#997 Darius On Why Inflation May Be Here To Stay

Darius Dale is the Founder & CEO of 42 Macro, the leading macro risk manager adviser. In this conversation, we discuss the macro economy, what's happening in the financial markets, how Darius is looking at various metrics, and what you should be considering as you're investing your capital. Darius joins us every Thursday on "The Best Business Show." To see the video with the corresponding charts that Darius references throughout the interview, go to "The Best Business Show: LIVE" YouTube Channel ======================= Exodus is leading the world out of the traditional financial system by building beautiful and user-friendly blockchain products. With its focus on design and user experience, Exodus has become one of the most popular and loved cryptocurrency apps. It’s supported on both desktop and mobile, allowing you to sync your wallet across multiple devices so you can have access to your funds anywhere. You can instantly exchange around 100 different cryptocurrencies straight from your wallet. Interactive charts let you view an asset’s price history and your portfolio’s performance over time. And maybe the best part, Exodus is integrated with the Trezor hardware wallet - making advanced security easy for everyone. Visit exodus.com/pomp for your free download or search Exodus on the App Store or Playstore. ======================= Today’s episode is sponsored by Abra. Based in California and backed by top VC firms, Abra is an all-in-one simple, secure app that allows you to trade over 110 cryptocurrencies, get 0% interest loans using your crypto as collateral and earn interest with up to 14% APY on stablecoins and 8.15% APY on Bitcoin. Join nearly 2 million users by downloading Abra from the Google Play or Apple App store. If you download the app today, you will get $15 in free crypto once you fund your account. You came, you invested — now conquer. ======================= DeFi Technologies represents what’s next in the digital economy -- providing simplified, trusted access to crypto, decentralized finance and Web 3.0 investment opportunities. Institutions and investors can gain diversified, secure, compliant, and easily tradable access to a diversified set of industry-leading equity products and protocols, through a single stock purchase on a regulated exchange. Currently listed on U. S. (OTC: DEFTF) and Canadian (NEO:DEFI) exchanges. For more information or to subscribe to receive company updates and financial information, visit our website at http://defi.tech =======================

• 0:02Speaker 00

  What's up everyone, this is Anthony Pompliano. Most of you know me as Pomp. You're listening to the Pomp Podcast, simply the best podcast out there. Now let's kick this thing off. Darius Dale is the founder and CEO of 42 Macro, the leading macro risk management advisor. In this conversation, we talk about what's going on in the macro economy, what's happening in the financial markets, how Darius is looking at various metrics, and also what you at home should be thinking about as you invest your capital. I really enjoyed this conversation with Darius, and I hope you do as well. Before we get into this episode, though, I want to quickly talk about our sponsors. This episode is brought to you by BCB Group. With a dedicated focus on institutional payment services, BCB Group provides business banking, cryptocurrency, and foreign exchange market liquidity for many of the world's largest crypto-engaged financial institutions.

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• 2:57Speaker 01

  Anthony Pompliano runs Pomp Investments. All views of him and the guests on his podcast are solely their opinions and do not reflect the opinions of Pomp Investments. You should not treat any opinion expressed by Pomp or his guests as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of his personal opinion. This podcast is for informational purposes only.

• 3:20Speaker 00

  Darius, what's up, man? Lots going on, man. What's top of mind? Gas prices. We're at five bucks a gallon, national average, California, they may be at 10 already. At least they're trending that way. What is going on with gasoline prices and how do you kind of evaluate how high they could actually go? Well, they're gonna go, this is traditional of energy crises and we're very much in energy crisis. If you look at how we define it at 42 macro, whenever you have a trailing to your change of, a trailing to your doubling or more of the crude oil price or natural gas prices or gasoline prices, which we're very clearly observing that. And across all three of those markets, we tend to see that as an energy crisis.

• 4:01Speaker 00

  And the history of energy crisis is actually not very kind when you think about it from an economic perspective or how they end, because they typically end because these are very inelastic goods. You know, we typically, you know, will demand, we'll need them no matter what the high price is. Do you really start to cut off the tails of consumption? These things typically end when we start to sort of price people out of the market, unfortunately. So we're talking about low income families, middle income families. Just not being able to fill up the tanks. So there's been a lot of talk of price gouging. Uh, and then also there is talk of the equivalent of shrinkflation. There was a little controversy on the show earlier today. Uh, they're increasing the amount of ethanol in the gasoline.

