Why The World Started Hedging Its US Dollar Exposure

Some economists expected that the dollar would strengthen when the tariffs were imposed. Instead, the opposite happened. The dollar fell sharply and it's been a poor performer all year. Concurrently, it's been a great year for a lot of dollar-denominated assets, like stocks. Even US Treasuries have rallied this year. So what's going on? On this episode, we speak with recurring Odd Lots guest Hyun Song Shin, Economic Adviser and Head of the Monetary and Economic Department at the Bank for International Settlements. Per his work, the world didn't abandon the US dollar, but it did start hedging exposure to it. We discuss this phenomenon, as well as other risks on the macro landscape. Only Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox — now delivered every weekday — plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.

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• 0:00Tracy Alloway?

  There are some market stories where you want every detail. Joe and I have made quite a few podcasts on that basis. But sometimes you've only got 10 minutes and just want to know what's moving markets fast. That's the Barclays Brief Podcast. Every week, experts from Barclays Markets and Research get you up to speed on what's happening and what to watch next. Concise, focused, and brief. Search Barclays Brief wherever you get your podcasts.

• 0:26Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw, innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 1:08Speaker 01

  and hiring practices, but according to recruiters, advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company, and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at chatgpt.com.

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• 3:14Tracy Alloway?

  Hello and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

• 3:18Joe Weisenthal?

  And I'm Joe Weisenthal.

• 3:19Tracy Alloway?

  Joe, there are so many huge stories that you could pull out of this year, but I mean, like some actually really, really big ones. So we had Liberation Day and the market crash. We had the continued weakness in the U.S. dollar, which has been this sort of slow burn crash across the year. And we're recording this, let's see, October 17th and, you know, dollar down yet again.

• 3:44Joe Weisenthal?

  Although it is down, but however, there's been a little, you know, it hit its low in mid-September.

• 3:49Tracy Alloway?

  Don't make apologies for the dollar, Joe.

• 3:52Joe Weisenthal?

  You know, I just like, keep going and then I'm.

• 3:54Tracy Alloway?

  All right.

• 3:56Joe Weisenthal?

  Keep going, then I might add something.

• 3:58Tracy Alloway?

  Fall in the dollar.

• 3:59Joe Weisenthal?

  Yeah, there's that. The fall in the dollar is very big so far this year.

• 4:02Tracy Alloway?

  But this huge ramp up in the price of gold, which seems to hit a new record all the time. And then we've had the continued strength slash resilience, whatever you want to call it, enthusiasm about AI in the stock market. And it really seems like there's this division at the moment between how people feel about corporate America and how people feel about sovereign America in the form of its currency.

• 4:25Joe Weisenthal?

  You know what I really regret doing, Tracy? I really regret.

• 4:30Tracy Alloway?

  Did you have like a hoard of gold that you got rid of?

• 4:32Joe Weisenthal?

  No, I took out a gold denominated mortgage. No, I feel so stupid. I feel so stupid. Why did I do that? I could have. I get paid in dollars and I took out a gold denominated mortgage. What was I thinking? No, I didn't. But had I done, that would have been a very bad trade.

• 4:46Tracy Alloway?

  Yes.

• 4:47Joe Weisenthal?

  Remember those stories from like, you know, a little bit of a tangent. Remember all those stories from like the Hungarians? They took out those Swiss denominated mortgages back in the 2000s and then.

• 4:58Tracy Alloway?

  That was very much a Europe thing for a while.

• 4:59Joe Weisenthal?

  Yeah, that was a really funny. We don't have to talk about that. But one thing I was just, the only reason I caveated the dollar fall, which I do think it has, it is quite a bit down from the beginning of the year. All that being said, it is striking in the last several weeks, the degree to which a few of the very popular consensus ideas for this year are turning a little bit. And I say that 10-year treasury is the time we're recording this, October 17th, has fallen below 4%. How many times did you hear about the steepener trade this year? How many times did you hear about fiscal dominance, losing control at the long end? The dollar, it stabilized a little bit.

• 5:40Joe Weisenthal?

  So it is a very interesting moment for markets in many respects right now.

• 5:45Tracy Alloway?

  There's definitely a lot to talk about. Congrats on managing your personal FX liabilities.

• 5:50Joe Weisenthal?

  I'm doing a good job.

• 5:53Tracy Alloway?

  Getting paid in dollars and paying your mortgage in dollars. Well done, Joe. All right. Well, you know, this is the kind of thing that a lot of big investors are thinking about at the moment and we should definitely think about it too. And who is the one person that we really like to talk to?

• 6:08Joe Weisenthal?

  There could only be one.

• 6:09Tracy Alloway?

  When we talk about these big trends.

• 6:10Joe Weisenthal?

  And who is the one person that is always in town? Cause we're in Washington DC right now. When we go to a new town, who is the other guy who always is probably going to be there at the same time?

• 6:20Tracy Alloway?

