RAOUL PAL: Good to get you on.
I really, really wanted to chat to you because
you and I have known each other for quite
a long time now and your understanding of
the complexities of the juxtaposition between
macro, politics and the plumbing is unparalleled.
You're very well known as the insider's insider.
I just thought with so much going on, you
are the person who really wants to reach out
to, just to get really an understanding of
what is really going on, and where do we think
this is all going and just to get your personal
opinions on some of this.
JAMES AITKEN: It was very good to see you
all, boy, and thank you very much for having
me on.
I'm very grateful to you and your subscribers
for their time.
Before we get into markets, Raoul, I just
like to give as our American friends would
say, the most enormous shout out to anybody
and everybody who's been affected by COVID-19.
Our thoughts go out to families who may have
loved ones in hospital or have lost loved
ones, and thoughts of course, go out to all
the heroes on the front line, medicine working
in ICUs nonstop.
Also, our thoughts, of course, go out to individuals
who are trying to keep their family portfolios
on an even keel, and of course, all those
small businessmen and businesswomen who're
imagining what the next six to nine months
or 12 months looks like for their business.
It's a very humbling time for us all, isn't
it?
I think that was a very generous introduction.
I appreciate it, I'm just [indiscernible]
who's deserved.
RAOUL PAL: Give people a bit of background
about yourself as well, just so they can catch
up.
JAMES AITKEN: No, I won't take the subscribers
through a whole lamentable sell side career.
I should be grateful for that.
Things got pretty interesting for me in 2002,
when I started working for a company called
AIG, and I was in the trading arm of that
and then it got taken over by Joe Cassano
in AIG Financial Products.
One might say that for the four years after
that, I had a front row seat at the circus,
and I thought I knew a tiny bit about economics
and markets and then I became an employee
of AIG Financial Products and I realized there
was a whole financial universe out there about
which I knew absolutely nothing.
The irony, perhaps tragedy of AIG Financial
Products is that while it was obviously opaque
to the rest of the world, internally, it was
transparent.
I was able to walk 10 feet maybe 15 feet across
the dealing room and Curzon Street in Mayfair,
which you obviously know so well that building,
and ask people what are you doing with this
subprime CDO?
What are you insuring?
Talk to me about collateral balance sheets
and everything else, and I managed to stay
out of trouble there for a period of time,
left to join UBS in August 2006, work with
some fantastic people there, Raoul, and some
of whom you know.
UBS, I'll be ever grateful to them, let me
loose on their client base and policymakers
around the world.
I was sitting on a foreign exchange sales
pit, but basically doing everything and that
was a very interesting time because from August
2006 onwards, I was trying to say to people,
here's this thing called subprime.
Here's what happens if house prices flatline,
level and go down, here's structured credit,
here's what's under the plumbing of the financial
system.
If A, B and C happen, we're in for a torrid
time.
Then through 2007 and 2008, I got to work
with some fascinating people.
I got to work with all sorts of institutional
investors around the world.
I was very, very lucky firstly, to have a
job during that period when many of our friends
were being laid off, and work with these people
but also help people not lose money, which
was critical, and help some people who you
and I know well make a fortune.
On the back of all of that, my client said
in early 2009, you don't need a bank.
Go work for yourself, we'll back you.
As you may recall, back in '04, working for
yourself is one of the most terrifying things
you do, but happily 11 and a half years on
with the backing of some fantastically loyal
clients around the world, I'm still here,
still plugging away and, Raoul, just to finish,
I'm still trying to be less wrong.
RAOUL PAL: Exactly.
That's all we try and do.
Talk me through the situation we're in now
from your top down perspective, and just we'll
dig in as we go just to see what comes out
that's interesting.
JAMES AITKEN: Yeah, let's think about the
highest level, we have a double supply shock.
We have the obvious disruption, which let's
not forget has barely begun and COVID-19 combined
with this oil dispute, which we'll get into
our shim later, between food and Prince MBS.
We also have on top of that, a nascent demand
shock because everyone's going into hibernation
and hunkering down and not spending or consuming.
The last thing you want to throw on top of
all of that is a financial crisis, hence the
extraordinary actions that central banks are
taking all around the world to prevent the
financial system crumbling upon itself.
Just to be clear, double supply shock.
Obviously, the economic jolt from COVID-19
combined with the oil fight, throttle on the
other side of that and nascent demand shock
as we all hunker down.
The number one priority of central bankers
everywhere is to ensure that the financial
system as best they can determine, remains
on an even keel and does not crumble on itself.
RAOUL PAL: Now, talking to the financial system,
clearly a lot of what they're doing, there's
an alphabet soup of stuff of which nobody
understands.
It feels like they're papering over a load
of cracks.
They're trying to get the system working.
Because I've never seen the Treasury market
really fail as much as it did.
It got itself in quite a bit of a mess.
What do you think the current problems are
and how are they addressing them?
JAMES AITKEN: It's like LTCM meets October
in '97 inside 48 hours, that's what it looked
like in the Treasury market.
At the most basic level, you cannot hope to
have a functioning financial system if there
are no functioning risk free curves for people
to price assets or hedge assets.
That's why last September, if we go one step
back, was so important.
People went on and on about the repo conniption,
and about Fed reserves and all these kinds
of things, which was broadly correct, but
not specifically correct.
The events of last September were a tremendous
wake-up call for anyone doing RV fixed income,
because we almost lost the bond market.
Let's think about a very simple example to
help subscribers think about what actually
happened in March in the Treasury market.
Now, we won't go into the precise reasons
but for most of the past five years, Raoul,
there's been a very nice little basis trade
available to RV fixed income managers.
You'd go long Treasury cash bonds, and you
sell the equivalent number of futures against
them, it's a positive carry trade, or at least
was, let's say, for simplicity around seven
basis points.
You would lever that to the hill and that
requires obviously a lot of Treasury repo
to be available to go long the bond, and it
also requires a lot of liquidity in Treasury
futures.
Most of all, it assumes that your cost of
financing is predictable and stable, which
of course for about 48 hours last September,
it was not, and we narrowly avoided last September,
a very substantial nasty unwinding of all
sorts of Treasury basis positions, and we
live to fight another day.
Fast forward to March, who would have imagined
that the Fed cutting 50 basis points out of
the blue, their first cut would have been
the event that derailed all these relative
value positions in the Treasury market because
without getting too technical, if JC repo
rates or let's just say repo rates are sticky,
and the Fed cuts out of the blue by 50 basis
points, then obviously, overnight index swaps
and other short term measures of dollar borrowing
come down a lot.
That, ironically, is what blew up a lot of
these RV fixed income trades that spilled
over into the Treasury market just to finish
the point, at a time when, let's just call
him a principled man, was trying to unwind
his risk imparity position, or risk disparity,
and it all just fed on itself, throw a sprinkling
of foreign reserves sellers of treasuries,
and is it any wonder that constrained primary
dealers and others found it very, very difficult
to price and distribute liquidity around the
world's ultimate risk free curve, which promulgated
the most astonishing intervention from the
Fed, which is ongoing?
You recall many years ago, we all would have
been blown away by the Fed buying 60 to 80
billion of treasuries a month.
Well, they've been doing 50 billion to 80
billion a day, and it's barely keeping the
bond market on an even keel.
Look, what do we have?
This basic, let's not forget, Raoul, this
applies to so many things we've seen over
the past two months.
It's not just Treasury basis trades.
It's not just credit, we went into this exogenous
shock with everything priced for perfection.
We'd had 10 years of leverage upon leverage,
roll down carry, short volatility, illiquidity
and duration all boxed up on itself, we came
into 2020 and all of these heroes were saying
cash is trash at precisely the wrong moment.
Of course, you cannot vote to unwind 10 years
of cumulative risk and leverage and everything
else in about two months but suffice to say,
we have removed an enormous layer of excess
over the past couple of months and the very
best news for the financial system is thanks
to these extraordinary central bank actions,
we once again have a basically functioning
financial system and we have basically functioning
risk free curves and the Treasury curve, but
I very much doubt any central bank's going
to be able to step out of this for a long
time to come.
