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Hello and welcome to What Goes Up, a weekly markets podcast.
My name is Mike Regan.
I'm a senior editor at Bloomberg.
I'm Woldana Huyerck, a cross-asset reporter with Bloomberg.
At this week on the show, well, life comes at you fast sometimes.
Not too long ago, this week's guest was one of the economists arguing for a so-called no-landing in the economy.
In other words, the Fed would be able to vanquish the inflation problem,
and the economy would be able to keep humming along.
Then, in the blink of an eye, Silicon Valley Bank failed,
becoming the second biggest bank failure in US history, and the whole outlook changed.
Now he's in the camp that believes we'll see a hard landing.
In other words, the US economy won't be able to avoid a recession.
We'll get into exactly what this prominent economist sees coming,
and why his outlook changed so quickly.
But, Woldana, first, I have to ask, are you a fan of March Madness?
No, I only watch football.
You should know that.
No, Mark.
So you're not doing the brackets?
No, I know we have a Bloomberg terminal of brackets.
I haven't even looked at it.
You're the best person to do the brackets though, then, because...
Why, because of all the tall Eastern European people I should know?
Well, that.
But you'll just take the lower number in each one.
People like me who've seen like, you know, 10 of these teams play,
or our opinions are completely polluted by the 10 games we saw this year.
I can't even name 10 teams.
Just pick the lower number seed.
I'm curious. You do that all the way through.
Fine, let's do it. Do I win anything?
I'll give you a dollar.
Deal.
Which is enough to buy the UK operations of SVV.
Oh my god, no, I would need like a dollar 30 years.
It's one of the 10s, pretty good ones now.
I don't know what it's trading here.
I made that up.
But I do want to bring our guests in.
I'm so happy to have them.
It's Torsten Slock, Chief Economist at Apollo Global Management.
Torsten, thank you so much for coming in and joining us on the podcast.
Well, thanks for having me.
So maybe we can start with what Mike was just talking about,
because you write daily notes.
They're extremely prominent on Wall Street, I would say.
I know on Bloomberg TV, everybody was talking about
your note from this week where you were talking about
when the facts change, my view changes.
So can we just take this as,
can you talk about that view changing as a way to explain what exactly happened
over the last couple of days and why your view has changed?
Yes, so as Mike was saying up until here this weekend,
the situation was very clear that the Fed had been raising rates,
because inflation was too high.
As a result of that, the interest rate sensitive components of GDP
had responded, meaning housing had started to slow down,
the auto sector has started to slow down,
because they were sensitive and they are sensitive to interest rates going up.
And durable goods more broadly,
meaning everything you buy, furniture, washers, dryers,
everything that requires financing was responding by slowing down.
And the problem for the Fed was that those components of GDP
that are interest rates sensitive only make up 20% of the economy.
The 80% of the economy that services was actually still doing fine,
so people were still traveling on airplanes, still going to restaurants,
still in thing at hotels, going to theme parks, concerts,
spawning events across the board, the consumer services sector was still doing really well.
So the debate up until recently was that, well, why is the economy not slowing down?
When the Fed is raising rates, why is it that the consumer is still doing so well?
And a very important answer to that was that, well,
there's still a lot of savings left across the income distribution,
that households still had plenty of savings left after the pandemic,
either because they saved it, because they didn't travel and go to restaurants doing the pandemic,
or because they had received transfers from the government,
or simply because they didn't spend as much money as their income
over the last several quarters.
And up until recently, the debate was, why is this economy not slowing down?
And that's what we can call that, what you want,
but that's what we have called the no-landing.
The economy was just not slowing down,
and that was the reason why inflation continued to be in the range of 5%, 6%, 7%.
That's why the Fed had to raise rates, and if I, on my Bloomberg screen,
type T-A-Y-L, and look at the Taylor Rule, which would tell you,
what should the Fed funds rate be as a function of unemployment and inflation,
it would say that the Fed funds rate should be as high as 9% or 10%.
So up until recently, everything was fine, the economy was doing well,
the Fed was gradually trying to slow things down,
they weren't succeeding as much as they would like,
but it was just humming nicely forward.
