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OCT 24th Podcast: Yra Harris and Peter Boockvar

By: Tenzin Lekphell

FRA: Hi welcome to FRA’s Roundtable Insight!  .. Today we have Yra Harris and Peter Boockvar. Yra’s a hedge fund manager, global trader in foreign currencies, bonds, commodities, and equities for over 40 years. He was also CME director from 1997 to 2003 and Peter is Chief investment officer for the Bleakley Financial Group in advisory. He has a newsletter product called boockreport.com which has great macroeconomic insight and perspective with lots of updates on economic indicators. Welcome gentlemen!

Peter: Hey Rich, hi Yra!.

Yra: Hey Rich!

FRA: Great! I thought today we’d focus on a number of aspects for the global economy and financial markets, Central Bank policy. You recently made some observations that the Federal Reserve could be hiking the US into a recession. Can you elaborate on that on your thoughts?

Peter: Well it’s what they typically do. Most rate hiking cycles end that way and not sure why this would be any different. We have to understand that not only are they raising rates but they’re also letting their balance sheet roll down so there is a double tightening going on that only recently markets have began to appreciate it.

FRA: And how do you see that playing out currently in the financial markets globally with all the volatility?

Peter: Well from a market perspective, we’ve already seen a bunch of different potholes this year, I think driven by the rising rate so the 10-year yield of beginning of the year one from 240 to 270 and you blew up the short fixed rate. Then turkey was exposed for the debts and deficits and rising inflation that they have, which is no mystery they have political issues for years but in a rising-rate environment, vulnerabilities get exposed and it started in Turkey then went to Argentina and of course you had a blow up in the Italian bond market just as the ECB is wrapping up there own Q.E program. From an economic standpoint, the rising rates is already slowing down the pace of transactions in the housing market and in the auto sector. And also we have to pay even now closer attention to corporate balance sheets where a lot of the excess has been created in the cycle. You look at small cap stocks particularly those in the Russell 2000. 40% of debt on Russell 2000 balance sheets is floating rate, which is obviously now very susceptible to the rising LIBOR and the question is whether cash flows can then deal with that rising cost of capital. Also from a leverage standpoint, small companies in the Russell 2000 have a debt/equity ratio twice of those in the S&P 500. So this rising rates, this rise in the cost of capital is beginning to have an economic impact and as I mentioned before, a market impact.

FRA: Do you see this being bearish on credit sensitive cyclical sectors ?

Peter: Well so far because you’ve thrown into the mixes, of course the slow down in the global economy, particularly in China and in Europe, so a lot of industrial are obviously cyclical, they have high fixed costs, and very sensitive to changes in economic activity. So a lot of confluence of events are combining for what is obviously a much different market this year compared to what investors are used to over the past couple years.

FRA: And is this all creating an emerging market crisis as well as emerging crisis in the European bond market?

Peter: Well I don’t want to speak broadly when you mention crisis. Certainly in Turkey there has been one. Certainly one in Argentina there has been one with with short rates north of 60%. That’s a crisis. We have to see how it plays out in China but China has a long road to hoe in terms of the enormous amount of debt that they have, the weakening in currency, the capital flows for current account deficit and so on.

So the crisis, I don’t want to say that just yet, but certainly this rise in rates, this drain in global liquidity creates a lot of potholes as I said and if you look at just the ECB, the Fed, and the B.O.J this year or this quarter, beginning October on a monthly basis, there is a net-zero of liquidity injection if you add in the behaviour of those three central banks so that creates also a drain and I think also is responsible for a lot of the fragility that were seeing now in markets.

FRA: Will this all create strengthening of the US dollar?

Peter: Well it has against certain currencies. It has against the Yuan of course, it has against the Turkish lira and Argentinian peso but if you look at the Euro heavy dollar Index, the average level of the dollar index over the past two years is 95 and say we’re a little bit over 95. So for all the talk about Fed rate hikes and how our Central Bank is far ahead of the curve relative to others and US growth is so quick compared to everybody else, the dollar index is basically in line with its average over the past two years. So it’s been strong against certain currencies and it’s done nothing against others.