• 4:43Speaker 00

  How do you think about the dilution of the gasoline, like the quality people are actually getting? And then how do you think about, uh, evaluating, are these gas stations or, or, uh, gasoline providers price gouging versus they're just responding to market dynamics? No, no, they're definitely responding to market dynamics. And if you look at a chart of crude oil prices outside of the, the grade that Russia ships, I think it's called Urals or whatever, uh, don't get me, don't quote me on that. But anyway, Brent prices are, you know, rocketing to the moon. WTI prices, which is what we produce here in the United States, rocketing to the moon. And oh, by the way, just for the folks who don't know, there's all these different grades of gas, of petroleum, of crude oil. Um, and one of the reasons, uh, you know, with the U S is, is I think the first of the large, second or first or second largest producer of energy in the world.

• 5:28Speaker 00

  But yet we're also still, I think, the first or second largest importer of energy in the world. And that's really just a function of, you know, our grade that we produce is very light. It's very sweet. I don't know who the hell's drinking crude oil to figure that out. But, um, it's very light. It's very sweet and we need to mix it with the much heavier sour grades of crude oil in order to put it in your, your car, fill up your gas tank for, for the engines to effectively work on an optimized basis. So when you start to think about, uh, gas prices, I immediately jumped to the fact that certain portion of people, uh, who have long commutes, who usually are lower income, uh, gas makes up a much, much higher percentage of their monthly expenses than, you know, some rich billionaire who, uh, it's, you know, nominal amount of what they spend on a month to month basis.

• 6:13Speaker 00

  Is that a perfect example of like, everyone experiences inflation differently? A hundred percent. Everyone experiences inflation differently. They experience financial tightening differently. And so when we talk about things like, you know, inflation pricing, pricing out, slowing consumer demand, it doesn't just hit like all in one month, or this is one monolith. It's a process whereby incrementally as prices can Continue to rise, we price and price more families out of from incremental consumption because again it takes up a greater share of wallet. So discretionary purchases and even some non discretionary purchases start to get curtailed at the margins. We're certainly already observing that.

• 6:51Speaker 00

  In the consumer spending data, when you look at um you know real PCE growth, it's somewhere we're tracking it around only 1.8% on a three month annualized basis. That's below trend. That's below our you know sort of potential growth rate that we've observed in the economy in the past kind of five or six years. Um you look at it on a goods, you know, goods consumption is basically zero. We've we're no longer growing from the perspective of consuming goods because again, energy prices, food prices, et cetera, are really pricing out discretionary purchases. And then even services consumption, you know, it is with a one handle on it at 1.8% through month annualized. That's telling you that very clearly the broader sectors of the economy, which is consumption, consumer is really starting to slow down and feel the impact of this stuff.

• 7:33Speaker 00

  And so to answer your question, yes, it impacts different families and different segments of the income cohort differently. But it's not just energy prices rising. Don't forget, we have this entity called the Federal Reserve that's hiking interest rates and draining liquidity from financial markets through quantitative tightening and through its reverse repo facility. And those that that financial tightening that we're observing in the equity market, rising equity risk premiums in the credit market, rising credit spreads. That doesn't hit companies all at the same time at the same time either. You're going to have bad companies or companies with, you know, very risky operating budgets or high fixed costs get hit sooner and harder in other companies. But ultimately, it's gonna gonna hit us all when you look at it on an aggregated basis.

• 8:13Speaker 00

  When you think about this, uh obviously there's core CPI and there's a CPI metric and they remove energy and food. Does that change how much weight of importance you put on either one of those metrics when you see gas prices exploding like this? Yeah, so let's start. The core CPI is just another name for that is convenience CPI for policymakers, right? Let's strip out the stuff that goes up the most whenever we have an inflationary episode. So we can make, you know, make it pretend like we're actually doing something without inflation or at least doing, uh it's not as bad as it it otherwise would be. Um but when you're talking about, so. Whenever you're trying to get financial markets right, you need to predict the things that the central bankers are looking at and will respond to.

• 8:54Speaker 00

  Irrespective of the fact that I, as a human being who fills up my gas tank and eats food, very clearly are experiencing the inflation and the shrinkflation that we're all kind of pissed off about. And again, this one thing about inflation, when inflation's high, it's the only thing you think about, it's the only thing you talk about. And obviously, we've been talking about inflation for quite some time on this program. And we'll continue to talk about it for some time on the program. But anyway, the point about core inflation, you always want to make sure that you're focused on the things that the central bankers are focused on, so that you can stay one to two steps ahead of positioning for the liquidity cycle dynamics that are important for financial markets. And with respect to core PCE, which is the Fed's preferred inflation metric, which basically strips out everything that you and I would consume on a consistent basis.