What happened, of course, here with Silicon Valley Bank,
was that suddenly, out of the blue, at least for financial markets,
really nobody, and I think that's safe to say at this point,
had seen this coming, and as a result of that,
suddenly we all had to go back to our drawing boards and think about,
okay, but what is the importance of the regional banks?
What is the importance of the banking sector in terms of credit extension?
And when you look at the data from the Fed,
you will see that roughly a third of assets in the US banking sector
are in the small banks, and here a small bank is defined as
bank number 26 to 8,000, at large bank is number 1 to 25,
ranked by assets, so that means that there's a long tail of banks,
some of them are fairly big, but further you get out,
of course, the smaller they get, and the key question for markets today is,
how important are the small banks that are now facing issues with deposits,
facing issues with funding costs, facing issues with what that might mean for
their credit books, and also facing issues with,
what does that mean if we now also have to do stress tests on some of these smaller banks?
So the short answer to your question is that this episode with the Silicon Valley bank
that we have seen here more recently, markets are doing what they're doing,
and there's a lot of things going on, but what is really the major issue here in my view
is that we just don't know now what is the behavioral change in terms of
lending willingness in the regional banks, and given the regional banks make up 30% of assets
and roughly 40% of all lending, that means that the banking sector has now such a
significant share of banks that are now really at the moment thinking about what's going on,
and the risk with that is that the slowdown that was already underway because of the
fundraising rates might now come faster simply because of this banking situation.
So that's why I changed my view from saying no lending, no lending, everything is fine,
to now saying, well, wait a minute, there is a risk now that things could slow down faster,
because we just need to see over the coming weeks and months ahead,
what is the response going to be in terms of lending from this fairly significant part of the
banking sector that is now going through this turbulent Swiss seeing?
Mike, is this where I add my disclaimer?
Yes.
I have a mortgage pending with First Republic, so I'm in the midst of this.
What a great timing on picking a mortgage at the top tech that pretty well, huh?
And great job picking a bank too, did you log in the interest rate?
Yes, but you know, they answer every single time I call, shout out to my banker Kyle.
But Torsted, I think there's such a unique element to this, if you want to call it a crisis,
in that typically when you're worried about the banking system and the quality of their assets,
you think about the credit quality. Financial crisis, yes, it was a drop in the valuation of
securities, but it was a result of deteriorating credit quality among mortgage borrowers.
This is so different right now. I mean, we haven't really seen any deterioration in credit
worthiness yet. So will it play out in a similar fashion as far as curtailing the supply of credit,
or is there a reason to think it'll be different? And just to tag one more question on the end of
that, is it possible we still have another shoot a drop with the deterioration of credit quality
going forward?
Absolutely. So I started my career at the IMF in the 1990s. And the first thing you learn,
literally on the first day, it is that a banking crisis and a banking run normally happens exactly
as you're saying, Mike, because there are credit losses on the banks books. We saw that in 2008,
subprime mortgages, credit credit losses. We saw that for Northern Rock, we saw the Volven Brothers,
we saw the Forbeas Derns. If you go back to the 1990s, you saw that on the savings and loan
crisis, there were commercial release date losses. And these were very illiquid losses.
This couldn't just be sold very quickly. That is exactly as you're pointing out, very, very different.
We have basically never had a banking crisis in a strong economy. And the irony of this situation
is that it is actually the most liquid asset, namely, treasuries that turned out to be the problem.
So that's why if you do have now that, let's say, 10-year rates, now they've been going down
quite a bit more recently, let's say that they go down to, say, 2.5 or even 2%, that will be helping
incredibly on the banks' balance sheet, because it is the liquid side of the balance sheets that
have, at least in this episode, been the main problem in terms of what the issues are.
So that's why, to your last point, exactly the fear is that if we now have not only the
lack defects of the Fed hiking rates or rate slowing the economy, we've already seen various
indicators, as I mentioned, in particular interest rates, sensitive indicators beginning to slow down.
But if you now have a magnified effect that the slowdown might come a bit faster,
then, of course, we do ultimately also need to look at what does that mean for credit losses
for everything that banks have on their balance sheets.
It's such a unique phenomenon. It really is. Who would have ever thought the treasuries would be
the riskiest thing? It is so unusual. Normally, it's the liquid stuff that gets their attention,
but it just shows the complication of this issue here, that in this situation now,
where it is treasuries and all this, held to maturity, are available for sale. There's a lot of fine
details on that, but the bottom line still is the same, that the bottom line was that because
interest rates went up, this created some problems for certain banks.
