150,000 Americans living and working in Seoul. We know what happens if the United States were to bomb North Korea. I’m just talking about bunker busters that the retaliation upon Seoul would be so great. There’s nothing going on there. To me, the most dangerous place right now politically is Europe because we have the Italian election coming up and there’s a lot more possible impact coming from there. You can’t show that on television. You can’t take a picture of what’s going on politically in Europe. You can talk about it but it doesn’t have that dramatic effect. The only thing is the Saudi-Russian connection and possibly Turkey but that’s with us at all times. The Mid-East is the Mid-East unfortunately. I don’t see much else.

FRA: What about your thoughts, Peter you recently mentioned, Europe could be the epicentre of the next financial crisis coming out of the European bond market. Do you still feel that way?

Peter: Yeah, we need to remember that the bubble this time around was in central banks and interest rates. Just by having a conversation about negative interest rates tells you the bubble ran because, you know, that’s the epitome of a hot potato market. With Europe flooded with negative interest rates and the ECB reversing themselves, that’s where I think there’s a major, major risk. I think people have to really focus on that. Plenty of risks that could emanate from the U.S but a blow up of the European bond market will have global market interest rate reverberations.

FRA: And Yra, your thoughts on that?

Yra: That says it all. There’s nothing I could possibly add to that.

FRA: Given this view on the horizon, how can investors protect themselves or what asset classes, generically, do you see as making sense in this environment? Peter?

Peter: I remain positive on commodities. Not just initially on the weaker dollar but we’ve seen years of underinvestment. Gold and silver is the way I’m playing the weaker dollar directly. I think that will continue to be a good place to be and I expect much higher prices. I think shorts from bonds, now all of a sudden, pay you something. As Yra said earlier, owning T-bills, you actually get paid in a coupon that is at or above the dividend yield on the S&P 500. Those are two places that is a way to protect yourselves, so to speak, in this kind of environment.

FRA: And Yra?

Yra: Here we are, three sophisticated money people and we’re going to park on T-bills and that’s what I’m doing. We know that real yields are still negative on the short-end but it is far better than where we’ve been. I’m moving more to cash every day. This to me, is one of the greatest gifts we’ve seen. Could it be more rational? Sure, you can. We know that. When the S&P 500 came under pressure today, the break was severe and it actually held at a huge technical level but we still have twenty minutes left and while the S&P’s are hovering at unchanged on the date, it wouldn’t surprise me to see some pressure. Especially Mnuchin and Wilbur Ross, as Peter said, they are on a slippery slope and they are playing in a very dangerous arena here and this isn’t good for equities. The equity markets are much higher ready and as Peter talked about the double-edged sword of a weaker dollar and the impact on corporate properties. It’s not as clear and easy as some people think it is because there is going to be a push back and all you’re going to do is wind up with more uncertainty and disruptions. These are serious disruptions. When you start playing and trying to manipulate financial instruments like currencies, you open up the door to a lot of unintended consequences and we saw it this morning. The first reaction was for the DOW Jones to go up because it’s a large multinational corporation they have been reading this for so long. They see a weaker dollar. “Oh that’s good for you European markets Of course, the European markets never could get up off their behind. In fact, I’m buying DAX this afternoon because they have the DAX under severe pressure but where else are you going to go in Germany? What am I going to buy? Whether the euro goes higher or not, really to me, unless it goes another ten or fifteen percent higher, would I really start to get concerned about it for European corporations. Nothing is going on here. They are playing with, not even dynamite, something that is far more volatile and I’m getting very cautious.

FRA: Great words of wisdom. Thank you very much Yra and Peter. How can I listen more about your work? Peter?

Peter: You can go to BoockReport.com and if you want to learn more about Bleakley, go to www.Bleakley.com

FRA: Great. And Yra?

Yra: Turn into Financial Repression Authority or check out my blog www.YraGHarris.com. It’s a good place where you can get thinking. The good thing is people can really do get some trade ideas that you can really act upon. Peter and I are not offering theoretical analysis. I think there’s really bonafide proof to act upon.

FRA: Thank you very much gentlemen. We’ll end it right here and we’ll do it another time as well in another session.

Peter: Thanks guys. We’ll talk in a few days

Yra: Yeah. See you Friday. Thank you.

Karl De La Cruz

Karl.delacruz@ryerson.ca

Disclaimer: The views or opinions expressed in this blog post may or may not be representative of the views or opinions of the Financial Repression Authority.