• 9:39Speaker 00

  I mean, it's a pretty, you know, we don't need to get on the index construction, but you know, that is running at about just shy of 5% at about 4.9% year-over-year. Now, obviously, you look around, that's a ridiculous statistic. House prices are up 20% year-over-year, you know, energy prices are up, let's call it 100%. You know, the food prices are up, you know, 50%, you know, that's obviously a ridiculous metric. But again, it's now starting to move in the right direction. So it's telling you that inflation momentum is really waning. But the key takeaway for investors is that the momentum may be waning, but the level is still dangerously high from the Federal Reserve, from the function, the perspective of the Federal Reserve reaction function. So we've got a chart here, it's the core goods CPI and disinflation.

• 10:24Speaker 00

  Explain what's going on here and why you think it's so important. Yeah, so this is, these two charts go together. This first one here is core goods. So tomorrow, for everyone not paying attention, we're going to get the May CPI report coming out of the US economy. And sort of part of the reason I put these charts together is there's sort of a developing consensus in the marketplace that inflation has peaked, it's rolled, and we're just kind of, now we're just getting closer and closer to the Fed finally, you know, giving up on policy tightening, et cetera, et cetera. We happen to have a very variant perception to that. We don't think the Fed's anywhere near giving up policy tightening. And in fact, when you look at the inflation dynamics themselves, which we'll talk about here in this chart,

• 11:05Speaker 00

  it's not so clear that inflation, yeah, maybe inflation's peaked on a year-over-year rate of change basis, but it's not so clear that we've, we're gonna see a significant disinflation, a deceleration in inflation in the coming months. And the reason I say that is because what if goods disinflation in core CPI in this chart, the, the, the, up the top panel just shows the index level of goods prices, core goods prices. So obviously, we've had a significant inflation in core goods prices. The middle panel shows the year-over-year percentage change in that, in that top panel. And the bottom panel shows the three-month annualized percentage change. So we're still, you know, very high on a year-over-year rate of change basis in the middle panel, but we basically ground to zero on a, on a sequential basis. And so it's telling you that,

• 11:46Speaker 00

  that disinflation in core good CPI, which is causing disinflation in core CPI and core PCE, has been the driving factor. But the next chart, uh, which is, uh, what if dot, dot, dot, is overpowered by accelerating core services prices. And to me, this is kind of the one thing that I don't think the average investor is paying attention to, which is the potentiality for the disinflation in core goods to get overwhelmed by the acceleration in, in core services. Same analysis, the top chart just shows the index level of core services. Uh, the, the, the middle panel shows the year-over-year rate of change. And the third panel shows the three-month annualized rate of change at around, you know, seven and a half percent. You know, we're expelling momentum to the upside in core services prices. And oh, by the way, services

• 12:30Speaker 00

  is a much larger segment of the, of the economy. It's about two-thirds of the economy, or two-thirds of consumption, sorry, sorry, seventy-five percent of consumption, two-thirds of the overall economy. And so, you know, if we continue to see this type of acceleration in services prices, which we should, based on house price dynamics and shelter price dynamics, it's very likely that inflation stops improving, i.e. disinflating and decelerating in the summer months, and we might actually get a pickup in inflation, which will cause the Fed to get incrementally more hawkish and markets to go down as a function of that. So off, off of that point, you also have a chart here that says people may actually be misunderstanding or misinterpreting the Fed. Fed's resolve, which is a pretty big point. Explain this. Yeah, so this chart shows the blue line in these charts. So just focus on the upper panel.