Yeah, and so what everybody in the market is saying, they were waiting for the moment that the Fed
broke something and now something has broken. So I'm wondering how you are recalculating what
you're expecting from the Fed. Everybody is talking about this because obviously they're going to be
meeting in a couple of days. What are your expectations?
So I would say a very important consideration here, of course, is that if you look back in the
history books, it is of course important to consider. Is this just like Orange County in the early 1990s?
Is this like LTCM in 1998? Is this essentially the same as the LDI crisis in a just different form,
where this is something that will come and go and will basically be back on track very quickly?
The main problem with this, and this was the main reason why I changed my view,
is that this is for the banking sector. And the banking sector just happens to play a really,
really important role in the Orange County, LTCM, even the LDI in the UK. It was still the case that
this caused some ripple effects, but it was not as essential for economic growth as the banking sector
is. So the challenge today, of course, looking to the Fed meeting is that there are some risks,
of course, for the Fed to financial stupidity. And it is very clear that up until if we had spoken
about this like a week ago, then I would have said they're going to go 50, nothing to discuss,
no landing, everything full steam ahead, the Fed needs to cool things down.
But today, it is certainly the case that the top priority, which we thought until the reason
it was all inflation, has been replaced and put into the backseat of the car. Now the top priority
is financial stability. And when the top priority is financial stability, then of course the Fed
needs to be absolutely sure that the financial system is stable and financial markets are calm,
and that therefore that credit is flowing to consumers, to corporates, to residential
risk state, commercial risk state, with the idea that if that is not the case, then you are at risk
of having obviously a much harder landing. So that's why financial stability being the top risk
would lead me to the conclusion that they can always raise rates later if this does turn out to be
like Orange County and LCCM. But at the moment, the biggest risk going into this meeting is certainly
that financial stability needs to be, financial system needs to be stable for them to feel comfortable
before they can begin to even think about raising rates again.
It's interesting. You keep hearing hard landing. It sounds like me on the ski slope in Vermont.
But could we just... I'd love to see that.
Which is, I will say it can be a painful thing. Well, maybe it's me when I'm playing Sargon,
PFI, out in Brooklyn, Bridget
5, where the cement underneath it. But let's put some numbers on that, because we are starting from
such an extremely low base in the unemployment rate. The last jobs report was still very strong.
I forget what, 300,000 was it? 250,000 jobs? Yeah, 311. 311. Good memory.
What does a hard landing look like as far as unemployment and GDP?
Yeah, this is really important because, again, if we already were set up for this situation,
where the Fed trying to slow the economy down and the Fed would raise, raise 25 basis points,
they would look around and say, how is the data responding? They would go another 25 basis points.
Of course, they did a little bit more earlier, but they've been going more slowly and they have
been thinking about going more slowly. In that situation, it's a more controlled slowdown.
Even in that scenario, remember, there was a big discussion, can the Fed actually achieve a
soft landing? And a lot of people were saying, no, they cannot, because you cannot micromanage
the economy. So we already had that debate even before this situation now in the banking sector.
But now, if you add on to that, what's going on in the banking sector? The risk in the banking
sector now is that if banks now are beginning to tighten credit conditions simply because they need
to reorganize and repair their balance sheets, then you can suddenly have the consequence that if we
go out to a bank and say, I would like to borrow some money for a car, and if the bank says, no,
you can't do that. And if a lot of banks say that at the same time, you are running the risk of what
the IMF, where it always has been, that you will have a sudden stop in the economy. So we have
suddenly gone from saying what you could say, they thought of the textbook, computer equilibrium
model in the Fed, well, they're saying, oh, let's just gradually try to slow things down.
And now we're suddenly facing a situation where maybe it's not just a gradual slow grind low on
GDP. Maybe the risk now is that you suddenly will have a sudden stop on people's ability to borrow
for cars, to borrow to buy a house, to borrow to your credit card, to borrow on consumer loans,
even corporates who want to build a new factory also might have challenges if the credit
conditions really tighten from one day to the other. So what we need to wait for now, and what's
really important is that for the next weeks and months, we need to find out how severe is the
credit contraction in the banking sector, because Mike to their question, that will determine how
quickly the unemployment rate can go up under the old system, meaning a week ago, where the Fed
basically stepping on the brakes, there were scenarios where that could happen in a gradual
and smooth way. And we could have a soft landing, even though there was a lot of debate about that.