FRA: And what about in China? You have observed that off balance sheet, government liabilities and the regions of China has amounted to $6 Trillion US dollars. Do you see that as a gigantic credit risk?

Peter: Yeah that on top of the amount of assets in their banking system relative to the GDP so we’re about to see how they handle this enormous debt load. Is it something they can paper over? Is it something that can grow their way out of? Is it something that’s gonna be like Japan that’s just gonna linger for 30 years? We’ll just have to see but there’s some serious challenges in the short-term. I mean long-term, I’m pretty bullish on China. I think that they’re the economy of the 21st century but I certainly don’t discount and don’t take for granted that in the next couple years can be a tough road for them.

FRA: What do you make of the standoff between Italy and the European Union, Brussels? Yra you’ve observed that Rome knows that the higher Italian yields are forced by the rhetoric of Brussels bureaucrats. The greater the losses for institutions forced to sell in any type of panic you have observed in your blog, what do you make at the standoff?

Yra: Well the standoff is real. Unfortunately, I think there are a lot of people who talk in Europe who really fail to understand or they don’t want to understand cause (Inaudible 7:20-7:21). The Italians… they understand perfectly what’s going on here. And I think that, if I were to (Inaudible 7:29-7:36), they know what they have. The problem for the Europeans is of course, and we saw (inaudible 7:46-7:54) it’s a compounding problem for Europe. They have the Italians, who understand whats going on here, they have the Brexit situation, and they have Trump, that they have to worry about. One thing we know about the president is he doesn’t forget flight. We know that. That doesn’t mean he actively pursues a vendetta but he does not do well with flight. In the G7 meeting, Merkel and Macron and two others really (inaudible 8:31) him, you know the famous picture. It wasn’t pretty. So there was an article in the (inaudible 8:41-8:42) last week titled: Donald Trump Looks To Start (inaudible 8:45) US-UK trade talk. There’s three things to look here;

1. You have the Italians who understand the pressure because there’s really nothing Brussels can do because the whole QE program has tied them up. I know we talked about this quite a bit over a couple of years that Draghi piling up all that debt.

The bigger problem is the zero risk waiting under the (inaudible 9:20-9:21) rule. They’re carry all this Italian debt, all these banks carry these debts Including the ECB and there’s no risk to it according to the rule of (inaudible 9:31). That presides a potential problem.

1. You have Trump who will throw a lifeline to the Brits. Unlike Obama who made a categorical mistake (inaudible 946) in real time that to say, you’re going to the back of the Que, and Donald Trump says, U.K you’re going to the front of the que and we may even create a free trade zone with you involved in it, which would be death for the Germans cause of all the auto capacity, manufacturing capacity that was built by the Germans and the Japanese in Britain. You have that and this really locks up Europe. They don’t have any leverage. But I hear people talking about what leverage they have. What leverage? The Italians say, what are you going to do to me? Our rates are gonna go up. We saw rates in Greece go up by 40%. And you know what? Greece is still here and they’re talking. We need growth. I think there are actually more people in Europe who support the Italians position than we hear reported. So I mean we have the (inaudible 10:48-10:50) really into Salvini and De Mayo’s hands. It gives them a lot of strength. I don’t think Brussels has any strength in this negotiation.

FRA: And Peter your thoughts?

Peter: It’s interesting because one of the proposals from Salvini in this proposed budget, which I only really read about is lowering taxes and having a flat tax. That’s growth encouraging and huge growth incentive. The spending side, that’s not really long lasting in terms of generating growth so you get stuck with more debt, higher deficits, and you don’t really get the growth. So I think that’s what the concern is. The Keynesian side of this budget, that I think is the concern, and the assumption that it’s going to magically improve the long-term competitive and economic growth rate of Italy, which it wont. Only lowering taxes and the massive regulatory state will. Paying people universal income and getting rid of the extension of retirement age and pensions, that’s not growth enhancing and so that’s what I’m worried about that they’re not going to get the growth they’re hoping for. And bigger picture, I keep arguing that the behaviour in the Italian bond market and response to what’s going on is the canary and when now the European Central Bank is 2 months away from stepping away from its purchases, who’s going to buy these bonds? I mean they were really the only buyer. Even Germany, which has a budget surplus which has a grade A fiscal situation, who’s going to buy German bundits 40 basis point when inflation is running 2%? Or PPI today which printed 3.2% for September? Who’s going to buy these French OAT for less than 1%? Who’s going to buy these things? I think that’s a big question and I think that has broader implications for the entire region and that Italy is really the poster boy initially because of the enormous amount of debt that they have and so little growth that they have to the point where their financing cost are now running above the rate of nominal GDP growth which means that their debt to GDP ratio begins to spiral upwards.