• 13:16Speaker 00

  The blue line shows the what the what the market is implied or is pricing in in terms of incremental Fed Fund rate changes. Over the next month, this is looking at overnight index swap for contracts. The red line shows what the market is pricing in in terms of Fed Fund rate hikes over the next two years. The black line just shows the actual level of the of the one year forward contract. And as we can see, you know, basically since early May, we've seen this this sort of, you know, the market in pricing in incremental hawkish policy up is hawkish, down is dovish. Incremental hawkish policy kind of peaked in early May. And it's function, it really was a function of, hey, we got the slowdown of the observed slowdown and year over year rate of change and

• 13:56Speaker 00

  headline CPI and year over year rate of change in core PCE. So the market's like, oh, let me take a break, take a breather. Everything's done. The Fed's done. You know, everyone sort of got ahead of themselves and saying this is a Federal Reserve that is going to be very quick in terms of this this policy, this reduction in liquidity that it's that it's that it's enacting right now. And to me, I think the market may be underestimating their willingness to stay tight, to stay hawkish, to do incremental rate hikes, to do incremental QT, to be incrementally tight with respect to its reserve's repo facility as a function of everything I just said about the, you know, the evolving inflation dynamics. If inflation starts misbehaving, may misbehave tomorrow with the CPI print, may misbehave on the 30th with the core PC print.

• 14:39Speaker 00

  Or it may just misbehave in the months ahead as energy and food prices continue to go higher. If those things, if the inflation misbehaves, we're going to see incrementally hawkish policy priced into Fed Fund rate expectations and into market valuations as a function of incrementally hawkish expectations on QT. So you also have a chart that says bear markets are common. Don't freak out, which I think is like a fantastic title. There are business cycles and when you get good times, at some point you're going to get bad times. Talk us through this. And give us some historical context here. Yeah, so this, great, great. I'm so glad we brought this up. And so to me, it's like, you know, you guys are used to this in crypto, like their markets in crypto like every six weeks.

• 15:24Speaker 00

  So, but I think that, you know, kind of the average investor who's, you know, you guys are obviously crypto oriented, but there's a lot of investors, particularly on the equity side, you know, have been used to, you know, this post crisis era of low interest rates, perpetual quantitative easing, Fed put no lower than 20% down on the S and P. And the reality is that's very inconsistent with with economic and market history. This chart, bear markets economy, don't freak out, just shows the 100 year chart of the S and P, showing a trailing one year realized volatility in the S and P in the bottom panel just shows the the drawdowns from the, from the, from, from, from the highs, whenever you go into these, these bear markets. And the reality is, you know, if you look at the far bottom right of the chart, and then you kind of scan your eyes back left in that, that bottom panel, you realize like,

• 16:09Speaker 00

  man, we've been living in a very anomalous time relative to the last 100 years of history in terms of both not only seeing significant bear markets, the frequency of bear markets, and also the frequency and significance of recessions. You know, we've had a very interventionist Fed throughout basically my entire career. You know, I started in the business in 2009, you know, and really since then, the Fed has been perpetually interventionist. Well, now that inflation is at a significantly higher, you know, it's orders of magnitude higher than their target, they are not allowed to be interventionist. And so no matter how bad things get this summer, this fall and into, into the winter, and maybe even into next year, they're not going to be able to bail you out unless inflation behaves. And what I'm talking about inflation is suggesting that it may not behave.

• 16:54Speaker 00

  And so we have to get used to the fact that this is what business cycles dictate. This is what human emotion, fear and greed dictate. And this is ultimately just, this is a, is a natural. Cyclical process that we shouldn't be afraid of. So really what this is showing is that there used to be way more frequency to the bear markets and much more severity to bear markets. And now, all of a sudden, we actually are in some way fortunate or privileged in that there aren't as many bear markets. And they're nowhere near as severe as they used to be. And your analysis is that the Federal Reserve's willingness to step into the market and manipulate interest rates and conduct quantitative easing, etc. Has actually allowed for what I think maybe is one of their goals, although it's not a stated goal,

• 17:37Speaker 00

  of keeping asset prices continuing to go up and to the right. The problem then becomes, I guess, we just get no cleaning out of bad capital allocation. We get no reallocation of resources from bad companies to good companies. And it kind of just allows for the proliferation of like zombie companies in some way, right? Yeah, not only, Pop, that was such a brilliant synopsis. It's not just the proliferation of zombie companies. It's also the growth of these gigantic moats around the good companies, right? It's just harder to be, have a dynamic economy like we used to have in the 90s. When you basically have a Fed that is preventing the business cycle.

• 18:19Speaker 00

  They're preventing a drawdown in capital and capital reallocation, which is a natural function of a capitalist society, right? They're basically trying to eradicate that function in society and replace it with, you know, perpetual intervention. And they've been able to do that fairly successfully. You know, I'm not saying that the outcome is successful for everybody in the country. But in terms of what their stated objective was, which is to smooth the business cycle and remove volatility from financial markets. They've done a fantastic job of that relative to, you know, 100 years of economic history. The problem is when inflation is really high and 350-plus million Americans are pissed off about inflation. And they're calling their local politician, they're calling the president, they're calling Jay Powell. They're at the Fed meeting, they're, you know, Jay Powell's addressing, you know, everybody directly at the Fed meetings now.