But now if you add on the layer here that the risk is that the banks might at the same time,
all begin to say, we just need to slow down our lending, then that comes with the risk of a
sudden stop in consumption in CapEx and in hiring, and therefore the risk that the unemployment rate
in the worst case could start to move higher relatively quickly.
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So what is with hindsight in mind? What's the answer? Did the Fed raise too much too fast or did
the Fed not have good oversight of SBB or the other banks? What is the...
All the above maybe? So the challenge, of course, for the Fed is that they really only have one
two namely interest rates. If you really think about it more broadly, of course, they have three
tools. They have interest rates, they have forward guidance, and they have the balance sheet. But
I view that from their chairs, I mean, what else could they have done? There was a pandemic,
they needed the economy to come back, then it came back much faster, and then we got a lot of
inflation, and then they said, okay, but then we need to cool that down. And then they've been
basically trying to cool inflation down. And here we are. Now we are at risk that that cooling
inflation down, something broke, as you said, and that resulted in the risk that we might now have
a faster slowdown. So it gets to the old saying that Milton Friedman said that you go into your
shower and you turn it on and it doesn't get hot immediately, and you wait, and then suddenly it
gets really hot, and then you turn it down and then you wait, and then it gets really cold. So for
the Fed, the risk really here is that they have just been really trying to manage as good as they can,
but they are... I mean, it has been really, of course, a challenge for them to figure out exactly
how much and how little and this new situation that has just appeared with the banking sector and
the risk again, because the regional banks are so important in the US economy that suddenly now,
if they are beginning to hold back on credit, then it could just have very severe consequences.
Proud Rutgers grad, by the way, did you know that?
No, I had not.
I just realized that a couple weeks ago, reading Alan Blinder's book.
Yeah, you don't hear of many Rutgers economists, but he's practiced the most prominent.
But, you know, Twerston, famously, and you hear this all the time from Chair Powell and other
Fed officials, is the long and variable lag in the effect of monetary policy. In other words,
you know, were they raising rates for more than a year there, and everything seemed fine, and then
then, bam, we get hit by this surprise problem with the banks. Do you think that works on the way
down with rates too? In other words, even if the Fed were to pivot immediately and either pause or
start cutting the rates, is it sort of that's not going to stop what's coming? You know what I mean?
Yeah, the problem with that, of course, is that now funding costs have also gone up.
The FRAO, yes, spread has been whitening. You have also seen the IG bank spread also start
into whiten. I mean, the defunding costs for banks have increased not only because of the Fed
funds rate going up, but simply because the spread on top of that has also been going up.
So that means that if that spread is now so high that it's become very expensive for banks to fund
themselves, if the Fed did cut rates tomorrow, then that would be helpful in terms of lowering the
funding costs for banks. But the answer to your question is that when you suddenly have a significant
increase in the cost of capital at the higher highest level across the economy, then the real
answer to do that for the Fed to solve that problem is just to lower interest rates.
But the problem is, as you know, that you put that up on the scale, on the one hand,
hey, wait a minute, inflation is 6%, they can't lower. We should actually raise interest rates.
On the other side of the scale, you have an apple over here and an orange over here, and you say,
well, we put the orange over here because now we should be actually lowering interest rates
to improve financial stability. And it really becomes a real challenge for them to suddenly
change their views from saying, now it was all inflation, inflation, inflation for so long.
So now suddenly say, well, now it's financial stability, and now it's not so much inflation.
And that's really the challenge in terms of the decision for the FOMC that they have ahead of
them, namely, what are they going to do in response to this when inflation is still so high?
Yeah, I've heard described as the Fed has two fires to put out in one bucket of water.
And presumably- That's a great description.
They're going to be focused on that inflation fire primarily.
So the problem, of course, is that if they start ignoring the financial stability fire,
then the risk, of course, could also the flames could come up quite substantially on that front.
So it is really a challenge. But let's see where the financial system is in a few weeks.