  The person that we run into on the street in various outfits. Although this time you're wearing a suit. So there we go. The last time we ran into you randomly, you were wearing hiking gear and so were we. Anyway, we are here in DC. We have the perfect guest as always. We are speaking once again with Hyun Sung Shin. He is the Economic Adviser and Head of the Monetary and Economic Department at the Bank for International Settlements, the BIS. We love talking to him and it's so great to have him here to talk about something that's really been on the minds of a lot of market participants, a lot of policymakers right now. So Hyun, thank you so much for coming back on Odd Lots.

• 6:56Speaker 06

  Thank you, Tracy. Thank you, Joe. It's great to be back.

• 6:58Tracy Alloway?

  Since Joe doubts my entire premise for this episode.

• 7:02Joe Weisenthal?

  I doubt his entire premise at all.

• 7:04Tracy Alloway?

  No, let's just start with how unusual would you say this year has been? And I feel like so much has happened. We kind of have to cast our minds back to April when we did have Liberation Day and when we did see the dollar fall as the market was selling off, which was something that's not really supposed to happen. You're supposed to have investors reach for the safe haven of the greenback in times of turmoil and stress. And now, you know, fast forward to October, I think we've gotten a little bit more used to that particular dynamic. But how surprised were you at that time?

• 7:37Speaker 06

  Well, it was a very unusual combination of events in April. So what we saw was the so-called triple decline, where you had stocks, bonds, and the dollar falling in unison. And that's very unusual because in a risk-off episode, you know, which April was, typically the dollar would rally, you know, there would be a kind of safe haven flow. And, you know, back then, there was, of course, a lot of news. And you saw a lot of stories back then about, you know, possibly the dollar, you know, losing its international status and so on. I think in retrospect, that was, you know, quite hasty. And I think now that we

• 8:20Speaker 06

  have the data, we can piece together in a more kind of coherent way what was going on. And

• 8:30Speaker 06

  In short, I think it was a kind of hedging story where investors who had lots of exposures to the US dollar were trying to reduce some of those exposures and we can get into some of the details on how that kind of trade might transpire. And it just so happens that this is also the year that the BIS conducts its triannual survey of FX markets. And we've just published the results and I think we can also shed some more light on the events in April.

• 9:03Joe Weisenthal?

  Let's keep it big picture still and then we'll drive down into specific months and weeks. People work for the BIS, they probably must take out mortgages and Swiss franc that live there in Basel. Anyway, sidetrack. What are some of the big takeaways from this year's survey?

• 9:19Speaker 06

  Yeah, yeah. So I think, well, actually, before we go there, Joe, I mean, it's worth thinking about how FX markets really figure in the investment strategy. So if you're a long-term investor, let's say that you're a euro-area pension fund. What you have are obligations to your local

• 9:39Joe Weisenthal?

  In euros.

• 9:40Speaker 06

  Beneficiaries in euros, but you have a very large balance sheet and so you need to have a very broad exposure to global assets, including those in non-euro-denominated assets. So what tends to happen is some of the euros are then converted into dollars to invest in dollar assets. But of course, what you want to do is to make sure that you hedge that currency risk. And this is where this instrument called an FX swap really comes into its own. And it's an operation where essentially the euro-area investor pledges some euros and then borrows dollars.

• 10:22Speaker 06

  And then with those dollars then go into dollar-denominated assets. And as you do that, you also promise to unwind that transaction at a known exchange rate that is fixed in a moment in the future. So essentially, once you've gone through that transaction, your currency risk is hedged. Now, exactly how much of your foreign portfolio you hedge in this way, that varies over time. I mean, it depends, for example, on how high the hedging costs are. And because you're typically doing this fairly short term and you're rolling over these hedges, what's important is the short-term dollar interest rate, because you're borrowing dollars

• 11:04Speaker 06

  in order to invest in dollar assets. So when the short-term interest rate is very high, that's typically a time when hedging costs are very high. And so what had happened over the last few years was that these so-called hedge ratios, you know, the proportion of your assets that you actually hedge, had been really trending down. And to the extent that some investors didn't hedge at all. And why would you if the dollar is surging and the hedging cost is so large? And so when the turbulence broke earlier in the year, a lot of investors were basically caught with very large dollar exposures, having not hedged.

• 11:47Speaker 06

  And I think one piece of evidence that this was, that the events of April was very much an ex-post hedging story, hedging after the fact, was that we saw a lot of the telltale signs of swaps being taken out and dollars being sold happening in the markets. So what would happen is if an investor is holding dollar assets without a hedge, but you're concerned about the dollar falling, then what you would do is you would put on a hedge ex-post, you would put on a hedge after the event. And you could do that, for example, by actually then engaging in an FX swap right there. But then selling the dollars that you've acquired.

• 12:30Speaker 06

  So rather than investing those dollars into dollar assets, you simply sell it in the spot market. What that kind of dynamics would imply is that there would be lots of downward pressure in those situations where institutional investors are trying to raise their hedge ratios but exposed. So back to the triennial, what do we see there that puts additional light on this episode? Oh, by the way, on the triennial, it's just so happens that the sampling period was April this year. Amazing. So it may be slightly distorted by the events of the April episode.