RAOUL PAL: Part of the issue here is that
the free market regulation of the Treasury
market switched from banks to private counterparties,
who don't get direct access to Fed liquidity,
and therefore, there's a link in the chain
which is what blew up essentially was their
access to the same price capital as the banks
would get.
JAMES AITKEN: Yes, that's one way of thinking
about it for sure.
There were a number of smaller broker dealers
that emerged over the past several years who
did nothing but repo.
Obviously, it's been a difficult time for
those fellows, and I feel sorry for them.
I would say at best, those folks were marginal
players and marginal providers of liquidity.
A lot of the repo provision was still via
the primary dealers, and we've all looked
at the data or examined the data on JP Morgan
and to a lesser degree, Wells Fargo and we
can see who had the biggest reserve deposits
at the New York Fed so we can imagine who
the top players were.
I just say, Raoul, that it was still pretty
much the banks we know, the famous household
names that were providing repo liquidity,
but I suspect your question is thinking through
the chain or following the money trail.
It's one thing for JP Morgan's broker dealer
to finance Treasury positions and provide
financing to their hedge fund customers and
others.
It's another thing altogether to downstream
dollar repo liquidity around the world or
through Japanese banks, and I'm taking a couple
of steps ahead here but bear with me.
When I think about dollar liquidity choke
points in the system and where things get
stuck, and where repos sometimes doesn't work
or gets congested, I think first and foremost
of the Japanese banks.
I think if I remember correctly, you've written
a bit or talked a bit about Japanese banks,
and how important dollar liquidity is to both
sides of their balance sheets.
If I think about the past month, critical
thing was ensuring that the Japanese financial
system more so than any other financial system
had an adequate stock of dollar financing,
whether it be secured or unsecured to tie
their financial system over.
To me, I'm spending a lot of time looking
at Japanese banks and thinking about their
ability to upstream and downstream dollars
around the world.
RAOUL PAL: We've talked a bit about the Fed
here, what about-- and again, we'll get into
that fiscal stuff in due course, but talk
me through what the other central banks, the
BOJ, the ECB, the PBOC, who's doing what here,
and what effects is that having?
Then I want to come back and talk to you a
little bit about why bond yields aren't lower
yet.
JAMES AITKEN: Good points.
Let's start with the relatively easy one,
the PBOC compared to their global peers has
done nothing.
It's remarkable.
Here's this event that is going to be disruptive
for some time to come, which you'd think in
the context of the shock to the Chinese economy,
the People's Bank of China would be doing
something like they did in '08 or '16, and
related to which you'd expect that the CCP
would be stimulating as, on the extent, same
extent that they did in '08 and '16.
It hasn't had.
It's odd, and maybe there's some constraints
there and to be clear, I don't mean the balance
sheet constraints.
I don't mean dollar borrowings by Chinese
corporations, although we can get into that.
I'm thinking more of the political narrative
that Xi Jinping has created since 2017, which
is this obsession, this persistent obsession
with a deleveraging campaign to try to make
the Chinese financial system fit for purpose,
that still seems to be the dominant theme,
which is remarkable.
The PBOC is a bit of a mystery to me.
I don't think they're boxed in by the renminbi
or the dollar borrowing by Chinese corporates,
but I am surprised they're not doing a heck
of a lot more.
We know they're going to stimulate, but it
seems quite limited and very gradual.
Moving across the Sea of Japan, the Bank of
Japan's all in every which way, because they
have to be.
They have to be.
RAOUL PAL: They just keep going.
JAMES AITKEN: Yeah, they have to, and I think
my rule of thumb is that they will be buying
every Japanese ETF at least until the Nikkei
has regained 20,000, and that could require
an awful lot of effort.
The JGB market-- I think we've had this chat
before.
It's to call JGB's a market to give markets
everywhere a bad name, the JGB market is just
two numbers on screen but they're completely
meaningless.
They're fair play to the Bank of Japan because
they are very savvy when it comes to monitoring
the liquidity of their banks.
You may recall in 2016 that there was some
pretty nasty spill overs of the QQE, as they
call it, the Bank of Japan was doing, and
you got some pretty nasty tightness in the
dollar funding markets which caused some strains
for Japanese banks.
A former Deputy Governor of the Bank of Japan
called Micaso, created a unique facility that
enabled the Japanese banks not to tap the
Fed of course, because that's always been
there but, Raoul, to use their JGBs to pledge
against dollar funding from the Bank of Japan.
The reason I flagged that, I know it sounds
a bit complicated is the Japanese authorities
have ample ability to liquefy their financial
system in dollars and yen, but they would
be hopeful that the problem goes away.
The executive summary of Bank of Japan is
muddle through, more of the same and things
seem to be improving for them.
RAOUL PAL: Why does the TOPIX bank index looks
like shit then?
It basically looks like the European banks.
I get what you're saying, but I just look
at the chart, it says something's not right
still.
JAMES AITKEN: Here's an example of what's
not right.
Over the past several years, the People's
Bank of China and other lenders of dollars
have taken advantage of the dislocation in
the infamous yen/dollar cross currency basis.
As we know, for most of the past several years,
there has been a premium for dollars and if
I have surplus dollars, I lend them via the
yen/dollar cross currency basis.
I lend them to, for example to Mizuho.
I convert it into yen.
I buy a Japanese T-bill, which gives me a
synthetic US T-bill with a yield pickup.
That trade's been going on for years.
The People's Bank of China and others supply
the dollars to the Japanese banks.
Let's stick with Mizuho.
Mizuho turns around and re-lends those dollars
or reinvest them in guess what?
US credit.
Five or six years ago, the Treasury teams
of Japanese banks would re-lend those dollars
into investment grade credit, or hang on,
let's take more risk.
Let's extend duration.
Let's end up in high yield.
Let's add some currency overlay on top of
that, say Brazilian real just to spice things
out.
Job's done.
What happens if the People's Bank of China
withdraws the dollars that they've lent Mizuho.
Well, that whole daisy chain unwinds and for
the past couple of years, if you look at the
chart of Mizuho and overlay US high yield
spreads at an index level, it's the same thing.
It's the same thing, and I think that makes
perfect sense.
I ponder, Raoul, if the Japanese banks would
appear to be adequately funded, I'm not worried
about that.
Unfortunately, they have taken a lot of their
dollars, it would seem and invested in some
very risky stuff at the wrong point of the
cycle, and they have been punished for that.
RAOUL PAL: Particularly, if we start to see
some downgrades of these BBBs, and if they're
in the junk bond sector, there is-- I think
we could say, a trillion dollars of BBBs get
downgraded and the junk bond sector's a trillion
dollars, even if my numbers are wrong by 50%,
it's still impossible for the junk bond market
to trade that.
JAMES AITKEN: There will be patches of indigestion
I would imagine.
RAOUL PAL: The ECB, so we've already seen
obviously Australia and New Zealand now QE.
ECB, that's the big unknown because there
seems to be this is where we start to move
into the world of juxtaposition between politics,
fiscal, monetary.
Talk me through what you're thinking about
that and then I want to come back to bond
yields again, as we said.
JAMES AITKEN: Sure, sure.
Raoul, the ECB, if we thought July 2012 was
whatever it takes, this is whatever it takes
hued, and to think that Madame Lagarde with
one loose sentence undid nine years of Draghi
when she said, unforgivably, my job is to
not control spreads.
That was quite courageous over, she realized
within five minutes how foolish that was.
Ever since, the ECB has been in repair mode.
If we thought the summer of 2012 was whatever
it takes, one would imagine, Raoul, that to
avoid fragmentation risk, which is the great
terror of European policymakers as we know,
to avoid fragmentation risk, the ECB is going
to have to be the buyer of first resort of
all its sovereign bonds and Italy, in particular.
There's a bit of a discussion around that
I'm sure you've seen, and your subscribers
would have seen, a lot of headlines and again,
last night, all the duction the Germans did
against euro bonds and joint and several liability
and all this stuff, okay, that's unfortunate.
You would have thought there's be a little
bit of more political solidarity right now
across and within Economic and Monetary Union.
It's not happening, but you know what, I don't
think it matters because the ECB has an open-ended
balance sheet here.