• 19:04Speaker 00

  You know, it tells you that this interventionist Fed that we're also used to and part of the reason why we got to 4,800 on the S and P or, you know. Sixty nine thousand in Bitcoin. Interventionist Fed was very much a part of those prices. And now we're not going to have interventionist Fed, in our opinion, for at least a few quarters, if if not potentially longer, if inflation continues to misbehave. Talk a little bit more about the Fed being so willing to intervene, how it creates these moats around the great companies. Obviously, if you look at the S and P five hundred, there's much more concentration in, you know, just a couple of the top companies. Is that related to the Fed's activities? Hundred percent. So it it the reason it's related to Fed activities is because if you're a large established company that's already generating cash flows,

• 19:46Speaker 00

  you have the ability to to raise debt at a significantly lower price than the rest of the world. And so the cost of debt financing, and as a function of this, the cost of equity financing for established companies has been lower and lower and lower to structurally all time low levels, all time tight credit spreads, you know, all time low levels of equity risk premium. You know, in this in this post crisis era, and it's allowed companies like Instagram to buy fate to buy, you know, sorry, Facebook to buy Instagram. It's allowed basically Google to buy pretty much every company that every supplier that had ever, you know, the business with. Um, you know, there's, you know, you go down the list in terms of the consolidation we've seen in industries. I mean, damn, what business has an Amazon taken over yet? You know what I mean? Like, Amazon used to sell books.

• 20:28Speaker 00

  Now Amazon sells basically everything at the highest level in the world. And the only reason they were able to do that is because investors were constantly being forced to reach for yield in Amazon debt, in Amazon stock, because there was no real alternative from a from a from a, you know, safety of asset perspective. You couldn't get money in your bank account. The Federal Reserve, the Treasury market didn't have a legitimate real interest rate. That was of substance of consequence that would cause you to not speculate in things like Amazon, et cetera, et cetera. So you have companies like Amazon, Uber, Tesla, Netflix, all these companies that basically used your money to grow and burn free cash flow for years in order. To gain the market share that they've gained, that process stops when interest rates go up and there's a legitimate,

• 21:12Speaker 00

  you know, real interest rate in the economy to to to park your money into on the short end of the curve. So you've got another chart here. FOMO is even more common. Don't blow yourself up and it's from two thousand or two thousand and two. I mean, great titles today.

• 21:25Speaker 00

  So so in the this, uh, this is from our our most recent, uh, macro scouting report. We put out this presentation every every every month. And kind of one of the key discussions I've been having with investors is kind of like the summary of all the the conversations I'm having with our clients. Throughout the month, like, okay, let me hear it. Let me answer all the key questions. And one of the key questions is like, was that the bottom? Was May the bottom? Was May the bottom? Was May twelfth the bottom? Bitcoin was made twenty at the bottom in in stock market. You know, I don't know the answer to that. I don't think it was the bottom. In fact, the compared to, you know, the preponderance of our research says the bottom is significantly lower. Um, and one thing I would just call out with that chart, you know, bring that chart back up. You know, when you, we've been looking at two thousand or two thousand and two as a very important sort of market analog to this current setup.

• 22:10Speaker 00

  Um, you know, you think about the sort of lack of leverage cycle risk of credit cycle risk in the economy. You know, if we do get a recession in this particular interval, it'll be very mild. It'll be very, you know, sort of inventory cycle driven, which is very different than a more financialized financial crisis type recession. Um, so it's a very similar setup, uh, very similar setup from a market or valuation perspective. Very similar setup from the perspective of the amount of household, uh, net worth is being allocated to the equity market. So I see a lot of the same corollaries. So I wanted to use this as an analog. Say, hey, the equity market got cut in half in this, you know, basically in a span of, let's call it two and a half, three years, um, in this timeframe.

• 22:50Speaker 00

  And throughout that process of getting cut in half, you had seven, eight very significant bear market rallies. Throughout that process, you know, several of them were, you know, orders, you know, fifteen, twenty percent off the local lows. But the reality is in the green arrow in this chart, if you zoom in and that, um, the green arrow is the third bear market rally. Uh, in this process, in this, this, you know, minus fifty percent process. And right now we're currently in the third bear market rally for the S. And a lot of other risk assets and at least looking at this historical analog market was down another, let's call it 40% from the highs of that third bear market rally. So the point I want to make is don't blow yourself up going all in too soon. Because it's not the bear market that gets you that blows you up.