But for now, I would go into this FOMC meeting if I were in there, FOMC, and say,
okay, you know what, it is absolutely okay to take a pause. And we can always just hike rates,
and we can even hike rates 50 if things really do stabilize. But let's now watch and see how
the economy, most importantly, how regional bank credit is doing over the coming weeks and months
ahead. The other thing I've heard quite a bit from people I talked to is that
the Fed had wanted to tighten financial conditions for the past year, and that this period,
what's happening now with the banking sector, has tightened them almost more than a 25 basis point
height. I'm wondering if you've been thinking about that as well.
If I, into my Bloomberg screen, look at the Bloomberg Financial Conditions Index as a power user.
I know. I didn't know about the T-A-I-L one.
I don't know. It's a Taylor rule. It's fantastic.
And for listeners who are unaware, the Taylor rule is simply trying to figure out what the Fed
funds rate should be based on inflation and the unemployment rate, right?
Only that and nothing else. And so, and of course, financial conditions to your great question.
If you look at where they are, there are various ways the Fed also has, St. Louis Fed has a measure,
Chicago Fed has a measure. So, but there are various ways, Kansas City also has a measure.
Goldman has a measure.
Everyone has a measure of financial conditions, but the Bloomberg one, which is real time,
which is why I like that the most, is that throughout the day, you can actually see
we're at financial conditions right now. It has certainly tightened, but we are now,
we are remotely close to where we were in 2020 and we are definitely far, far away from where we
were in 2008. So, yes, it's good that financial conditions have tightened in terms of slowing
inflation down, but it's happening in some sense too quickly because it's beginning to raise the
risk of financial stability. So, yes, financial conditions, you want to tighten that to slow
inflation down, but the problem is if that comes with the risk of financial stability,
then of course, it becomes a quite different manner.
You mentioned the spreads as far as bank funding costs go, and I think the
center of that story right now is obviously Credit Swiss. They've had a bad week. I mean,
this has been a bank that's certainly been the focus of a lot of concern for a while now,
but this week, first, they came out and said, look, we had material weakness in our reporting
for the last couple of years. Their auditor PwC gave an adverse opinion. They delayed their
annual report because of back and forth with the SEC, but really what is causing the acute
problem is the chair of the Saudi National Bank. Their biggest shareholder came out and said,
we can't buy any more stock for various reasons, but really spooking the market.
So, how do you see the Credit Swiss playing out?
No, and the situation is evolving as we speak here. I view this in the broader context of that.
There's just a lot of uncertainty and instability in the system, and if you are both the ECB and
the Fed and you look at this, the conclusion would be to say, okay, but we got to have some
resolution and some stability to whatever these challenges are at the moment. So, I absolutely
agree that there are certainly a lot of challenges for markets. And as we move forward,
we will see how it's resolved, but it is clear that this continues to be a broader risk to the
macroeconomic outlook if you have financial stability with the intensity that we have at the moment.
Why does it matter for US investors if it's happening in Europe?
Yeah, so the very important answer to that, of course, is that the global financial system
is just highly integrated. There are some finer nuances that the Chinese banks and Russian banks
are somewhat separated from the European and US banks, but across US and Europe,
you have so many big US banks operating in Europe, you have so many big European banks
operating in the US that the counterparty issues, issues about everything that has to do with lending
and borrowing, and ultimately trust will be very important in this regard. So, that's why the global
financial system is just so integrated and so interlinked in so many different ways
that trust and confidence in each other is just absolutely critical.
The
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you know, we obviously have a lot of individual investors and some professional money managers.
I hope, anyway, listening to the show. What's your sort of two-minute advice to them on how to
approach the rest of the year? So, one short answer to the current situation is to buy duration.
In other words, if you think that short rates have peaked and you think that the fit is not going
to raise rates more, and if you're worried about some slowdown potentially coming, the first
answer to that is that you should then begin to worry about, well, maybe long rates are going to go down.
So, that means that make sure that you are protected with your risky assets. They're S&P 500,
you're high yield, your loans and low-rated credit against the potentially risk of a slowdown.
Investment-grade credit and high safe credit assets will still do well if there is a recession,
historically done that. So, that's another way to quote-unquote hide if there is a slowdown.
But the textbook will tell you that if there is a risk of a slowdown coming,
then you should be in the safest places which in this situation would be up in quality and long
in duration. So, IG and treasuries with 10 years, 5 years? 30 years. 30 years.