I think they're going to need a lot of it,
so they are buying and buying and buying.
Their priority is to prevent a fragmentation
premium in Italy in particular, for obvious
reasons.
I suspect they're going to be on the hook
as the sovereign buyer of first resort for
a long time to come because there is no alternative.
I would recommend we all keep a very keen
eye on BTPs obviously.
I am somewhat concerned to say the least,
that despite extraordinary and persistent
ECB buying, Raoul, these BTP spreads keep
leaking.
That's not a great sign, not a great sign
at all.
The ECB, I assume, is a constant presence
in all those sovereign curves for a long time
to come.
I shouldn't overlook the fact that they've
given tremendous regulatory relief to Eurozone
banks.
To be clear, that does not mean a catalyst
for any sustainable rewriting of European
banks, but it does mean that they are free
from balance sheet restrictions and via the
ECB is financing facilities, they are getting
enormously cheap funding at a cost of minus
75 to put into eligible collateral of all
sorts, which creates a positive carry trade
for European banks.
Again, that doesn't mean you own them, but
the idea would be that that positive carry
trade enables the best European banks to muddle
through.
The final point, as much this also applies
in the United States, the regulatory relief
that we've seen in the United States, such
as at long last, a one-year raincheck or relief
on the leverage ratio, it's not as some people
have said to allow primary dealers in the
United States to go hog wild on Treasury repo
or anything like that, it's to ensure that
there's enough balance sheet capacity to lend
to the real economy, which is obviously the
critical thing here.
It's about the real economy and ensuring that
there's ample credit flow into households
and small businesses and that's critical in
the US as much as it is in Europe.
RAOUL PAL: I just want to get back to the
Treasury market right now, just because it's
been interesting to me that you imagined that
the Fed wants to have yields as low as possible,
it's a bit sticky still that the market hasn't
woken up to the game or there's something
else going on.
Why is that?
Why have bonds been stagnant for the time
being?
Why is the whole curve not trading at zero?
JAMES AITKEN: There's a lot of bonds to be
sold, Raoul.
That's the short answer.
RAOUL PAL: Who's selling them, the sovereigns?
JAMES AITKEN: Well, there's some of that and
we can see it in the Fed's custody data.
There's definitely been some liquidation of
Treasury securities by-- it's called the North
Asian reserve managers.
That's no surprise that the holdings would
go down.
When I say there's a lot of bonds to be sold,
I should have been more precise.
There's a lot of bonds to be issued, a colossal
amount of bonds to be issued more than anyone
can perhaps tally up yet, because we've got
the CARES act that went through Congress the
other day, and that's going to require a lot
of issuance.
Now, they're talking about oh, well, the cost
of borrowing's free, let's tag on another
2 trillion of infrastructure or whatever.
There's no barrier to issuance.
I think quite a few people, Raoul, are starting
to or trying to tally up the amounts of treasuries
that will need to be issued or even bunds
or BTPs or gilts or Australian government
bonds to finance this bridge that all these
governments are trying to provide through
COVID-19.
I wonder if that is in the back of investors'
minds in terms of, you know what, now we're
going through an economic emergency, perhaps
an economic catastrophe.
All in all, if the world's going into a sudden
stop, Treasury yields ought to be perhaps
a lot lower given the disinflationary undertow.
However, when I imagine the future supply,
perhaps that ensures that yields don't fall
too much yet.
Now, of course, the flip side of that is that
for macro financial reasons, it would be a
disaster as we work our way through or perhaps
we've arrived at this very tenuous equilibrium,
if we dare call it that in financial markets
where realized and implied volatility is coming
down a bit in equities, which is no bad thing.
Somewhat similar in the better parts of the
credit markets, giving everyone a time to
take a deep breath and reflect on what their
right exposures ought to be.
The worst thing that could happen in this
mini-timeout here is that long term nominal
and real bond yields start to go up a lot.
RAOUL PAL: Yeah, I'm worried about the real
bond yields.
JAMES AITKEN: Exactly right.
The good news for the Fed and by golly, that's
taken a lot of buying is that they have arrested
what was a very nasty selloff in TIPS, or
should I say yields backing up a lot.
These days, Raoul, even positive 10-year TIPS
yields in the United States would probably
be orthogonal to any hopes of a rapid rebound
out of this mess.
RAOUL PAL: How can you possibly-- look, I
don't know how big the deflation number's
going to be in CPI and core CPI which lags
it.
I have no idea how big it is.
Is it 5%, 10%?
I don't know, but it's going to be monstrous,
even if it's 3%.
The problem is with bond yields that close
to zero, you only get a tightening of financial
conditions.
JAMES AITKEN: Temporarily, you would think
so.
At the highest level, that's not a bad way
of thinking about it.
Then I also have to calibrate this extraordinary
support that the Fed and other central banks
are providing and then I need to calibrate
it another step further, because I think we're
all aware that this is going to be a very,
very difficult couple of quarters, if we're
lucky.
This current quarter, every piece of data
is going to look a little bit like the Great
Depression, and I very much doubt anybody
incorporated that in a vamoose, except Renaissance
Technologies.
Anyway, that's another conversation.
We all know it's going to be hideous.
If we're lucky, we get one quarter of data
that feels like the Great Depression.
Then if we dare to imagine the third quarter,
we get some serious crappy, tentative recovery,
although it won't actually be a recovery for
a lot of people, it'll feel like a really
bad recession that comes after the Great Depression.
Now, the reason I flagged that is because
there's no doubt we have this extraordinary
disinflationary undertone to the current quarter,
but as realized and implied volatility comes
down, markets will start or data start looking
through and saying to themselves, okay, near
term disinflationary risks are given versus,
dare I say, medium term inflationary risks
as we attempt to restart the world in a heterogeneous
fashion with bottlenecks everywhere.
What's the unemployment rate?
We'll probably be ending up quite high for
the foreseeable future.
We may have an extraordinary situation in
the third quarter, I don't know yet.
This is just a theory or thesis.
We may have an external situation in the third
quarter where the unemployment rate remains
high, and firms are having to bid back for
labor to get people into the labor force again
to help them expand capacity and deal with
the global economy spluttering back into life.
I hear what you're saying.
I don't doubt that we're going to get some
extraordinarily bizarre CPI prints through
the middle of this.
I'm trying to imagine the second half of this
year when the world starts to come back online.
Temporary disinflation, a given.
Structural reflation or more inflationary,
I think that's what we need to keep our eye
on.
Again, it comes back to the Fed, what's their
trade off?
Well, they told us going into this ironically,
they were going to consider the yield curve
control and revising their inflation target
and everything else.
By the way, what they're doing now looks awfully
like yield curve control without actually
targeting a particular rate, because they're
in the market every day.
They are going to be so cautious dialing back
any of this liquidity provision as we move
through the rest of '20 and into 2021.
They are only might be that the inflation
that they've long desired might arrive in
a meaningful way later this year, but they
will remain on hold.
That's, indeed, the answer to your question
about between inflation and real yields and
everything else.
RAOUL PAL: Going back a bit to the comments
about the issuance of bonds.
We know there's probably more to come from
fiscal stimulus around the world, probably
quite a lot.
Particularly when you go into let's say, Q3,
things have dragged on a bit, the economy's
not there.
We expect to start to see stuff and certainly
around the election, we're going to start
to hear a lot of noise.
Now, I presume the central bank will be the
buyer of every bond issued, and we start moving
to the MMT style environment where basically,
the government balance sheet as they're trying
to repair everybody's balance sheet, the households,
the small businesses to everybody else, the
central bank has to step behind it.
That's globally, the same central bank did
everywhere to try and allow governments to
run massive deficits to do this.
How is your thinking of that evolving?
JAMES AITKEN: The implicit in your question
is central banks everywhere, which to me means
competition for global savings.
If we assume that any central bank anywhere
is not going to be a backstop buyer of all
those bonds to be issued, we assume that one
or more private sector actors will find them
decent value and consider the case of the
United States.
Yields are still positive, a bit.
They're certainly not zero, but there are
no incentives for example, for the fully hedged
Japanese investor to buy any treasuries account
prices, level and structured credit, they're
just odd.