• 23:34Speaker 00

  It's the going all in too soon that blows you up because you wind up losing a significantly larger chunk of your money in the ensuing downturn. So when you start to think about not getting blown up, obviously, there's this idea that diversification protects wealth, concentration builds it. How do you think about people navigating back and forth between diversification and concentration? Is it a fluid type thing? Is it something where they should always be positioned a certain way from an asset allocation and just that provides, you know, capture of the good times and protection in the bad times? Like, how do you think about investors navigating these types of business cycles? Yeah, so I think you had a great tweet the other day. It was like the person with the lowest time preference wins.

• 24:17Speaker 00

  And I think concentration, you can afford to be concentrated as an investor if you have a very low time preference. And you know, it's concentration, it's fine. You don't need the money. So you can suffer the volatility, the drawdowns because you don't need the money. The reality is the vast majority of people, even if they don't need the money, are going to be emotionally affected. You know, you know, just financially affected by changes in their overall portfolio. And so the reality is most people don't have as low as a time preference as they would like to admit. You know, this is proven behavioral has been many of, you know, Nobel Prize winning very real studies on this kind of stuff. So I take my word for it. Take Danny Kahneman's word for it. Don't take my word for it. I'm not a Nobel Prize winner. But anyways, my point is, is when you talk about the the scale between diversification and concentration,

• 25:01Speaker 00

  the more diversified you are, the more likely it is that your portfolio has lower volatility. And if you want the most, I think the ideal outcome for everybody would be a low volatility, you know, high sharp, low, high shortrentino ratio. That means, you know, you're returning excess relative to drawdowns. You want to basically align that goes up, you know, over time that doesn't change very much and goes up a very high. That's impossible. It's very hard to do. Obviously, we can do that. We now you and I wouldn't be talking to other people on podcasts. It'd be counting money on a boat. Uh, but maybe we maybe we wind up counting money on a boat, but that's neither or nor there. My, my point is when you talk about diversification concentration, it's a personal choice.

• 25:43Speaker 00

  You need to understand your own risk parameters, your own time preference. And if you can suffer, if you're the kind of person that can suffer a twenty, thirty, forty percent drawdown of your capital, then that's fine. Go be divert, go be concentrated in whatever you think your best idea is. But if you're like ninety-five percent of us and you cannot do that, then you do need to have a little bit more diversification and not just in diversified assets, because a lot of assets are correlated, but you also want to have diversification across time horizons. You, you want to have diversification across themes. Like it's not all just one big, you know, deviation or derivations of the same bet. You know, I see a lot of investor portfolios when we get new clients and we sort of walk through this process. You know, they'll be like, well, I'm diversified because I'm long Nvidia, Apple, Netflix and, and Google.

• 26:27Speaker 00

  And like, those are all the same factor risk, right? It's all the same trade. You know, that then, so that's what I mean by, you know, being aware of the kinds of diversification you're actually making and whether or not you actually are diversified. When you start to think about the Federal Reserve, uh, moving forward here, um, it seems like they are going to continue doing exactly what they've been doing. Which is they are going through the end of this year. They remain committed to increasing interest rates. They remain committed to the quantitative tightening. We're now a little bit into the quantitative tightening. Is there anything that's happening there that would suggest they may change or reverse course? Or so far, exactly what we would expect to happen is happening.

• 27:08Speaker 00

  No, man, we, we do. We're just getting started, dude. Like, like technically speaking, and it's already, we, we were already like two days into quantitative tightening because it started on Tuesday. There was an auction. I think a forty billion treasury securities and, and normally the Fed would be taking that down revert, you know, investing its full fifteen billion dollar maturity next week into that. Uh, but they only did like, you know, five or six billion into that. So we've already basically lost, we've already done like ten billion dollars with the quantitative tightening. Since Tuesday. And so, you know, and again, it won't be like, you know, linearly throughout the month and won't be linearly throughout any, any particular month. But my point is, we are so early in this process.