• 13:12Speaker 06

  On the other hand, the silver lining is that we have some great data. I bet. On really the events of the April episode. But the headline numbers are really quite notable. It's nine point six trillion dollars daily flow. This is like something like almost thirty percent higher than the previous survey in twenty two. The dollar is still very much the dominant currency. It's ninety percent of all of the transactions have the dollar on one side. It's even higher than what we saw in twenty two. So in spite of the survey being affected perhaps by these stress events in April, we think we've got a very, very good sort of take.

• 13:57Speaker 06

  One of the things that we noticed this year is, of course, as well as the FX swaps, which is by far the largest segment of the transactions. We also see a lot of a big increase in the spot transactions and also outright forwards. So let me just explain that for your listeners. When you engage in an FX swap, the investor would borrow dollars by pledging euros. And then there's also a promise to reverse that. Now, that promise is called a forward. And of course, you can get that, you know, without going through the swap. You can just go to a dealer and say, look, you know, just sell me a outright forward,

• 14:41Speaker 06

  so called, and then I would actually then have a dollar obligation.

• 14:44Joe Weisenthal?

  So the swap is like a spot trade plus a forward?

• 14:48Speaker 06

  Exactly.

• 14:49Joe Weisenthal?

  Okay.

• 14:49Speaker 06

  It's that combination.

• 14:50Joe Weisenthal?

  Yeah.

• 14:50Speaker 06

  And what we see is, as well as the swaps, we see the two components, the spot and the forward, being very, very large this year. And we think that the events of April must have had a, you know, had an impact because, you know, as well as getting a swap and selling the dollars in the spot market, you can also just ask a dealer for a forward contract. But then, of course, the dealer has to hedge. So there, you know, there's going to be a spot sale anyway. And so that combination would actually lead you to a situation where both the spot and the forward transactions go up a lot. And that's exactly what we see.

• 15:31Joe Weisenthal?

  Interesting.

• 15:31Speaker 06

  So this is another piece of the evidence that this was very much ex post hedging. And let me mention just two other things on this. We put out a bulletin earlier in the summer. We, you know, lay out all the other pieces of evidence that we could, you know, gather. But it's also notable that if you look at the actual portfolio flow numbers, the international portfolio flow numbers, there was no real selling in April. So, you know, there was a very, very small outflow, but on the scale of things, it was really tiny. There were certainly no, you know, concerted portfolio outflows, you know, from the US. So that's really the, I think perhaps the most, you know, compelling evidence that the so-called Sell America trade was not, you know, was not the story behind the April episode.

• 16:32Tracy Alloway?

  There are some market stories where you want every detail. Joe and I have made quite a few podcasts on that basis. But sometimes you've only got 10 minutes and just want to know what's moving markets fast. That's the Barclays Brief Podcast. Every week, experts from Barclays Markets and Research get you up to speed on what's happening and what to watch next. Concise, focused, and brief. Search Barclays Brief wherever you get your podcasts.

• 16:58Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw, innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 17:40Speaker 01

  and hiring practices, but according to recruiters, advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at ChatGPT.com.

• 18:21Speaker 07

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• 18:51Tracy Alloway?

  Why should we care either qualitatively or quantitatively if this was a hedge America story and not a sell America story outright?

• 19:00Speaker 06

  Over the long term, it is possible that, you know, long term investors would then reassess their global exposures. And you see, and you hear a lot of anecdotal evidence that, you know, these conversations are going on. But so far that hasn't really been, you know, translated into actions. But I think what, um, you know, does flow very, you know, clearly from, you know, from the actions in the spring is that when we look at the various pieces of the global financial system, every part, you know, depends on other parts. And there is this network effect where provided that everyone else is doing what they're doing around the US dollar, then it's also in my interest to actually, uh, you know,

• 19:44Speaker 06

  be part of that, you know, ecosystem. So if you have this kind of, you know, network effect, it's very difficult to, you know, have this wholesale shift away.

• 19:53Joe Weisenthal?

  One of the things that I think is unusual, and I probably said this in a few other episodes, but what I think is striking about this environment is that if you look at the US, I can come up with a long list of reasons to be concerned, which we don't need to come down, uh, recapitulate. Now, on the other hand, the most profitable, impressive, cutting edge companies in the world that everyone would love to have exposure to in some way are in the US. And it strikes me as that's the unusual situation, which is we don't typically associate volatile sovereigns with being the home of the most dynamic companies in the world. And so to my mind, I would love to have exposed more exposure to Nvidia and Microsoft and

• 20:38Joe Weisenthal?

  all of these companies that are making money hand over fist without having exposure to the US itself. And hence I might want to hedge.

• 20:47Speaker 06

  I mean, certainly, you know, the equity market story, I mean, that really is in a class of its own. And as you say, that's really been a very, very strong theme. But more broadly, you know, capital markets, if you think about how capital markets operate, there's a whole ecosystem behind that. And you have the underlying securities, obviously, but then you have the hedging instruments, and then you have a whole set of investors who are actually, you know, taking part. And the banking system is absolutely crucial in providing those hedging services. And I think when we last discussed this back in Jackson Hole, you know, we talked about how the FX swap market makes, you know, money fungible across

• 21:29Speaker 06

  currencies. And, you know, money is ultimately something to do with banks. So, you know, the central bank, you know, issues high-powered money, commercial banks are there also to issue money that the other users will will take advantage of. And FX swaps are there, you know, basically providing this, you know, service of making money fungible across currencies. So, you know, every piece fits into every other piece in that sense. And so, you know, we should think about this in terms of the mutually reinforcing pieces of this, you know, of this network.