Unless, unless you get the dollar down a lot,
so in yen terms, to use Japan as a proxy for
global power savings, the only way you entice
private capital back into the Treasury curve
in a meaningful way that would enable the
Fed for example, to step back, I think is
via a very substantial dollar depreciation,
which we'll talk about later on.
RAOUL PAL: Just the other thing is why not
the US pension system, which is massively
underweight treasuries and has a need for
it because of the aging population?
JAMES AITKEN: Well, that's what I thought.
One of the most extraordinary things of the
past month is that you look at holdings of
Treasury securities and holdings of STRIPS
have actually declined in March.
Now, if I read the data correctly, it was
$15 billion.
Who cares, but obviously, the STRIP treasuries
have been very, very popular so US pension
funds, in particular are managing their long
term liabilities.
I'm like, why on earth would US pension funds,
assuming they're the biggest holders of these
STRIP treasuries, why on earth would they
be net sellers?
What other exposures do they have that they
got called away from, because I think there's
much redemption risk?
The broad answer to your question is, yes,
of course, at a price, the US pension system
will be a buyer, but then I need to calibrate
that for capacity in terms of the amount of
bonds to be sold.
Of course, there are banks as well who would
be happy to own Treasury securities in their
HQA buffers, so of course there are buyers
of Treasury securities around, but I still
come out to myself and say, I very much doubt
that the Fed's going to be backing away much
from support in the Treasury market because
they cannot afford to have any sustained rise
in nominal, and especially real yields.
I think they're stuck that there's this broader
question about competition for global capital.
Australian superannuation funds, are they
going to be buying huge amounts of Ozzy government
bonds?
Well, I guess so.
How about Japanese investors?
What's the cost of hedging your FX risk into
Ozzy and stuff?
Then you go around the world and you're saying
who's been the keenest buyer of Treasury securities
or certainly one of the biggest constituencies
of Treasury ownership over the past several
years?
Unsurprisingly, it's the sovereign wealth
guys or more accurately, the reserve guys.
If for reasons of downstream liquidity to
their own financial systems, they're no longer
a net buyer, they're the net seller.
You keep coming back to the Fed, I'm afraid
they're the only game in town.
We have a lot of unfinished business in government
bond markets.
I would be surprised if central banks have
stepped back much, if at all, by the end of
this summer.
You may have seen yesterday the Reserve Bank
of Australia articulated that they were intending
to step back a tiny bit from the rate of bond
purchases they've been conducting while still
targeting three years of yields of 25 basis
points.
Perhaps it was another misunderstanding by
markets, but even the merest hint that the
Reserve Bank of Australia was stepping back
from their current run rate of bond purchases,
sure, a pretty nasty selloff in Australian
government bonds and the 10-year in particular.
I think, Raoul, that's not a bad metaphor
into thinking about how difficult it will
be for the Fed to step back and to finish
this point, how impossible it is for the ECB
to step back.
RAOUL PAL: Then I think that the fiscal stimulus
side is going to be huge, and I'm interested
in what you're picking up within Europe, because
that's what interests me, because we talked
about the dollar deval and we'll come into
that, but I also see the risk of Europe having
to do certain things which may put pressure
on the euro for a period of time as well.
I think there's, in my mind, a phasing that
comes from global weakness in currencies,
with the dollar going higher, and then everybody
having to do something about the dollar.
Talk me through a bit about that and the relative,
what Europe's going to have to do here, and
maybe why Lagarde was actually brought in,
in the first place.
JAMES AITKEN: Let's deal with Madame Lagarde.
There's this theory going around that Madame
Lagarde was brought in there to take Economic
and Monetary Union to the brink and make euro
bonds and more fiscal union inevitable to
save it all.
I doubt that.
I think she recently learned the hard way
that it's a big step up from the IMF to being
a central bank president when the markets
are hanging on your every word, she won't
make that mistake again.
That's the first point.
I wouldn't overinterpret the fact that Madame
Lagarde is the president of the ECB.
I'll just add quickly that she is ably served
by some extraordinary staff running their
balance sheet as good as any people in the
world, and they've been the ones who have
rescued Economic and Monetary Union for itself.
You're asking about fiscal, look, I think
the initial response in the Eurozone was loans
as opposed to spending, credit guarantees
for creating industries, in Germany using
KfW to provide a wrapper if you will, for
companies that couldn't borrow, all sorts
of things like that.
I think, look, there's a lot being announced
and done already and it's all moving in the
right direction.
I don't know quite how to answer the question
other than to say that the extraordinary change
in fiscal attitude in Germany in particular
is to be welcomed and encouraged.
Look, a year ago, if Germany had said, you
know what, debt to GDP, the debt like everything
else, we're letting it go, it doesn't matter
anymore.
Gosh, we would have all been betting on a
very reflationary world, which is part of
the irony here.
It's like oh my gosh, the Germans have discovered
fiscal policy, hallelujah.
Well, the fiscal policy that they're now deploying
is barely offsetting the economic disruption
from COVID-19, not just within Germany, but
around the world because obviously Germany
is a leading manufacturer.
The way I think about fiscal policy, if I've
understood your question correctly, is that
it's going to be with us for a long time to
come.
All these so-called debt breaks and everything
else in the Eurozone are obviously no longer
relevant because they've been superseded.
I hope, I hope that Germany in particular,
is not tempted to step back from this extraordinary
response too soon.
I hope they keep it going as I do hope that
every fiscal authority around the world overdoes
it rather than underdoes it as we seek to
navigate this economic disruption.
Really, I come back to the ECB, the ECB is
the fiscal backstop in the Eurozone.
Just with the Fed, I suspect, Raoul, that
many European politicians are quietly very
pleased that the ECB is the getaway car, just
as the Fed is expected to be the getaway car
and the backstop of everything under the CARES
act.
Really-- go ahead.
RAOUL PAL: Do you think there could be a massive
agreement amongst the European finance ministers
to also, right, we're all going to be allowed
our own fiscal stimulus of x so we can all
breach our agreements with Europe itself,
we will do this, and ECB will backstop it.
That's where I'm come from that that coordinated
or semi-coordinated mass fiscal stimulus is
something that Europe needs.
There's no way Italy can get around it without
it or Spain, or even France now, it's so difficult,
unless they got that backstop explicitly.
JAMES AITKEN: I think they're well on the
way towards that.
As we know, from looking at the history of
Economic and Monetary Union, it has advanced
over the decades one crisis at a time.
This is a big one, because the whole project's
at stake, their citizens welfare is at stake,
and as you would have seen in the headlines,
there are any number of sneaky plans afoot
to spring Germany and the Netherlands into
agreeing joint and several liability by euro
bonds, but to focus on one specific idea that
subscribers might like to dwell on, the European
Stability Mechanism or ESM, there are proposals
afoot which haven't been agreed upon but they're
proposals to use the ESM and ramp up massively
its borrowing and then to downstream that
cheap borrowing because it has a AAA rating
to all sorts of European sovereigns at the
same spread.
Now, that's very cheeky, isn't it?
Because that is a backdoor euro bond without
actually calling it as much.
They're very cheeky these people in Brussels,
and they will never give up.
I would focus on this emerging story, that
the European Stability Mechanism, ESM, I think
I've got the name label correct.
Let's just call it the ESM in case I'm wrong,
that could be fired up in a large way to issue
AAA paper in size at a spread compatible to
Germany or maybe even inside it, and then
to downstream that as a central Treasury to
other sovereign states.
It's very crafty, I take my hat off to them,
but I'd recommend we keep an eye on that as
a backdoor towards fiscal solidarity.
RAOUL PAL: I want to talk through the currency
markets now.
Then we'll move on to different scenarios
in how this could play out, because it's a
very uncertain world.
Talk me through your phasing of the currency
markets, how you see this play out.
We all understand that the dollar is a problem.
How do you think this plays out?
JAMES AITKEN: Well, we've seemed to have inverted
that famous anecdote from Secretary Connolly
in the 1970s.
Remember when Connolly was negotiating the
end of Bretton Woods and he famously said,
add dollar, your problem.