• 27:47Speaker 00

  I mean, you look at, you know, they're going to do forty five billion in QT in the first three months and then ramp that up to ninety five billion in, in the, you know, in the ensuing months. And one, forty five billion is as big as they've ever done in history. And they're getting started with that in this month here, and they're going to double that in three months. And so when you look at, when you look at our math, and this is, you know, I'm not trying to make a headline here, but I think this is very important to take to, to, to write home with, to end the show on. When you add up the expected change in, in, in quantitative tightening between now and year end, and then you, you also overlay that with our analysis in terms of the likely change in the reverse repo balance.

• 28:25Speaker 00

  Between now and year end, i.e. somewhere around four, an additional four hundred billion dollars of liquidity being trapped in, on the reverse repo facility. You're talking about over nine hundred billion dollars of liquidity being drained from global financial markets just because of the Federal Reserve's actions between now and year end. That nine hundred billion dollars is greater than the entire sum of the prior quantitative tightening program from two thousand seventeen to two thousand nineteen. So that's twenty one months, they drain eight hundred and fifty billion dollars. We're going to try to drain nine hundred billion dollars in seven months. And I, I just don't think that's a, that's a, that's, that's going to be a bumpy ride. And when you think about that, what would be the thing that you think investors should watch for?

• 29:05Speaker 00

  Like, what, what are the, the milestones, the markers, the waypoints on that journey that, that you're like, yeah, this is the stuff I'd be paying attention to aggressively? Yeah. So, uh, so there's a couple of things. Uh, so we're, we're, at least according to our models, and again, our models could be wrong like anyone's, but at least according to our models, we are, we're projecting a sharper deceleration in growth in the coming months, particularly starting in July, you know, persisting through the back end of the year. So I'd like to see the growth data start to actually confirm that. Um, I'd like to see how interest rates respond to the confluence of a sharper deceleration in growth, yet obviously a significant reduction in liquidity in the bond market.

• 29:46Speaker 00

  I would like to see how that, you know, I don't know the answer to this. I expect bonds to rally, bond yields to go down. Um, once the growth starts to really pick up to the downside, but there's no guarantee, just given a lot of the sort of liquidity dynamics in the marketplace. And so I want to be, I, I want to observe like how bonds are reacting in that particular moment. Because that'll have a pretty significant signal, um, as it relates to investor willingness to speculate in things like, you know, the, the tech stocks relative to value stocks or, you know, digital assets relative to real assets, you know, stuff like that. So that, that, that may start to influence a change in leadership in the market, although I'm not so sure that, uh, risk assets will bottom until that, that process is, is closer to concluding than closer to the beginning.

• 30:29Speaker 00

  Yeah. What are the institutions doing that may be different than retail investors right now? Is there anything that, uh, retail could be looking at and saying, oh, institutions are doing this, that's surprising or, or different than maybe what retail thinks? Yeah. So the, I would break in institutions into two sort of camps, right? There's the camp of institutions that is a little bit more slow moving. And those folks are looking around and trying to find that like value and trying to buy dips in, in their favorite names and their favorite long-term names. And then there's a sort of faster moving institutions, you know, the sort of hedge fund type community. Um, those folks are, are, have largely taken their ball and gone home. They, you know, they, they're bracing for impact, um, because, you know, they, they, I think they see the writing on the wall as it relates to, hey, we didn't get it, we got here because of aggressive monetary easing.

• 31:13Speaker 00

  Now we're about to have aggressive monetary tightening. And so the, your central case, your base case scenario should be an unwind of everything we just saw. Right? And I don't think that the average person realizes how, you know, how that mirror works. Uh, but you know, so institutions are certainly, uh, bracing for impact. Um, and, and, and one final thing that institutions do, generally speaking, then I think in retail investors do poorly. Um, generally speaking is, is again, having this sort of concentration of views in one singular bet. You know, they think you might have 10 positions on, but there are 10 highly correlated positions. And more importantly, not just correlated in terms of the price movement and volatility, but also correlated in terms of the catalyst you need to get those positions to work. And one thing institutions do that is, I think, a, a retail investor should adopt.

• 31:57Speaker 00

  Is understanding how to separate your portfolio into different themes, into different core themes. That way you're, you know, you can have, you know, something like, hey, we're long China and China's working, but it's separate from our negative view on the NASDAQ and things like that as opposed to like, I'm just, you know, short the NASDAQ, short China, short Germany, short everything else. And it's all one basically big trade. So I just wanted, you know, just from a, from a, from a risk management standpoint, I think it's very important for everyone to look at what you own, even if it's all crypto, if it's all digital assets. Are they tokens or are they stores of value? If you're, if you're all in tokens, then you probably got a problem because you're going to be levered to, you know, whatever dynamics are influencing that market at any given time. And so again, it's just, just understand the kind of bets you're making and how correlated they are and how diversified you may be or may not be.