• 22:06Tracy Alloway?

  What have you observed in terms of the actual trends in FX hedging costs? Because as you described it, in April, suddenly, it all starts kicking off. A lot of large investors who are not that used perhaps to having to hedge their dollar exposure suddenly scrambled to do it ex post, as you described. Did that mean that the cost of actually doing so actually increased, or was it still relatively cheap?

• 22:31Speaker 06

  Well, actually, it's primarily about how high the short-term interest rates are, actually. And in particular, if you're a non-US investor investing in dollar assets, it's really how high the short-term dollar interest rate is. Because essentially, what we're doing is, you know, you're pledging euros, let's say, and then borrowing dollars short-term, and then investing in dollar assets. And so it's really about how high that short-term interest rate is relative to the yield you're getting on the on the asset itself. And so if you have a flat yield curve, you know, which is what we've had, or even inverted yield curve. Then hedging costs are very high. And so in fact, you know, investors have typically

• 23:11Speaker 06

  hedged and hedge ratios have fluctuated. There's no systematic survey, but it's fluctuated between forty and sixty percent. I mean, there are some pockets of official data like the Japanese life insurance companies, but typically this is, you know, really quite quite anecdotal. But what had happened in the last year or so was the hedge ratios had gone down gradually. Some firms were not even hedging at all. You know, they were trying to win both on the stronger dollar, but also on the high yields.

• 23:42Joe Weisenthal?

  Yeah.

• 23:42Speaker 06

  Yeah. Actually, let me just mention a very interesting point here, actually. It's actually worth thinking about the parallels between this story about, you know, advanced economy investors holding US dollar assets with the story about local currency emerging market bonds. You know, that's actually a very, very, you know, important asset class.

• 24:05Joe Weisenthal?

  Yeah.

• 24:05Speaker 06

  That really grew up after the GFC. And that's typical asset class where the investor would not hedge. So if you want to enter into a large emerging market sovereign bond trade, you would actually buy the instrument on an unhedged basis. And you do that because, you know, you think the emerging market currency will appreciate as well as the yield fall. And so you win twice. You know, you gain both on the yield, you know, as well as on the exchange rate. But of course, when the tide turns, that's when you, you know, scramble to, you know, hedge ex post. And that's exactly, you know, the same type of thing that we

• 24:46Speaker 06

  saw, you know, in this, in this episode. And, you know, and there were actually emerging market investors, especially from Asia, who were, you know, caught with very low hedge ratios. And there was this ex post hedging going on. So there's actually a very interesting parallel between, you know, what was, you know, going on this April and the much older trade, which is the emerging market trade.

• 25:11Tracy Alloway?

  So Joe, on the plus side, people aren't necessarily selling dollar assets. On the downside, the negative side, we're basically treating dollar assets the way we would a local emerging market bond.

• 25:23Joe Weisenthal?

  People are like, I think I'm going to buy some local currency US debt.

• 25:27Tracy Alloway?

  That's right.

• 25:29Joe Weisenthal?

  Actually, but like, so what was it about April then that caused the, like, what? I mean, we know there was, you know, they launched a trade war and there were like massive tariffs, etc. But like, what was it about that such that people's impulses to hedge more ex post facto, as you've described it? What was the thing that said, oh, we want to change our, the, our sort of, our exposure to US dollars, even if we don't want to sell them?

• 25:57Speaker 06

  I think it's probably a combination of several things, but where the, you know, where the investors found themselves in terms of the hedge ratios had a lot to do with this. Actually, if you look through your, you know, Bloomberg News database, you'll find plenty of stories from 23, 24, where, let's say, life insurance companies announce that they will not be hedging, you know, they're, so, you know, they would be holding, let's say, US dollar assets, but without a hedge. And as I said, you know, there were some firms that didn't hedge at all. And in a risk-off environment, what typically happens is that you want to take some chips off the table, and that just means reducing your exposure.

• 26:42Joe Weisenthal?

  Yeah.

• 26:42Speaker 06

  And if you're exposed, you know, in this double whammy fashion, you know, you would actually try and, you know, either hedge ex post or reduce your exposure. It looks like, from the evidence, that it was very much the ex post hedging story.

• 26:58Tracy Alloway?

  So if people are hedging their dollar exposure more than perhaps some of them at least used to, do we have to worry about things like rollover risk or some sort of, I guess, duration mismatched, where you have a short-term hedge, whether it's a forward or a swap or whatever, mismatched to a longer-term asset? I mean, this is, this is what the BIS does on a day-to-day basis, is worry about potential risks. So are you worried here?

• 27:29Speaker 06

  That's a really great comment, Tracy. And I think this was, you know, where I was going to go next. Of course, you have this, you know, once you hedge, you've hedged the currency risk at least until the maturity of the swap, which is typically, you know, one month to three months. But it's a short term, it's a short term liability that you need to roll over. And from time to time, you might get caught in a liquidity, in a stress episode, where it's difficult to source the dollars to actually repay. And this was, for example, what happened during the GFC.