FRA: So do you see Italy changing their budget per the request by the EU Brussels?

Peter: I mean I’m sure, Yra has been saying this, there’s some agreement because Italy is really carrying the leverage here. There’s only so much the EU can do but I do think that everyone realizes it’s in their best interest and I think that the end of the day, it’ll be the EU that folds and gives into what Italy wants to do. I don’t think what Italy trying to accomplish, as I mentioned, is going to work but I think the EU has no choice but to at least give them a try. And you know the ultimate decision-maker a year of how this is gonna go is going to be the market. If the market sees that Italy can’t generate the 1.5% GDP growth that they’ve budgeted for next year, and it’s going to be less than that, then the bond markets going to speak up and you’re going to see a much higher rise in interest rates because even at a 3.5 or 3.6% 10 year yield relative to the fiscal situation in Italy, that’s still a historical low yield.

FRA: Yra, did you see that same rise in interest rates?

Yra: I think Peter is right about that but I’m looking more in the short term. What the effects are going to be? Europe needs an infrastructure program bad. Even the Germans seems to be admitting to that. So with that, there is going to be some deal. I truly believe that. If they think this through because if we look at this through those eyes you know of what George Soros and others have been recommending for several years, and not wrong but they’ve just dragged their feet for so long and that’s what they should have done to begin with. They could create a European almost like what Obama did with those infrastructure bonds, build an America Bond.

So you could do a build Europe, and I’m not saying that it’s gonna be responsible in any ways.

You could put together a package, lets say, 500 billion euros to build infrastructure projects all over Europe and use the capital key for those ratios and get this done. If you did it with the European wide bond, you would actually start doing what people have suggested as long as you see this project all the way through to its conclusion so your gonna need a European bond. So you could do this and get the Italians. From everything that I read, the Italians would buy into something like that because that’s what they’re really pushing for anyways. So if they did it across the European wide situation, I think that’s doable. I don’t know if they have the political strength to do it, and again I think Merkel has really dragged her feet here and Macron would have pursue this. He’s been dreaming about this. So I think you could see it and they can sell it in the short term. That way it eases the pressure on the Italians and everybody gets a little something. We’re probably (Inaudible 16:57) equity markets. Any sense of discussion is (inaudible 17:01) of equity markets that are looking for anything in the short term to give them some support. I think we’re gonna see something out of this group cause it’s bad. The election was 2 weeks ago and (inaudible 1750) the results were terrible. There’s an election this week in (inaudible 17:20) so everybody will be watching for this and they’re losing the middle ground so badly. I mean the worst part of the German election, a week and a half ago was that the Social Democrats, who have always been a mainstream, middle of the road policy they polled below the alternative for Germany. So there’s real problems going on and they need something and I think that’s what you’re gonna get out of this cause its a way to placate a lot of people in the short term. I agree. Peters right, who’s going to be buying these bonds? Let’s be serious, it’s a terrible flawed policy that is now coming home to roost. We’re not quite there yet. We still got 15 billion to be bought of fresh money every month so there’s still work in it. Peter’s a hundred percent right. It will come to no good. I just don’t know what the timeline is.

FRA: And what about the effect of any political movements in Europe? How could that affect all of this like the recent elections in Bavaria, trends towards populism, and the movement away from the Merkel government power?

Peter: I’ll leave that to you Yra.

Yra: The populists are trying to make this into a global phenomenon. There are a lot of people that feel like they’ve been disenfranchised by the what I refer to as the (inaudible 18:50) elite, people who sat there and made their policy or projected a sense of making policy with little regard for basically middle classes of the world. Let’s face it, globalization has benefited capital far more than labour put it into Marxist term.