Any of it, depending on what long it's you can get. Well, and as long as it's liquid and you want
to make sure that you're ready for, if there is any quick resolution to any of these things,
then you could be prepared then to jump into the S&P 500 and ask that again. But the issue here is
that nobody really knows the duration of how long time this turbulence is going to persist.
I feel very strongly that it will not be forever. It may be over even in a few weeks. In the best
case, it could be over in a few days. But given that this uncertainty is still here,
and we still need some resolution to a number of the things that we have spoken about here,
then for now it will probably take some time. It's like the VIX and thinking about it. The memory
of a lot of the things in financial markets is like 20, 30 days. So, you probably need,
I would say three, four weeks at least where things are relatively calm before you can come
out of the bushes and see what's going on again. Yeah. Well, and the whiplash in rates this year
on the short end, this week on the short end, that two-year yield up, I don't know what,
down 50-60 basis points one day, up 30 in the next day, which is last week that Paul was saying
we'll be hiking a lot more. Yeah. I've lost track of how many Sigma events that have been.
But the volatility is just the stomach journey here. I mean, it's eye-popping what we're seeing.
The move index relative to VIX. VIX has also gone up by the move index, which is implied
vault for rates. It has also gone up quite significantly because there's just a lot of,
and this is of course from options. So, this is real money that people are betting on saying
either rates are going to go up, people are bearing to pay for that, and other people are willing to
say no, no, rates are actually going to go down. So, the dispersion of views, which is basically
what implied vault is, the dispersion of views is really, really wide when you have these elevated
levels of uncertainty. And that makes complete sense. Different people are doing different things
and buying protection against different scenarios because the outcome and the outlook is just so
foggy. But I feel like a big chunk of the macro hedge fund community must have been caught on the
wrong foot. Very much a short position in the short end, according to the CFTC data.
A painful week, I mean, is how do you see this week affecting the hedge fund world? Does it add
to the worries about risk aversion going forward? Yeah, because the hedge fund macro trade going
into this weekend was no landing. Everything is fine. Inflation is high. We got a high rate.
It's slow and gradual. The Fed will go maybe 25, maybe 50, and then 25, 25, 25, and then
ultimately the economy will begin to slow down. But most people were probably thinking in the macro
hedge fund community, well, you know what, we probably have another three to six months before
I need to worry about that. So for now, I'm still betting on rates higher. And boom, out of the blue,
this weekend, we now have, of course, a very significant decline in rates over the last few
trading sessions here. And the consequence of that, of course, is that a lot of people were just
squeezed out of the short positions that they had in fixed income.
So back to what you were just talking about with the move and the VIX, Katie Grafald and I
actually were looking at this this week, the spread between the move index and the VIX on
Tuesday was the widest since 2009. And what we were thinking about is just the pessimism that's
been inherent to the bond market for weeks now, whereas maybe on the stock market side, you had,
even on Monday, I think we were down 0.15%, which considering what we're talking about,
is sort of impressive, I would say. But then we had that spread actually narrow a bit where it does
feel like the stock market side is also starting to take things much more seriously. I'm just wondering
what was it that, because in the stock market, people are known to be optimists, right?
Yeah. And you have been told for the last 15 years to buy on dips.
Yes, exactly. So and you're seeing the retail flows, we've also seen him in the last several
trading sessions that a lot of the buyers are just ETF buyers, many retail, because, hey,
stocks went down, that's always a good opportunity to go up. But you absolutely
write a very, there were some very important things going on inside the S&P 500, a rotation,
of course, away from regional banks and up towards other sectors that, of course, have been
particularly cyclical and financials that have been doing better, meaning at the bigger financial
names. But the short answer to what you're saying is absolutely, if you think about the VIX and the
move index, meaning implied volatility in fixed income and implied volatility in equities,
you would think that the story that's being told in this stock market is the same as the story that's
being told in the rates market. So you would think that a shock hits the economy, in this case, inflation,
and suddenly out of the blue, this is only something that's a worry for rates markets,
it's not a worry for the stock market. I mean, why was it that the move index has been so elevated now
for actually several years, relative to the VIX just saying, oh, inflation, that's not for us,
that's just for those people over there in bonds. So this divergence and inconsistency,
you can't tell different stories and different markets, we're living in the same economy,
the same financial market. So either the stock market is wrong and needs to be a lot lower,
and bond markets are right, that things are actually pretty bad, and there should be a lot
more volatility or vice versa. Maybe the bond market is wrong, and maybe inflation will be coming down
quickly, and maybe we will have a soft landing that's absolutely not my baseline scenario at this point,
and in that case, stocks should be higher. So that's another way of saying that, yes, it's absolutely
the case, and I totally agree with what you're saying that equities have been surprisingly resilient
in the face of this inflation shock. Because remember, if we just step back and say, what was it,
up until the reason that the Fed was trying to achieve, the Fed was trying to slow down growth,
the Fed was trying to slow down consumer spending, slow down hiring, slow down capex spending.