Well, right now, it seems that the United
States say add dollar, our problem.
We will be the world's central bank.
We will downstream dollars at a fair price
wherever they're needed in unlimited quantities
to prevent the financial system tipping over
on itself.
Now, if you consider that, if you consider
what the Fed's doing, and if you consider
what we discussed earlier about the amount
of Treasury issuance to come, you'd say yourself,
my gosh, that's creating the conditions for
a very weak dollar.
Now, to be clear, I'm not overlooking all
the dollar indigestion that we've seen over
the past couple of months, and which, broadly
speaking, has calmed down a lot so that the
plumbing is starting to work much better.
It's not perfect, but it's much better.
The Fed is shoving money, shoving dollars
out the door.
That seems to be working, but the dollar is
not weakening.
Here's where we need to get a little bit technical
and down into the plumbing.
Let's think about this scenario.
The Fed is offering dollar liquidity to other
central banks at a price of three-month OAS
plus about 25 basis points, which let's say
for simplicity, 35, or 40 basis points all
in.
Now, that's very cheap dollars, and unsurprisingly,
that has had a tremendous impact on a lot
of dollar funding spreads around the world.
The cross currency basis swaps, which have
developed quite some fame over the past several
years, there's now a discount for dollars
as opposed to a premium.
It's spectacular.
Then the next step back, we have the Fed's
commercial paper funding facility, which doesn't
get up and running until April 14th.
The initial cost of this commercial paper
funding facility, which need I remind subscribers,
is a short term unsecured loan, commercial
paper, in original cost, I think advised by
Mnuchin which was a ridiculous three-month
OIS plus 220, which is stupid.
They kept the cost to three-month OIS plus
110, which I still argue is stupid, especially--
sorry, to be clear, it's not stupid, it's
unnecessarily high to be fair to them.
You have dollar liquidity going out the door
via central banks at 35 or 40 basis points
via the dollar swap lines, and you have a
commercial paper funding facility at three-month
OIS plus 110, 120 basis points when you factor
in the thing.
That's very, very high.
The problem here to think about exchange rates
is that the cost of this commercial paper
funding facility is acting as a floor to Dollar
LIBOR.
The one price of dollar funding, if we want
to think about it this way, that looks completely
out of line on my screen is three-month Dollar
LIBOR, which continues to set let's say simplistically,
around 130, 135 basis points.
That's because I'd argue that the commercial
paper funding facility hasn't started yet.
The cost of it is too high, and we'll have
a clearer picture on dollar funding conditions
from April 14th onwards, and you can tell
where I'm going with this.
Up until April 14th, if Dollar LIBOR is still
fixed in, three-month Dollar LIBOR still fixed
in at 130, 135 basis points, it's going to
be very hard for the dollar to come down.
Even though there's dollars going out the
door and we're re-liquefying the plumbing,
135 basis points compared to negative numbers
in some other jurisdictions, the dollar's
going to remain sticky.
I think after April 14th, Dollar LIBOR is
going to ease off, maybe through May and June.
On balance, my suspicion is that may tend
to undermine the dollar.
I don't know yet but I'm watching carefully.
RAOUL PAL: Because one of the things that
still goes through my head, I'm still very
much in the camp that the dollar goes much
higher.
My fear within this is that the swap lines
are just an alleviation of a symptom.
It's taking a headache tablet for the flu.
That's all it's doing.
The actual problem is Chinese, South Korean,
Indian, Brazilian and a bunch of corporates
have a lot of dollar debts.
Now, the problem is in this world, as you
know it, flows from the central bank to the
banking system.
BOJ gets a bunch of these or whichever central
bank it is, they give it to the banking system.
The banking system, utilizes what it can,
and obviously, in a world like this, you only
give the dollars to the best credit.
It feels like game of musical chairs, where
the worst creditors are trying to get their
dollars, trying to get the chair and so I
worry that there's a negative convexity in
this market that if the dollar goes up, it
goes up a lot.
JAMES AITKEN: Well, we certainly saw a hint
of that in the past month, didn't we?
RAOUL PAL: Yes, that was scary for a minute.
I've not seen that for a while.
JAMES AITKEN: It was brutal.
It was just this mad scramble for dollars
because there was this absolute preference
for cash, dollar cash.
You know the world's in a bit of a bad spot
when you can't even sell a Tbill, or the bid
offer spread on a T-bill is like 10 basis
points wide, which it was.
That's just insane.
That added to the panic when corporate treasuries
around the world said, oh, I'm just going
to just move out of my T-bills into dollar
cash.
It's like, you mean it's 10 basis point wide,
and I'm actually hitting a negative.
It was bizarre.
Let's use a real anecdote here to help illustrate
the point.
Yes, there's been a tremendous amount of dollar
borrowing around the world over the past several
years.
No surprise, because large scale asset purchases
in the United States in particular, reduce
the flow of dollar securities.
We know that.
I was in Beijing and Shanghai in February
2017.
It was extraordinary, very humbling experience,
by the way, because you realize you just know
nothing about China at all.
You can read everything you like, but it's
just unknowable, almost, almost.
I met some of the treasurers of the big Chinese
policy banks.
It was a fascinating discussion about how
they manage liquidity.
There's the onshore Renminbi liquidity, which
within reason, within political reason, can
be managed to increase yield.
Then there's the gigantic dollar liquidity
buffers that the biggest Chinese banks have
offshore.
That's when I suddenly realized wait a minute,
who owns all the dollar paper issued by Chinese
corporations?
Where is the bulk of it?
The answer is tucked away in the Treasury
books of the biggest Chinese banks.
Now, of course, there's a smattering of other
dollar paper that falls into the hands of
sophisticated mutual funds, the Evergrande,
probably a dreadful example but Evergrande
paper and other paper, there's some mutual
fund holds, or mutual funds plural hold, but
again, the key point here is that a lot of
this dollar paper issued by wobbly Chinese
corporates is tucked away in the dollar balance
sheets of the big Chinese banks.
I would suggest that they're very interested
in continuing to support the home team.
I imagine it's extremely unlikely that they're
a forced seller.
If things got immensely grim in China, I would
imagine that the People's Bank would happily
lend against dollar paper issued by the most
critical Chinese borrowers.
Why have I shared all that with you?
Look, I've been as worried as the next person
for a long time about the minimum amount of
dollars, if one thinks about it that way,
that the Chinese financial system may require
on any given day to remain on an even keel.
There's one little magic trick that I think
people may have overlooked after August 2015,
yes, there was a lot of styles of Renminbi
for dollars from August 2015 onwards, but
the magic trick is that those dollars did
not leave the Chinese financial system.
They were redeposited with the Chinese banks.
That's one of the ironies of that episode.
The point I'm making here is like yes, am
I watching the price and the yield on Evergrande
bonds in particular?
Absolutely.
Absolutely.
Am I watching the cost of dollar high yield
bond spreads from-- Asia high yield dollar
bond spreads?
Absolutely.
If you asked me to rank the issues that worry
me now, I put that it might be in the top
10 maybe, but it's not there yet.
I think the broad answer to your question
about how hard is it to downstream dollars
to the people that need them in emerging markets,
I would say it's improving.
It was remarkable to see yesterday that the
Bank of Indonesia announced they too have
created a dedicated $60 billion repo facility
with the New York Fed.
That's remarkable.
Now, I can't tell you with any certainty what
difference that makes to the Indonesian financial
system and Indonesian dollar borrowers, but
the fact that Indonesia has that backstop,
I would suspect it does a lot of confidence
across the Indonesian corporate sector.
Really, I don't think we've answered, ultimately
answered your question about how do we ensure
there's always adequate dollars flowing around
but there are a few things being worked on
particularly in the IMF to create backstops,
which might give everyone time to think and
reflect.
RAOUL PAL: Because we've seen-- two questions.
One quick question is there's been no dollar
swaps with the PBOC.
JAMES AITKEN: And there never will be.
RAOUL PAL: Okay.
Talk to me about that.
JAMES AITKEN: It's just not going to happen.