I saw the interview that Alan Greenspan had in (inaudible 19:18) this weekend. It was interesting because he actually gave a Marx high grades for certain things that I thought from him was interesting, because I think that’s right.

And that’s what the world has had to answer was the shift and the reward for global capital vs. labour and its what we’ve dealt with which is why I believe that it’s a major flaw in the modelling of the Phillips curve but that’s a different discussion for another time.

So I think these are real and you have to find someway to placate those voters who really have been….and wages have not kept up and that’s by design.

You know the whole (inaudible 20:07) Germany was to free wages to sustain jobs in Germany rather than moving them to Eastern Europe.

NAFTA, when you go back and look at the beginning of NAFTA, it was meant for the North American region to take advantage of the Canadian natural resource base, combined with US capital and combined with Mexican wage rates. I mean it simplifies it but that’s a big part of it. So wages has been the real drag here and which is why we’ve seen the stock markets to get to levels that are…..we could argue historically where they’re at but they’ve been rewarded vs labour. It’s now starting to change and how everybody adjusts to it, I don’t know.

There’s a movement afoot but we shall see. But to diminish it and to pretend that it doesn’t exist is a major mistake which is why we got Donald Trump.

FRA: You’ve recently observed, Yra, a quote by last vice chairman of the Fed, Stanley Fischer, who said, “we the central Bankers cut interest rates severely to encourage growth and to support equity prices”. That adjustment hasn’t been fully made yet and then you point out a dilemma that Nehru vs Nehru. Can you elaborate?

Yra: Well, we come back to the wage thing. They all admit that they don’t understand why there is no wage inflation. I’m not saying that’s the answer but the Nehru model, I think is flawed I believe it’s flawed for many years and when you have the mobility of capital, and not the mobility of labour, you wind up with a lot of downward pressure on wages. When you’re given the alternative, Do I want my job or do I want a wage increase? Well Peter’s younger than I am Richard and I’m not sure how old you are but in the 60’s and 70’s, when I was a teenager starting to get in the work world, unions had a lot of power because we’re still in the post World War 2 situation capital wasn’t that mobile yet, breakdown Bretton Woods but when capital becomes so mobile that can go in search of lower wages and you have the transportation mechanism, you know ships, and containers today, we can move products today so you have the ability and therefore, labour comes up in the short end. And that’s what we see and so it’s not a surprise and now you have a billion Indians coming up in the global labour markets just like you had over a billion Chinese, of course those aren’t exact numbers. And to the global labour force, you had Eastern Europe unleashed into the global labour force. These have kept wages flat even if profits grew. So we built up this whole Q.E mechanism searching to push inflation higher but if its a phenomenon that has a lot to do with the global capacity, which is vast, the Chinese have a vast amounts of capacity labour force and it keeps prices down. But they built Q.E to push us out but if it’s not happening because the models are flawed, we’re in a serious dilemma. How we resolve it is going to be the big question.

FRA: And your thoughts Peter?

Peter: Well just to quantify a couple years ago the wage for the labour portion of the profit pie, that percent is low since World War 2 and that has now shifted and labour is gaining more leverage. And I do expect and I do think the wage data has been understated, especially over the last 6 months because most of the entrance into the labour force are young people and those with just a high-school degree. So when you measure the average hourly earnings for example, that’s most of the entrance, well that’s lower than the average. For those that are already working, I think wage pressures are pretty persistent and I think that’s being seen and in many different places because if companies are in search of labour and they cant find it, well they just have only a few choice in order to get it and raising wages is a key way of doing it.

And today’s Richmond Fed survey, not really saying anything we don’t already know but highlighting again, they said quote, “firms were unable to find workers with skills they needed as the skills index drops to an all time low”. That’s also a problem as well that there may be some workers out there but there’s a mismatch of between what’s demanded in the labour force and what’s supplied. I mean we know the demand side, there’s a record amount of job openings

But the inability to fill that is a problem and for those that can fill it, at least now has leverage and are gonna be paid a higher wage. And you throw in Amazon, which is raising their minimum wage which then forces and puts pressure on a lot of other companies to respond and sort of raises the lower end of the wage band.