• 28:09Speaker 06

  It's also what happened during March 2020, when there was also a scramble for dollars. And, you know, when you're a long term investor, you've hedged using a short term FX swap. But you're holding, you know, long term securities. You have a maturity mismatch. So either you have to somehow, you know, sell your long term assets, which is going to be very difficult at a fair price. Or you have to join the scramble for dollars with all the other borrowers of dollars in the market. And so this is the paradox where, you know, you're a long term investor, but actually you have this short term, you know, dollar obligation.

• 28:48Speaker 06

  And so, you know, we are swapping one, well, we are actually exchanging one type of risk for another. We're actually changing currency mismatch for maturity mismatch. And, you know, empirically, if you look at the evidence over the years, it's when the dollar is falling for a long period of time that these hedge ratios become very, very high. So, you know, a good example is the period before the GFC, when, you know, dollar was, you know, really falling, you know, quite considerably.

• 29:21Joe Weisenthal?

  Yeah.

• 29:21Speaker 06

  But then what happened at the GFC was, of course, in a dollar really spiked.

• 29:25Joe Weisenthal?

  Right.

• 29:25Speaker 06

  Because there was a scramble for dollars. So, you know, there's always this trade off. You either have to bear some currency risk or you bear this maturity risk and then bear this maturity mismatch risk, I should say. And, and so we, you know, it's really, you know, changing one type of risk to another.

• 30:03Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume, so writes Bloomberg Businessweek's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 30:45Speaker 01

  and hiring practices, but according to recruiters, advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company, and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at ChatGPT.com.

• 31:25Speaker 07

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• 31:55Speaker 08

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• 32:56Joe Weisenthal?

  Tracy really loves currency markets because she loves the fact that when the line moves, you can never tell whether it's the numerator or denominator that's at fault.

• 33:06Tracy Alloway?

  This is sarcasm, by the way. For those who don't know, I hate currency markets.

• 33:10Joe Weisenthal?

  She hates currency markets because you never know whether we should be telling you it's the numerator.

• 33:14Tracy Alloway?

  You say the dollar is going down, someone's going to be like, oh, no, but it's up against like some obscure currency that no one's ever heard of.

• 33:20Joe Weisenthal?

  But EM, and you mentioned EM, and many EM bond funds, EM indices, and EM currencies are doing very well. And so this gets to the question of like, is this a numerator story? Is it about dollar weakening or is it about? So we've been talking a lot about financial flows. Has something changed, though, in the sort of underlying economic fundamentals of a lot of EMs? I've heard some rumblings about this. People excited about EMs in a way that I don't think they were excited about to the same degree during the 2010s at all. And I just, while we were chatting, I pulled up a bunch of lines of EM-related funds, currencies all doing very well. In your research, are there fundamental changes in the EM world that are like,

• 34:02Joe Weisenthal?

  people are excited about for reasons other than the fact that the dollar is weak?

• 34:08Speaker 06

  So this is very timely, Joe. And as it happens, on Monday, we published a bulletin exactly on this question. Are the emerging markets doing well because of better policy, better fundamentals? Yeah. Or is it really about the the global financial market trends? And the short answer is it's a bit of both. Tracy loves this answer. And you would and you would, you know, not think of otherwise.

• 34:34Speaker 06

  Why is it better fundamentals? Well, I think it's certainly there's been much better policy, especially monetary policy. And also, the emerging markets have have really been buoyed by actually, you know, the weaker dollar. The weaker dollar has been a tailwind for much of the year. This is why emerging market assets have really, you know, rallied quite hard. And there's there's a parallel with credit spreads as well. Because, you know, when credit is doing well, we also tend to see emerging market assets also doing well.

• 35:13Speaker 06

  And if we break it down, so why would a weakening dollar be a tailwind for emerging markets? Well, you know, in the simplest possible case, if a borrower has borrowed dollars, but then has invested in local currency assets, you know, there's this currency mismatch. But then there's a windfall when the when the dollar weakens. That's a very simple story. It's probably not the most important. But there's another very interesting element here, which has to do with the so-called risk-taking channel. And the idea here is if you have a very diversified, you know, portfolio of these of the loans to all of these, you know, currency mismatch borrowers,

• 35:52Speaker 06

  the improved credit risk on these borrowers really, you know, shrinks the tail risk in the credit for the, you know, for the lender. So if you like, the value at risk goes down. And that really opens the door to to more credit. So there's this very, very strong relationship between a weaker dollar and faster growth of dollar-denominated credit. And Because of how important dollar credit is for supply chains, if there's any product, if there's any good that out there that relies on very complex supply chains, global value chains, those products will tend to do very well.