In other words, the Fed was trying to slow down earnings, and if I'm told that the Fed is trying
to slow down the E in the PE ratio, I should also worry about that maybe that probably means that
equities should be going down, but equities have remained incredibly resilient, and the VIX has
just been basically saying, oh, this whole issue about slow down coming, and that's probably because
equity investors probably mainly care about the last earnings season and the next earnings season,
but if I'm a bond investor, I don't have the luxury of only caring about the last earnings
season and next earnings season. I need to think about what will happen in two years,
five years, and even 10 years. So that means that bond investors have said, well, when the Fed raises
rates, earnings will slow down, but equity investors have looked at the latest earnings season as
it, but it's not slowing down. So why are you so worried? So that's why it was the case of that we
were waiting for the lack of monetary policy to eventually slow things down, and equity investors
said, but it's not happening. So why are you so worried in bond markets? So that's why there was
indeed, as you pointed out in your story with Katie, that there is indeed a very
inconsistency between what the bond market on the move index side and broadly speaking on the level
of rates was saying relative to what we were seeing in equity markets.
The other big major story of last year was that that traditional inverse bond stock correlation
broke down and both fell together and worst year for 60, 40, and anyone's lifetime.
You also pointed out, well, if we do have this risk off rally in bonds, that does take some
of the pressure off of the banks who are long duration. Are we stuck with that correlation,
stock bond correlation that we've seen over the last year? Or is there a chance that this risk
off could get so extreme that it kind of returns to the normal correlation?
Yeah, that's really important. So absolutely, 60, 40 didn't do well. Obviously, when you both had
that bond prices went down and stock prices went down. So now today, of course, up to a week ago,
I would also have said 60, 40 will continue to not do well. The problem for 60, 40 today is that now
we have a fairly significant issue about, well, maybe stocks are at risk of really going down
because they haven't adjusted to what we just spoke about, namely that there might actually
be a snow down coming not only because of the Fedhiking rates, but there might also be a
snow down coming because of credit conditions tightening. So the risk to the 60, 40 portfolio
is that you may be winning something, maybe if rates go lower, but the stock part of your portfolio
is just going to get hammered if we do have a recession. So that's another way of saying that at
this point, as much as 60, 40 is the easy thing to do and then go and play golf or batmans on
whatever you do for two years and you come back and say, hey, how is it going? The risk, of course,
now is that if you are too overweight in some of those more risky assets that tend to underperform
when there's a recession, so that's again, lower ready credit and that's of course equities,
then you run the risk, of course, ultimately that your portfolio will take a hit. So why not just
step away from the 60, 40 and say, I can actually do some stock picking and credit selection with the
idea of if there is a risk of a recession coming, maybe I should just not be in the stock market.
Maybe I should just think more about up in quality and credit and maybe of course also in duration
in bonds. Twister and Slock of Apollo, such a treat to get your views at this crazy time in markets,
we really appreciate it. We can't quite let you go just yet, Vildana.
Because we're going to play craziest thing I saw in markets this week and there's...
So what did I choose from? So many things. I know if we had done this last week, I had nothing to say.
Yeah, last week, I struggled last week and then this week I have the first Republic chart up,
the two-year yield, the 10-year yield, like crazy charts. The financial conditions chart is like...
Vildana's looking at yields, you know, it's things are something's going on.
Yeah, I hate the bond market. So yeah, this is...