So how that filters into consumer prices is obviously the main question. If productivity picks up, then it would not be a big deal but if companies find the need to pass it on in to higher prices, than you know then you got that wage price spiral that was similar to the 1970’s, not that this it’s gonna be repeated this time around but it gets to a broader picture here.

When you look at, and it combines with my comments on interest rates, the two biggest drivers of profit margin expansion in this recovery was

1. Lower interest expense, which allowed companies to dramatically reduce that with low interest rates.
2. Low wage costs.

And now both of those are turning upwards. So can revenue growth be quick enough to deal with that? Well likely not if 40% of S&P revenues are sourced overseas and see what’s going on overseas. So you have profit margins that in my opinion have peaked out or going to regress to what portion to the long-term mean we don’t know because technology is so dominant factors nowadays but I think that profit margins have peaked out in this cycle.

FRA: And finally what everybody is wondering about the last few weeks is where are global equity and bond markets heading and what events and risk factors should we be looking out for in that regard starting with Yra?

Yra: Well I think, Peter and I would agree on this. First, I think bond rates are going higher. I was not looking for curve inversion. I was interested in watching to see where they were gonna hold here so it’s interesting that 530 as we talk is breaking out above its 200 day moving average for those who are technically oriented for the first time since I think in 2 years. So I find that interesting.

You have Greenspan again and his interview (inaudible 18:23) but of course he raises the issues of entitlements and the pressure it puts on, well he thinks productivity and bond values. I mean Europe is an abomination and those bonds value, we know, some of the populous fever in especially in Northern Europe, you know, people forget that this populism is taking place in a very healthy environment. Yes it’s starting to slow a little bit but you measure this stuff by historical perspective, this is not when you get populism. You don’t get populism when unemployment rates are as low as they are. This is supposed to be the feel good era but yet something is broken.

This mechanism is broken economically and politically and you can’t divorce one from the other. You certainly can’t divorce politics from the economics. It’ll be healthy if bond rates would actually go up because I believe that interest rates are a very important signalling mechanism for the entire global financial system and its been broken for so long that its trying to reassert itself. Peter is the one is the who really first one to coin the phrase quantitative tightening. Its impact? Well we don’t know the impact was but I think we’re starting to see it.

It’s amazing to me, even the Fed admits it, that they don’t pay enough heed to the fact that they’re raising rates while the balance sheet is beginning to shrink. That’s a dual edged sword. Then of course you have the Europeans cutting back dramatically. And yet you are dealing with lax fiscal conditions especially in the United States, you have the deficits growing regardless of what Larry Kudlow has to say. I’m looking for bond prices especially to be moving higher and we’ll get a good picture in Europe after January 1st because then the ECB will be replenishing rather than increasing the balance sheet.

While there won’t be quantitative tightening, there won’t be the act of participation by the ECB and the Japanese we don’t know what they’re doing. It’s too hard to tell. They own so much of the market so we’re trying to get a sense of it.

The Chinese, the book is still out. Everybody who’s talking about the Chinese…I think what they failed to understand is that China borrowed a lot going forward when they began a lot of stimulus in 2015 and 2016 so I think the stock market in China is more a story about, hey they borrowed a lot from the future and the future is here. They got some issues about how to deal with what they borrowed from the future. So it doesn’t surprise me that the Chinese capital markets are as weak as they are.

FRA: And finally your thoughts up here on the transfer equity and bond markets?

Peter: I definitely agree with Yra on the interest rates and its a variety of reasons why rates are rising and I expect them to continue and it’s very easy for people to take out their historical playbook and say, okay, inflation and growth are the two drivers and whatever that plays out that’s where rates will go but unfortunately, we have to throw in the normalization and reversals of the central bank balance sheets on top of Fed rate hikes. We have to deal with foreign appetite for US treasuries which has been dramatically reduced partly due to the cost of the hedging but certainly also related to the dramatic reduction in reserve buildups that we’ve seen in China. Then you can throw in some other reasons that I think combine for a rising rates which will continue and I think the big question going at the 2019 is how do European bond yields respond to the ECB not adding more to their balance sheet? I probably said this on your show before but just to quantify the extent which ECB was buying European bonds at the peak when they were printing 80 billion Euros a month, they were buying 7 times net issuance. 7 times! An extraordinary ratio! For the Fed was never buying really more than 25% of Net Insurance.