• 36:35Speaker 06

  And what you've seen is actually, in spite of the weaker dollar, exports have gone up in these very highly sophisticated goods, and much more so than the goods that are much more affected by just a simple, the simple trade effect and the exchange rate. So semiconductors, for example, I mean, this has been one of the surprises. Clearly, there's the AI boom, but it's not just that. If you look at semiconductor trade, exports from Asia, that's really been very, very resilient this year. And anything that has to do with global supply chains, you will also see. But there's a, you know, there's a sting in the tail here because, as we talked about

• 37:15Speaker 06

  earlier, emerging markets increasingly are becoming net creditors to the rest of the world. And there was very little hedging going on. And so when you're caught in one of these downdrafts, you get hit both from, you know, the weaker dollar and also the, and also the high yields. And so we saw a lot of this, you know, scrambling, you know, back in April. So it's primarily a tailwind, and it has been a tailwind for a long time, but there is this third element, this new element, which I think we need to keep an eye on.

• 37:50Tracy Alloway?

  What do you see when you look at the price of gold? So we are recording this on October 17th. It's coming down a tiny bit this morning, but still above $4,000 an ounce. What is that telling you about how investors are feeling about various global currencies at the moment?

• 38:07Speaker 06

  Well, Tracy, I mean, we, we hear a lot about the so-called debasement trade, but I think that's probably overdoing things. You know, debasement is really about the value of money relative to, you know, goods and services. We don't really see a surge in inflation.

• 38:25Joe Weisenthal?

  Yeah.

• 38:26Speaker 06

  We don't see surge in the price of, you know, even commodities. I mean, look at, you know, look at oil, look at other commodities.

• 38:33Joe Weisenthal?

  Yeah.

• 38:33Speaker 06

  You know, everything other than gold. And I, so I think we should probably look for a more tailored explanation for gold. Other than simply, you know, this broader sort of sense of, you know, in a flight from, you know, fiat currencies. And, you know, I think one thing which goes back to our initial conversation on the role of the dollar and the global financial system. Certainly, central banks have been big buyers of gold. And there has been, you know, that's sort of, you know, set a very sort of firm, you know, backdrop to, you know, to the market. And other people have jumped on the bandwagon. In a way, it's actually behaving like a risk asset. Yeah, it really is. And the events today and, you know, last week as well.

• 39:16Speaker 06

  Rather than there being a flight to gold during stress times, what we're seeing is it's behaving a bit like Bitcoin. And, and the risk asset. So it sort of tells you that there's been a little bit more of a speculative element, you know, here. But it's certainly behaving in a way that's very different from the, from the historical norms.

• 39:38Joe Weisenthal?

  You know, for a long time, and Tracy's talked about this. For a long time, you could sort of model the price of gold via real rates. And when they're very low or suppressed or whatever, gold went up. Kind of seemed like it changed not long after Putin had a bunch of his money seized. Like, and when you talk about central banks accumulating gold, being woken up to the fact that your money is never really your money if it's in a bank. That seems like it could be part of it.

• 40:06Speaker 06

  Well, Joe, I mean, certainly there are very few assets which are not the liabilities of someone.

• 40:11Joe Weisenthal?

  Yeah, yeah.

• 40:11Speaker 06

  Of someone. And, you know, typically, whether it's a fixed income instrument or an equity, it's someone's liability. So someone has the obligation to pay you. And gold is one of those, which is not the liability of, of, of any particular individual. Now, I think, you know, when we look back, we can see these sort of broad, you know, swings in the price of gold. After the breakdown of Bretton Woods in the early seventies, you know, there was a brief spike. But then we had a very, very long period. When gold wasn't doing very much. I think it's probably something even before the Russian invasion of Ukraine, Joe. So we've seen the trend where something like this has also happened actually a few

• 40:55Speaker 06

  years back, even before the Russian invasion of Ukraine in 22. But I think this element, this attribute where it's not the liability of any particular legal entity or individual, I think is giving this a particular. Yeah.

• 41:16Tracy Alloway?

  So I'm looking at the top menu on Bloomberg right now and it's feeling a little bit nervy at the moment. So the number one story is banks trio of alleged fraud sparks fear of broader issues. So this is the idea that this is Jamie Dimon's cockroach idea that we're starting to see some losses emerge from either outright frauds or just bad investments and people are starting to get a little bit nervous. Do you see any sorts of, I guess, credit oriented concerns out there at the moment?

• 41:51Speaker 06

  Well, Tracy, I mean, certainly this week is a very news rich environment.

• 41:58Tracy Alloway?

  That's one way of putting it.

• 42:00Joe Weisenthal?

  We love it.

• 42:01Speaker 06

  You are contributing to that and I think it's great. We hear a lot of these comments. On credit, certainly credit standards have been eroding for a long time and we have been one of the many voices even before this week, just pointing out that credit spreads have fallen to historical lows. But if you look at the trajectory of credit to the private sector and compare that to what's been happening to government debt, there really isn't a comparison. So certainly before the GFC, the big growth was in credit to the private sector, especially

• 42:46Speaker 06

  in the form of mortgages. But after that, what we've seen is credit to the private sector has really been very subdued. And instead, it's really been the government in a bond market, which has grown tremendously. Now, what we're seeing now is, you know, some signs of the erosion of credit standards, you know, coming back to bite. But if you're worried about something very systemic, if you're worried about systemic risk, the first thing to ask is how fast has this grown in the recent past? And typically, something that's grown very rapidly will, you know, give you some cause for concern. In this case, the really rapidly growing element has not been credit to the private

• 43:31Speaker 06

  sector, it's been credit to the government, and in particular, the government bond market. So we should, you know, we should of course worry about, you know, these, you know, these events. And of course, the headlines, you know, create, you know, as I said, it's a very news-rich environment. We hear that, and we hear the same stories in the panels. If it's really a concern about, you know, is this the precursor to the next, you know, systemic crisis, it's probably not the case.