Let's talk about this Fed's new repo facility
that went into place last week, this FIMA
repo facility, I'm sure subscribers have seen
the announcement of that.
One report that's come back to me, and I need
to be careful here, but I think it's true.
SAFE, the State Administration of Foreign
Exchange in Beijing who managed China's reserves,
there are a few more price sensitive clients
in the world.
I will haggle over every basis point whether
it's an FX hold, a swap, spot execution, let
alone a Treasury purchase or sale or bund
or BTP, whatever.
There are reports coming back the during March,
SAFE was an indiscriminate seller of treasuries,
and I'll just say all the government bond
markets around the world, highly unusual behavior
for such a price sensitive market participants.
Were they desperately short of dollars, or
were they trying to create mischief?
I think we should all reflect on that deeply.
I was struck by the way this New York Fed
repo facility last week was announced.
It's designed to help people liquefy their
Treasury securities, an overnight financing
transaction to get dollars to the real economy,
but it makes absolutely no sense at all, Raoul.
Let's imagine you and I, the People's Bank
of China are safe and for whatever reason,
we need more dollar cash in the system, so
we pick up the phone, the New York Fed say,
hey, look, we want to lend you 20 billion
treasuries overnight.
Well, hang on a second, I'm going to have
to roll that every 24 hours.
Do I get the dollars back again every 24 hours?
It doesn't make any sense even if you assume
it's a term repo facility.
I think this repo facility that the Fed has
artfully created, is to send a message to
Beijing, don't you dare do that again.
Don't you dare, if you want to go and hit
a bid in the open market in treasuries and
create mischief, we're on to you.
Meanwhile, here's the facility that can actually
act as an off market purchase facility in
a sense for your holdings of treasuries.
Thanks very much for coming.
I think there's a lot more to it, and I would
be surprised if the People's Bank of China
were to receive a specific facility.
This might be as good as it gets.
The last quick point on that is if I read
the term sheet correctly, this FIMA repo facility,
or foreign reserve managers, I imagine who,
comes at a cost of interest rate on excess
reserves plus 25 basis points, something like
that.
It's not cheap.
It's not cheap.
I'm not holding out for China to get much
love here.
RAOUL PAL: Do you think the Saudis and the
Middle East have to liquidate stuff as well?
I feel like it might help them a bit because,
obviously, if the oil revenue is imploding,
they're going to need a bit of cash to maintain
their system.
JAMES AITKEN: If one reads the term sheet,
there's nothing to stop Riyadh using that
facility as well to generate a few extra dollars.
I did think it was a tell, I don't know if
you saw this, was it last week or the week
before, where Aramco says, oh, we're thinking
of selling a $10 billion pipeline.
Well, hello.
I think this morning, I caught the fact that
the Saudis are doing a $10 billion bond issue,
also a known here.
Strange times in the Kingdom, as always.
RAOUL PAL: I want to look forward a bit because
the market's going to have to grapple with
a number of outcomes.
One is, is the liquidation event finished?
None of us really know yet, but it's-- then
there's probably, I think we both think there's
probably a respite phase, whatever that is,
whether that's a real recovery, which is what
you said, then we get inflation issues, maybe
things change, we've got an enormous amount
of stimulus coming through eventually, et
cetera, particularly after the election in
the US as well.
What happens if growth remains negative year
on year and ongoing for a while?
Because if I look at the psychological impact
of what's happening, if I look at what's happening
in Hong Kong, which is now seeing a rise in
cases again, if I see what Singapore has just
done, the Singapore Prime Minister had a fabulous
speech where he just said, listen, it's basically
broken for a year or two, whether you like
it or not, we're going to keep-- we're never
going to open our borders and we're going
to be closing down the population from time
to time.
All that says, to me, all of this stuff and
the scarring of people's behaviors means that
the trend rate of growth goes down significantly
for a period of time.
The question is, how long that period of time
is?
I am focused on I think if we go to three
quarters of negative year on year growth,
though Q2 growth is going to be impossible
now because of this last quarter.
Let's say so we're in it, we go from depression
quarter to bad recession few quarters, which
would be normal.
Normally in recession, you got 18 months of
this stuff.
I fear an insolvency event.
That's my biggest fear, it's my highest probability
that we have the largest insolvency event
in history.
That's what I'm looking at.
I know, again, neither was know, we don't
have a clue.
We're just trying to look at what the probabilities
are out there.
Talk to me about that.
JAMES AITKEN: Thanks for such an easy question.
Let's try and knock that out of it in an effort
to be less wrong.
Let's face it, if we get any of this half
right, we're doing very well so let's try
and think about less wrong, and what we know.
We know that we have a very tightly bound
complex system called the global economy that
for decades has been optimized to fault.
Just in time inventory, just in time liquidity,
just in time borrowings, just in time leverage,
supply chains going every which way.
It's a very complex system.
Therefore, the notion-- not held by you, of
course, but the notion that we can flick a
switch and turn this complex system off, and
then reflate it in a quarter or two, I think
is wishful thinking.
Because think about incentives, pending the
arrival of the small business loan or the
PPP loan, or the unemployment check in my
account, which in the United States might
in some unfortunate circumstances, still take
another month, what am I doing?
I'm knuckling down, I'm hunkering down every
which way.
My consumption other than a Netflix is going
to zero.
I'm not buying anything.
I'm not spending, and economy wide and globally,
that is a very bad outlook, and businesses
everywhere are incentivized to fire employees
first, ask questions, apply for loans late,
and then imagine to extrapolate this example,
the dilemma for small business owners around
the world, and we were talking about it a
bit earlier, it's not terribly social for
you.
I do agree to go to a bar in which we have
to stand 20 feet apart.
No bar owner's going to open that way, we're
not going to turn up for a drink.
Then the restaurant, do we all have to have
sit three tables apart?
Why would any small businessman reopen if
their revenues are going to be at best 50%
of peak revenues, which is your point?
The answer is, they may not do that.
No matter how grand the government largess,
no matter how long the PPP loans go for, and
everything else, look, in the United States
right now-- I'm not sure about other jurisdictions,
but in the United States in particular, we
are not yet arresting the rise jobless claims.
We are not yet arresting the rise in unemployment,
we are chasing it.
That's most unfortunate, but knowing that
and observing that, if we're daring to sketch
any economic recovery in the world's most
important economy, bearing in mind that the
US consumer has been the world's consumer
of first resort for decades, and we have penciling
in not only a very patchy recovery for the
United States, but are very patchy recovery
to the global economy, because as we seek
to move through this, the global economy will
only be as strong as its weakest link.
Where I come out-- and we could go into more
details, but for the sake of time, if we can
muddle through this with some L-shaped recovery
for two or three quarters, I would take that
because I think that would be a phenomenal
outcome, phenomenal outcome.
I actually hope it's an L-shaped recovery.
It's certainly the intent of fiscal authorities
and monetary authorities around the world
that we don't have an exact rerun of the Great
Depression.
It's remarkable, it's breathtaking, Raoul,
that we have turned off the global economy.
We've turned it off.
Some estimates I've read who said there's
a billion people at home right now, just waiting
for an employment check, or waiting for the
bailout.
The idea that you flick a switch, and we all
go back to work, or we all take the Lexington
Avenue Express, the four or five train or
we all rush back to get on the-- RAOUL PAL:
Here's something interesting.
A couple of things.
Obviously, China asked people to go back to
work, to go to factories-- JAMES AITKEN: Well,
because they can.
That's another important point.
We have command and control in China, because
that's-- RAOUL PAL: What happens is, if you
look at the TomTom data, the Shanghai, weekend
traffic is still down 80%.
People go to work, but on the weekend, they
don't go out because they don't want to.
Also, they've now got factories building stuff
to sell to who exactly?
JAMES AITKEN: Well, that's it, that's it.
RAOUL PAL: This is what I worried about, solvency,
because you've got this rolling issue of subdued
demand.
It's either catastrophic demand as it is right
now, but on and off if you're not Brazil out
the global economy for a few months, you're
not India out for a few, you've got this rolling
destruction of demand.
That whole situation just really concerns
me.
Just to see that people-- there is no normality,
people don't go back to normal does not happen
quickly.