Hey, shout out to Mario DiAngelo for putting out that HSBC buying Silicon Valley bank for
one pound. I think that is... I think he wins the week for craziest thing, but let's hear what you
get. So I am really trying to not think about the banking sector as much, which is been impossible,
but there's a Bloomberg story, which also actually is very sad. It says if you make $100,000 living
in New York City, it feels like you're making $36,000 because of taxes and the high cost of living.
$36,000. So it's the worst for any major city.
$36,000 from $100,000. And you still want to buy in New York City?
Oh my gosh. Don't make me feel worth. That sounds about right. $36,000 for $100,000 in New York.
Well, it's funny, you know, with the federal tax rate being uniform across the country when you
have an issue like that, you know, it is a different standard of living. But I'll tell you the craziest
thing I saw. This is a Wall Street Journal story. I believe it was their A-head, you know, the kind
of fun story they put on the front page. SVB's collapse brought a niche industry back into focus,
financial disaster swag. Sellers have cashed in on SVB's infamy to make money on all sorts of
company merchandise that they may have once neglected. So you know the stuff when you go to a
conference and you get like the freebie handouts, it's all that stuff. So on eBay, there was listings
for an SVB branded blanket for $26, a purse hook for $12.50. I don't know what a purse hook.
No clue. That's a weird choice. I can get you one if you want one.
And a cheese board for $200. I don't know why the cheese board is the most expensive.
You're not going to make us guess prices? No, I feel like they're up for sale on eBay. So we
don't really have the proper price discovery. But I will say it's a pretty good story you
read it if you haven't yet. And it's also inspired sort of fake swag from the banks like
Silicon Valley Bank Risk Management Department T-shirts are selling very well.
Well remember they were all those FTX T-shirts that had to be thrown out in the garbage?
Well right and they might have... In November?
They might have you know... Oh are they up for sale too?
Their bankruptcy administer maybe should have kept on to them because they probably sell
pretty well. They quote one woman who bought an ugly Christmas sweater that read FTX Risk
Management Department 2020. How much did she pay for it?
They don't say. I don't know.
Ugly Christmas sweater though. But that's pretty good. I like that one.
Terson, how about you? What's the craziest thing you saw this one?
I'll just follow up on what we just talked about. I mean the incredible thing is that we have inflation
at 6% and we're sitting talking about how sharp will this low down be. The fact that we have high
inflation and we're debating with this be a hard landing or if we re-log it will be a
soft landing is just incredible. I mean normally we have had for a long long long time inflation
just at 2% so the fact that we have this incredibly complicated macro backdrop of inflation being
high while the economy is now poised to slow down I think that's pretty crazy.
It really is. I think unlike any other setup by any of us have ever experienced.
Well and that's why as we just spoke about the FOMC meeting here ahead of us is just a real
challenge. I mean because how do you deal in an environment where inflation is normally something
that you would worry about is the number one thing and that's what you said for the last 18 months.
This is our top priority and now suddenly you're having a meeting where you're saying well by the
way now there's something else that's our top priority in making financial stability.
So for us in markets it's about figuring out how long time is this financial stability issue going
to be such an issue that's at such a level that the FET will worry about and the ECB will worry about
it. Is this just again a few days a week or maybe two or is this something that's going to be long
and lasting at some point we will go back to more calm and and quite frankly more boring environment
and we can't wait to get to that. I can't wait. Well and the timing for all this to happen in
the middle that's quite period before the meeting is. So they can't communicate about it and that's
of course also the challenge but it is really it is really it's really difficult for them because
these challenges are really significant. When you have things moving that's back to your story
well and I hear about that the move index telling us volatility is just really high
in so many different ways and that's what of course is creating this complicated environment.
It really is a credit select as in a stock pickers environment where you need to say I can't just
buy the index and these will be much more careful with what I do given the risks that I'm seeing.
Right right I think if I was Jay Powell maybe I'd call out sick next week. You think you can get away
with that? That would probably cause a bigger problem. Anyway I think that is all the time we're
able to steal from you today. Torsten Slock, Chief Economist of Apollo Global Management.
So great to catch up with you and hear your thoughts. Thank you for your time and
hope we can talk again soon. Oh absolutely thanks for having me. Thank you Torsten. Thank you.
What goes up will be back next week. Until then you can find us on the Bloomberg terminal,
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