• 43:59Joe Weisenthal?

  Actually, this brings to mind something that I don't think I've really asked in such a way before, but another thing that's grown a lot is the stock market or equity, equity markets. There was actually a really good article in the Wall Street Journal several days ago about the degree to which equity exposure, at least in the US, has spread demographically. So a lot, many more like working-class households own stocks than they used to. When I think about people who are in the business of being worried about financial stability, they don't, I don't think the stocks are high on their radar. They're called risky assets. We all know they're risky, and usually crises don't emerge from assets that we all agree are risky.

• 44:41Joe Weisenthal?

  Crises emerge from assets that we think are going to be redeemed from a dollar's worth, we're going to get a dollar's back, or whatever, or we're worried about getting back at all. But I'm curious, from the perspective of someone who professionally maybe worries, how do you and your colleagues Think about equity exposure, especially given the widespread view that equity exposure is fueling consumption in the United States, a driver of the economy, that there is a lot of speculative activity. Like, is there much modeling work being done on equity and risky assets specifically as a source of broader risk?

• 45:18Speaker 06

  Absolutely. I think the, you know, the main channel would be through the real economy.

• 45:24Joe Weisenthal?

  Yeah.

• 45:25Speaker 06

  Through real economic activity, rather than through, let's say, a deleveraging episode or a liquidity episode. I think it's worth thinking back to the dot com bubble of 2000. You know, that was a period, of course, when the valuations were even more extreme. And when the stock market fell in 2000, of course, we did see some effect. And of course, a lot of investors lost money. But there was nothing like the same kind of impact on the real economy that we had with the GFC. And a very simplistic way of putting this is whenever you have debt of various kinds, that's when you should be worried.

• 46:08Speaker 06

  Because, Joe, as you said, it's when you're promised one, $1, but then you don't deliver, that's when, you know, there are sort of repercussions throughout the economy. Now, clearly, with the equity markets, there are wealth effects. So, you know, if you have a very large portfolio, you feel richer and then you spend more. And so there is a real economy effect of the stock market. And so if we see a pullback in the stock market, a very sustained pullback, we will see, you know, some effect like that. Now, the estimates of the wealth effect on consumption, for example, has varied over the years, but given the, if you like, the democratization of stocks.

• 46:48Joe Weisenthal?

  Yeah.

• 46:49Speaker 06

  We could, we could expect a slightly larger magnitude. But on the scale of things, that effect tends to be very small compared to the kinds of effects that are associated with deleveraging episodes.

• 47:00Tracy Alloway?

  Do you see any pockets of leverage out there that aren't getting enough attention at the moment?

• 47:06Speaker 06

  Well, I think you're very good at shining a light on those, you know, all those pockets, actually.

• 47:10Tracy Alloway?

  Oh, thank you, Hyun.

• 47:10Speaker 06

  So I don't think I can really say anything here that you haven't heard of.

• 47:15Joe Weisenthal?

  Okay.

• 47:15Speaker 06

  But I think it's certainly worth bearing in mind the broad magnitudes. Yeah. And one of the things that we've, you know, we've talked about a lot this year in our various official publications is the fact that even, you know, safe assets can be a source of stress in the market because it's not default that, you know, propagates stress. It's more the deleveraging. I think, you know, if, let's say, long rates were to, you know, shoot up and therefore mortgage rates also shoot up, you know, that would be a really big deal for the real economy. And that would happen even without any defaults.

• 47:54Joe Weisenthal?

  By the way, when we started this conversation, the 10-year was below 4%. It's above it now. So just keeping our listeners up to date on what's going on in the treasury market on October 17th, 2025.

• 48:06Tracy Alloway?

  Very good. I mean, the other interesting thing is if gold is acting like a speculative asset now, what happens when all of that starts reversing? And, you know, the thing that you thought was worth $4,000 is no longer worth $4,000. And gold is typically used as collateral, right?

• 48:20Joe Weisenthal?

  Well, I always say, you know, it's really scary when you see people like intensely buying gold, because like, what's up? But what's really scary is when they start selling, right? Because again...

• 48:30Tracy Alloway?

  No, it's true.

• 48:31Joe Weisenthal?

  Because actually, no one has, you have to be a real psycho to have a gold-denominated mortgage. You have dollar-denominated mortgages, et cetera. And so when you see, like, usually, one of those things you notice is that in a real credit event, when you really get that VIX spike and people are really worried about making that payment on their mortgage and they're really worried about paying their monthly subscription to their Bloomberg terminal, they need dollars and then they sell gold and you're like, oh, things are getting really rough.

• 48:57Tracy Alloway?

  All right.

• 48:58Joe Weisenthal?

  I'm just throwing things out here.

• 49:00Speaker 06

  I think that was a comment, Joe, rather than a question.

• 49:02Joe Weisenthal?

  It was a comment, not even a question.