Obviously in due course, but supply chains,
everybody's going to change.
The trade tariffs already started it.
Now, every boardroom's act are going to have
to say, can we allow for this weakness?
JAMES AITKEN: That's it.
At a minimum, there will be a much increased
preference for cash as opposed to just in
time leverage refinancing and everything else,
who much increased preference for cash.
As I think a lot of corporations are finding
out even in a low yield world, and we need
to be very mindful, Raoul, that does not become
self-fulfilling, because then, every corporation
around the world, and every household around
the world says I prefer cash over every other
asset.
To be clear, we are not there.
We're not there yet.
We may never get there, but that is your classic
liquidity trap, which the authorities are
doing their best to avoid.
In a liquidity trap, by definition, you have
some very serious solvency problems because
not many people can refinance at any price,
and that's not good.
To be clear, look, we can guess various letters
for an economic recovery, and we can speculate
endlessly on how difficult it is to restart
this complex financial system, complex system
called the global economy, but that doesn't
mean we should not be looking to invest.
We have to keep an eye on some of the extraordinary
attractive assets that have been coughed up
over the past month and may yet be coughed
up.
To talk specifically about insolvencies, and
you mentioned it earlier about high yield.
I think it's very interesting and important
that the Fed has made no effort to backstop
the riskier parts of the US credit markets.
It's not an accident.
If we think about the politics of what we're
sketching out here, which is I hate to say
it, human misery and human tragedy, which
hopefully we can work our way through.
The optics, the political optics of the Fed,
or frankly, any other central bank, bailing
out the financial system yet again, before
money has arrived in the bank accounts of
consumers and households and small businesses
around the world, it's not a good look, and
yet everyone tells me, oh, don't worry, the
Fed's going to be on the hook for all the
credit.
They're going to buy high yield.
They're going to do this, they're going to
buy CLOs, you go down the credit food chain,
they're going to be the bar.
I'm not holding my breath.
They have been consistent-- I know it's hard
to divulge from what the Fed's been saying
for several years, but if you read between
the lines, they have been laying down a marker
on commercial real estate, CMBS, leveraged
loans, they have in conjunction with their
peers around the world, been warning for five
or six years about something you and I have
chatted about which is secondary market illiquidity
in corporate bond markets, and to then do
a handbrake turn and support every part of
the credit market, some investment grade,
will be setting them up as a political punching
bag, especially if this unfortunate crisis
drags out for more than one or two quarters.
RAOUL PAL: Why did they not do it via the
municipal pension system?
Why don't they just inject money into the
pension?
That's my theory, because like you, I think
it's impossible politically to go and buy
the high yield market, but to say, well, the
pension system, we need to make sure that
they're solvent.
You inject money into them, because they're
basically funded by tax receipts at the moment.
There's no tax receipts.
The Fed can essentially or the Treasury--
the Treasury or the Fed can-- or government,
whichever mechanism, inject money into those
with the, you can support the credit markets
for us.
JAMES AITKEN: I think you're asking me what's
the probability of a state bailout and then
what's the probability of a local bailout
across the United States?
RAOUL PAL: Yeah.
JAMES AITKEN: You are seeing some minor improvement
in the municipal bond market, which is no
surprise because like so many risk assets
over the past month, the enormity of the Fed
and other central bank responses has injected
this enormous amount of liquidity, which has
reflated pretty much everything.
Just to give people time to regroup and think
about what they own and municipal market has
benefited to some extent.
Rather than getting too involved in a direct
bailout of state and local pension authorities,
perhaps part of the idea of the CARES act,
potentially, is to create some special purpose
vehicle for state borrowers, I don't know
yet.
Again, I come back to the point I'm sure they
thought about it, and yet, isn't it interesting
that they haven't done it?
I don't have a great answer for you other
than pointing out they haven't done it and
there must be a reason for that.
Maybe they are hoping that the liquidity eventually
trickles down from some of their other programs
and that there's an element of balance sheet
capacity and arbitrage which brings pass of
the muni market back into line, but Raoul,
if you're asking me about a bailout for state
pension funds, I'm not holding my breath.
RAOUL PAL: Well, that's going to be a problem
at some point.
I guess it's not today's problem.
Today, we've had a liquidity event, not a
broader-- but if this drags on, then we got
a pension crisis front and center.
I just want to-- because we've been chatting
for a lot, and there's a lot we've covered,
which is fantastic.
What I'd love to get you talk about some opportunities,
where are you seeing the opportunities here
because it's very difficult for most people
to get their heads around what's shit and
what is gold within this.
You're getting through this, so we have to
know what you're doing.
JAMES AITKEN: One way of thinking about it,
for sure, but I think there are-- yeah, there
are plenty of opportunities for patient capital.
To provide a metaphor, one consistent observation
across all the largest pools of global capital,
who I advise, is that they've all been nibbling
in this selloff.
No one's trying to pick a bottom, no one's
trying to predict the bottom.
They're deploying capital into very specific
assets and sectors based entirely on valuation.
I think that's important for all of us, because
we can read every COVID model we like.
I don't think that's going to give us much
insight into how to deploy capital.
It might make us informed, but it's not going
to tell us how to value a security that might
be on sale at an enormous discount.
I think that metaphor, nibbling and to be
very precise, there is capital being deployed
at the top of the US credit markets, so AAA
CLOs.
Just an anecdote, and I keep saying just an
anecdote, but I'm trying to make it tangible
for your subscribers.
There was a strange Bloomberg story last week,
and I think it was ill advised if true, that
Citigroup had made 100 million dollars by
buying a AAA CLO trash from potential investments.
Now, that's a very strange transaction, because
first, why would [indiscernible] of all people
given they're fully funded need to sell a
bulletproof and they are bulletproof AAA CLO
tranche in the low 90 range?
It doesn't make any sense, and yet Citigroup
had the balance sheet to take the other side.
The reason I share that is because I think
it reminds us how different this is to 2008
because in 2008, it would have been Citigroup
spraying stuff everywhere to the buy side.
Now, Citigroup that has the liquidity to allow
the buyer side to sell, and it tells you where
a lot of this risk is held, hopefully in a
sensible way.
There is capital being deployed, very specifically
senior secured credit for those who have read
their prospectus, AAA CLOs.
Obviously, this money that's dribbling into
US credit up in the bulletproof tranches is
not nearly enough to offset the potential
supply and destruction to come, level out
and offset anything people might need to distribute
in high yield.
Now, this is a very important technical point
when we think about opportunity and solvency.
On March 24th , ICE BAML indices said that
they were going to take a raincheck on rebalancing
their credit and fixed income indices at the
end of last month.
Now, that's very interesting.
Then the other index providers, including
Bloomberg to a degree, followed on and that
actually gave the credit markets a lot of
breathing room because if the rebalancings
had gone ahead as planned, Raoul, there would
have been a tremendous amount of liquidation
in all sorts of credit, which the market would
not have absorbed.
It would have been particularly problematic
for the Vanguards of this world and all the
passive quant funds.
They've postponed that to April 30th . The
point I'm flagging here is there will be plenty
more opportunities in credit for the professional
credit investor, and the long only credit
investor because they're able to name their
price and they're able to hold on rather than
picking a bottom in all this other stuff.
We could talk about credit, more data afterwards,
but I want to come back to equities as well.
I think we all need to be very careful here,
especially now, given the uncertainty to try
to stay within our circle of competence.
To be very frank with your subscribers, some
of my friends would argue-- I'd even argue
whether energy more at the broadest level
is within my circle of competence.
Although you and I know many very, very smart
energy investors who have done phenomenally
well in all sorts of market conditions.
Now, let's think about numbers.
Potentially over the next week, there may
be some agreement between major energy producers
that takes 10 million barrels a day of supply
off market, perhaps by May.
On the other hand, if you look at what traffic
Buru and other leading oil firms are saying,
demand action right now, as a result of the
things we've been discussing in the energy
markets, is running somewhere around 30 to
35 million barrels a day, a day.
Let's take 10 million barrels of capacity
off market, the frank answer is so what?
Why should we care?