That all changes as of January 1st, granted they’ll be reinvesting but on that basis, they will not be expanding their balance sheets and again who’s going to buy the stuff? So if you get a rise in German Bund yields, you have to believe that you’re going to see a coincident rise in US treasury. With respect to US stocks, it’s been a party for 10 years and what typically ends the party is Fed tightening and I think it would be hard to think that this is not going to happen again. Valuations are very expensive in the US. If you look at metrics other than P multiple(inaudible 33:55-33:56), If you look at variety of other (inaudible 33:58) prices cell ratios and are very expensive. Also, the rising rates are having an economic impact which has potential hurting earnings so I’m pretty defensive when it comes to US equities.

I am becoming more intrigued with the values being created overseas market that have got hammered. You look at China for example and China’s gonna have a couple of years of serious challenges no question but the markets gone pretty cheap and its down almost 60% from its highs in 2007. And even Japan, the Nikkei is down almost 50% where it was from 1989. I know that it’s been the case for a long time now but your looking for value so it’s unlikely going to find much on the US but you’re the potential finding a lot of it overseas.

And then lastly, I remain bullish for gold and silver because I think it’s respite in this crazy environment. The dollar has been strong against some emerging market currencies particularly the Yuan and then the troubled ones like the lira and the Argentinian peso and certainly the British pound related the Brexit but the dollar index over the past two years has done nothing. It’s gone up and gone down. It’s pretty much at the same level it’s been. I think that it points to major headwinds for the dollar and then maybe it’s the twin deficits that people are beginning to focus on.

FRA: Well great insight as always gentlemen. How can our listeners…

Yra: Richard can we come back to one thing?

FRA: Oh yeah sure.

Yra: In regards to China? You know unfortunately the airwaves get filled with ludicrous assessments, I mean it’s really ludicrous. I had to listen to some of these tirades yesterday what the United States, with Trump and Navarro especially, were trying to do is force regime change in China. That’s such a ridiculous concept. If that was the case, then you’d be verge of not a cold war but a hot war because if you think the Chinese would cave to US pressure for regime change… I had to listen it to 10 mins! Its ludicrous! People need to be, this is just a warning, be careful of about what you hear and what you listen to. There are a lot of people out there with ridiculous narratives. Ridiculous narratives! That one was mind boggling because that has not happened. That shows no understanding of how China works of the politics of China. China, we want to think in terms of a western style democratic capitalists model. It’s just not appropriate. You may wish that for the end result for China and they may get there but the present situation is far so from that and any discussion of what the Trump administration is really pushing for and what they think they are able to get because why would you pursue a ridiculous policy if you had no chance of ever attaining it? Let’s just be cautious. You need a filter, that’s what I’m advising. You need a filter and you have to understand what the entire global perspective is rather than somebody who may be selling something so be very careful!

FRA: Great and we’ll end it on those words of wisdom. Thank you very much gentlemen! How can our listeners learn more about your work? Yra?

Yra: By blog at notesfromunderground. It’s a pleasure and of course doing podcasts like these, it makes for important discussion. I advise you, you need to read! You need to subscribe to people like Peter’s work because you can’t do this alone because this is an endeavour. To be a trader and investor takes a lot of effort. It takes a lot of discourse between people. I remember when I was a floor trader, one of the great things on being on the floor was you had opportunities to discuss things with people. Now that we get more isolated, anatomized by computers, we lose that ability. So anytime you can involve yourself in any of these discussions and to read as much as possible. There’s quality work out there. Peter’s work is quality. Avail yourselves of these opportunities and listen to these podcasts.

FRA: Yes exactly and Peter?

Peter: Thank you Yra for that. You can read my daily work by subscribing to boockreport.com. If you’re interested in assistance with wealth management, you can reach out to me at bleakley.com

FRA: Thank you very much gentlemen! We’ll do it again.

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.