• 49:04Tracy Alloway?

  Thank you, Joe, for your comment. Hyun, it's always lovely catching up. This has been fantastic. Thank you so much for coming back on the show.

• 49:11Speaker 06

  Thank you very much, Tracy, and thank you, Joe.

• 49:13Joe Weisenthal?

  Thank you so much. That was awesome.

• 49:27Tracy Alloway?

  Joe, I always enjoy catching up with you. He has a fantastic way of explaining things in a very soothing, calming manner. I do think, so nuance is important, absolutely, and technicalities in the market are important. So if the dollar going down is being exacerbated by hedging versus people selling dollars outright, that is an important thing to talk about and to capture. However, I still feel like the direction of travel is not fantastic for the dollar itself. If people are treating dollar assets the way they used to treat local EM bonds in terms of hedging that exposure, that doesn't seem great necessarily, for the US, I mean.

• 50:08Joe Weisenthal?

  No, I mean, look, it's, you know, I think of a currency as sort of like being the token at Chuck E. Cheese, you know? And you want to play the games, but it was really nice of like the token is going up and you can play the games at the same time.

• 50:21Tracy Alloway?

  You can play more games or eat more pizza.

• 50:23Joe Weisenthal?

  Or eat more pizza. But I think we're in this situation where people want to keep playing the games. They just don't really like the whole arcade.

• 50:32Tracy Alloway?

  Yeah.

• 50:34Joe Weisenthal?

  This is, this is the way I think about it. The games are still fun. It's just that you're worried about the direction of the arcade.

• 50:40Tracy Alloway?

  Yeah.

• 50:40Joe Weisenthal?

  And so I think, because, and this is why, you know, like, how are you getting, what, you're not going to like do business in the United States? Give me a break. That's completely unrealistic, even if you don't like, if you put it, the direction of travel. And so I think sort of intuitively, you can sort of understand why I don't want to leave town. I just don't want to have arcade exposure.

• 51:01Tracy Alloway?

  Absolutely. I guess what we kind of need, we need another big crisis so that we can observe what gold does during that time and also what the dollar does during that time.

• 51:10Joe Weisenthal?

  I think I'm going to run with this. Actually, I'm going to run with this a little bit more. Because like, if you think like, you know, Chuck E. Cheese has a lot of fun games, but also I don't really think the business model of Chuck E. Cheese is like that good.

• 51:22Tracy Alloway?

  How dare you?

• 51:24Joe Weisenthal?

  Well, a lot of them have closed down, but it doesn't mean the games inside were less fun. So I don't want to hold those tokens in my pocket forever. I want to have exposure in case they go out, they go out of business or something like that. Doesn't make the games less fun in the meantime. And you've solved this problem of wanting to play the games, but being worried about the future of Chuck E. Cheese by hedging them.

• 51:42Tracy Alloway?

  I'm going to restart Chuck E. Cheese and roll it out across the country just to ruin your analogy, your preferred market analogy. No, I think it's a good one.

• 51:51Joe Weisenthal?

  Thank you. Thank you. Finally.

• 51:53Tracy Alloway?

  All right.

• 51:54Joe Weisenthal?

  But I will not be taking out Chuck E. Cheese denominated. Well, no, so that would be the great thing. If you could imagine getting a Chuck E. Cheese token denominated mortgage and then it goes out of business, you don't even have to pay them back.

• 52:04Tracy Alloway?

  You know, I'm pretty sure somewhere in like a box somewhere, I still have a bunch of like Chuck E. Cheese tickets or something like that. Maybe I should take them out. Anyway.

• 52:13Joe Weisenthal?

  Well, this is another interesting question because what is the exchange ratio between a token and a ticket, right?

• 52:19Tracy Alloway?

  Yeah, and that I don't know.

• 52:21Joe Weisenthal?

  This is sort of like one of those communist countries. Chuck E. Cheese, this is a paper that someone wrote, Chuck E. Cheese is the dual circulation economy in which they have tokens for the games and tickets for the prizes. And how they manage that exchange ratio is very similar to a planned economy.

• 52:39Tracy Alloway?

  Do you think I could find someone to provide like a swap on

• 52:42Joe Weisenthal?

  Yeah.

• 52:43Tracy Alloway?

  a token versus a ticket or something?

• 52:45Joe Weisenthal?

  I think there's something here. I think we're, I think we're hitting on something important.

• 52:48Tracy Alloway?

  Okay, I think we should end. We should leave it there.

• 52:51Joe Weisenthal?

  We can leave it there.

• 52:51Tracy Alloway?

  All right. This has been another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

• 52:57Joe Weisenthal?

  I'm Joe Weisenthal. You can follow me at TheStalwart. Follow our producers, Carmen Rodriguez at Carmen Armin, Dashil Bennett at Dashbot, and Kell Brooks at KellBrooks. For more Odd Lots content, go to Bloomberg.com/oddlots, where the daily newsletter and all of our episodes. And you can chat about all of these topics 24/7 in our Discord, discord.gg/oddlots.

• 53:18Tracy Alloway?

  And if you enjoy Odd Lots, if you like it when we talk to Hyun Sung Shin about upcoming risks in the market, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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