If I go down another layer, and I turn on
the Bloomberg and I look at all those products
and spread products and all down the energy
food chain, it roughly comes out with a market
clearing price of oil, let's just call it
broadly oil, somewhere in the low teens.
You think to yourself, uh-oh, there's a lot
more reckoning to come.
It is however striking then in the context
of that which every oil professional knows
that some of the better shale, the large cap
energy stocks have stopped going down, because
eventually they discount the worst case scenario.
We need to sharpen our pencils here, but we're
in the process of what you might call the
shale reckoning, or the shale restructuring
that was postponed in 2016.
On the front edge of that, there will be consolidation,
people will need to tie their balance sheets
to the ground, but there will be winners,
and at some point that despite this supply
dispute, despite the demand destruction today,
we will need the oil and we will need these
companies no matter as a sidebar, whatever
people tell us about ESG.
If we're going to restart the global economy,
we need these companies and we need the shale
companies in particular.
If I dare to think about what's not in the
price, I look at what, again, to use that
metaphor.
Our friends down in Texas, the really sharp
guys are doing, and I say, okay, I'm watching
what they're doing.
I'm doing my own homework about the liquidity
on the balance sheet, and the funding and
the hedging, of course, and the breakevens
of some of these companies that I imagined
might last, so it might be the Devon Energies,
the EOGs, the WPX, those sorts of things,
passive energy, and then of course, I'm thinking
about Chevron, Exxon and Hess.
Then I might be thinking about what side of
Australia.
It really depends, but the point is, I am
very carefully-- I don't trade, but I'm very
carefully deploying some of my liquidity buffer
which I've had for a long time into some of
these companies.
RAOUL PAL: Equity or bond?
JAMES AITKEN: Equity.
I'm doing so knowing that the demand destruction
is staring at me in the face.
I do so knowing that I'm very likely to be
punched in the face again if I missed the
market, but I'm prepared to absorb that because
I think to myself there's long term value
in these particular companies.
RAOUL PAL: Do you think that the shale credit
market has priced much of this in as well?
Look, it's not going to be completely correctly
priced, but everyone knows it's all going
bankrupt and somewhere within that, you're
going to find some real gems as exactly as
you say.
Do you think it's all priced in, or do you
think there's bit more ugliness still to come?
JAMES AITKEN: Put it this way, if I'm a sharp
reducer, and I couldn't refinance at the end
of 2019, which was the greatest credit liquidity
bubble of all time, I'm dead.
I think it's CUSIP by CUSIP.
Mr. Market is identifying it company by company.
There's a long way to go yet.
You saw Whiting petroleum, I think it was
last week, basically tapped out, there will
be others.
The ones that are left behind are the ones
we need to keep an eye on.
A similar argument could be made for certain
infrastructure companies if one's taking a
long term view.
Now, I know what I'm describing so far is
a little bit boring and conservative perhaps,
but everyone goes on and on about Warren Buffett,
especially now, everyone's trotting out Warren
Buffett clichés and finding out the hard
way, but it's all very well to talk like Warren
Buffett, it's a very different matter to actually
act liking when things go 50% off, but I would
have thought, Raoul, that the ideal time to
buy the metaphorical monopoly toll bridge
is when there's no traffic.
I'm looking at things like Sydney Airport,
which has never had this few-- well, certainly
for six decades has never had this few flights
looking at their balance sheet.
I'm looking at Ferrovial in Spain, which is
a company with which you'd be familiar, they
evaluate their market capitalization versus
their 25% stake in Heathrow, the LBJ tollway
in Dallas, and also the 407 around Ontario
and they've got a look on those assets until
2061 and 2076.
I'm pretty confident they're going to have
future cashflow.
I'm just trying to think about, as best I
can tell, the survivors, the money good assets,
but on only dribbling money in because every
analog for bear markets like this tells you
in no uncertain terms that you revisit the
low.
Everyone has it.
RAOUL PAL: I wrote about this in GMI, I was
like, look, all the smartest people I know
are doing exactly what you're doing.
I say one thing I do know is everybody will
get stopped out once or have a gut check once,
and then it usually works because it's always
the people doing their homework who figure
out, okay, these things have now ridiculous
pricing.
For whatever phase that is, whether that's
ongoing or it's the next three months, whatever
it is.
It's always interesting.
I think you're right.
JAMES AITKEN: Yeah.
It's very careful, very selective.
No doubt subscribers have different things
on their radar that they understand.
It's not trying to be fancy.
You and I have used airports, or at least
we used to.
Still think to yourself, they've got a minimum
amount of liquidity, their net debts are--
RAOUL PAL: That's a great idea.
JAMES AITKEN: Just very gently and-- RAOUL
PAL: That's right.
The toll roads have no tolls is a really bright
idea.
JAMES AITKEN: Monopoly toll bridge with no
tolls, and you can use that metaphor for a
range of industries and sectors.
Mr. Market is giving an opportunity for patient
capital to have a look-- RAOUL PAL: They always
adopt.
Those businesses are not reliant on growth.
They're just-- because they're not like--
not oil services company, oil services company
to get back to the highs, needs building tons
more pipelines, whatever it is.
The toll roads just expect some return to
normality, and before you know it, it's cash
play.
JAMES AITKEN: Look, but believe me, it's not
nearly as exciting as Bitcoin or anything
like that.
Then again, nothing might be.
For someone like me just trying to be sensible,
trying to lay out some capital, trying to
imagine a year or more out what a healed world
might look like, it's not sketching in growth.
It's not trying to forecast growth.
It's not trying to predict anything.
It's just trying to say, okay, I am reasonably
confident that we will need X, Y and Z.
We will need energy.
We will need logistics and infrastructure.
We will need-- I could go down the list and
if Mr. Market is allowing me in, allowing
me to have a small ownership stake in these
assets at a discount to their replacement
cost in what-- and this is the cherry on top,
might be for a while a more inflationary world,
I have to think carefully and deeply about
those assets and the opportunity, not because
any of us have the ability to predict the
bottom.
In fact, if we wait for the bottom, it's too
late.
We have to think about it now.
We have to think about how we feel if they
all go another 10% or 20% off, which actually
affords you would hope a larger margin of
safety.
We're not a seller at that point.
We actually have to say, okay, I need more
of it.
I'm just trying to imagine the world one or
two years out that's looking a little better,
and what might be quite valuable.
RAOUL PAL: James, listen, I can't thank you
enough.
It's been an epic conversation.
We've covered an enormous number of crowns,
and enormous other things and you're exactly
the right person for this because your, as
I said, your breadth and depth is very unique
and rare, and I think to come out with some
opportunities out of it as well.
It's not just gloom and doom or listen, we
don't know where it's going, but here's some
concrete things people can think about.
I think it's incredibly useful.
As ever, I'm ultra-grateful.
JAMES AITKEN: I'm grateful to you as well,
mate, and well done for the success at Real
Vision.
I'm glad to finally at long last, be a tiny,
tiny sliver of it, here I am.
RAOUL PAL: You were with Jim Grant before
me, that was outrageous.
JAMES AITKEN: I do apologize.
Now, I was actually tempted to wear that revolting
sky blue jacket that I wore for that interview,
but I thought your subscribers have seen enough
of that.
Look, just to send a message to you, your
family and your subscribers, it's a very difficult
time.
There's no precedent, no easy precedent, no
easy analog, I had greatest sympathy to all
the families that have been directly impacted,
and indirectly impacted by COVID-19.
The most monumental shoutout to the first
responders and everyone in ICU and to the
small business owner, husband, the wife, the
person sitting at home trying to keep their
portfolio on an even keel, as an antidote
to all the troubles immediately in front of
us, and there's any number of them, try this.
Draw up a list of the assets you've always
wanted to own with a margin of safety and
dare to dream that you might actually get
a piece of them in the period immediately
ahead, which will help you protect your capital
for a long, long time to come.
RAOUL PAL: James, great, thank you.
Appreciate it.
JAMES AITKEN: Thanks for your time.
JUSTINE: If you're ready to go beyond the
interview, make sure you visit realvision.com
where you can try real vision plus for 30
days for just $1.
We'll see you next time right here on real
vision.