• 32:42Speaker 00

  Yeah. When, when you start thinking about fixed income, obviously pensions, endowments, uh, many of these large institutions, they have immense exposure, uh, to the fixed income market, uh, sometimes 70 plus percent. Uh, obviously on a real return basis. So that, those have been doing so hot. Uh, and it feels like, um, you know, Worst year ever. Yeah. If you look at something like CalPERS, you know, towards the end of last year, uh, they started to push further into alternatives. They started to actually add in some leverage into some of their investments. And it feels like, uh, the slower moving, more conservative organizations right near the top, started to take on more risk, which in hindsight probably was like, uh, a pretty obvious sign of, um, you know, good times.

• 33:25Speaker 00

  Uh, what is the ramifications of that stuff? As they pushed further out on the risk curve, added more alternatives, took on leverage, like what do those institutions do now? Do they try to unwind it or do they basically just plow ahead and say, look, we got to last for 18 months, 24 months, but you know, we'll get back to good times and, and let's not, uh, become, you know, very, uh, uh, volatile in our strategy changes. No. So this, this thing called myopic loss aversion that, that investors, uh, struggle with in financial markets is one of the behavioral heuristics of investing. And so the reality is when you make a big asset allocation pivot like that, and don't forget like CalPERS is like the slow moving of the slow moving, like they need to have a, a committee meeting to decide whether to have a committee meeting, you know, that's the

• 34:06Speaker 00

  Kind of organization that this is. And so whenever they make a decision like that, they're not reversing course anytime soon. And, you know, so the reality is they're probably going to be the last people to have to sell out of whatever the hill they bought. At the highs in January of 2022, at some point later down the road in this process, assuming we're right, I mean, we can obviously be very wrong on all this, but. I I'm not going to bet. I'm not, I'm not smart enough to bet against $900 billion of QT.

• 34:34Speaker 00

  I'm certainly not smart enough to bet against $900 billion of QE, so why would I do it in reverse? Yeah, it's um, it's fascinating to me that, you know, the the human emotion, all of the lessons of history are playing out here. Uh, once again, um, when we look at the Fed, uh, they obviously have one. Point in time where a lot of people are pointing to, which was Volcker and high interest rates. Do you think that, uh, they are looking at those situations and and aspirationally saying, hey, look, let's go. Uh, replicate what happened there, or do you think they more so just look at it, you know, as one point in history among many? Uh, they're aware of it, but but there's less aspirational, uh, uh, you know.

• 35:19Speaker 00

  Interest in like replicating times where, you know, we look at Paul Volcker now, and I think a lot of people say, hey, that was pretty courageous. Like, how do you see history playing into the Fed's decisions? So, great question. So I think we talked about this before, which is the Fed is fighting two wars right now. On one hand, they have to get inflation back under control. But on the other hand, they have to regain their credibility on the associated with them getting the inflation call very wrong last year. And a lot of people are are really struggling as a function of them getting that call very wrong last year. They should have been tightening in March of 2021. I mean, it's pretty clear that you were going to have an inflation cycled in, um, as if you look at the fiscal policy dynamics. But but that's neither nor there. My my point is when you, when when Jay Powell sort of elicits.

• 36:04Speaker 00

  You know, the imagery associated with Paul Volcker, I think what he's trying to do is say, hey, look, I got this thing wrong, but I, I, I, look, trust me, I got, I have an archetype, I have a blueprint of, of unwinding this mistake that I made. And I think it speaks more to the, to the behavioral side of the equation than it does to the just their mandate of stable prices. Right. And so ultimately, what I really think it wants to happen, Jay Powell doesn't want to retire as the guy who let the inflation genie out of the bottle, right? He doesn't want to be the Arthur Burns. Arthur Burns was the Fed chair prior to Paul Volcker, who was constantly being cajoled by, uh, it was Nixon, it was, it was, uh, Jimmy Carter, constantly cajoeling him to keep monetary policy very easy throughout the seventies, you know, you know, even though we

• 36:48Speaker 00

  had very high inflation then, and that was an issue. Um, and so Jay, uh, Jay Powell does not want to be Arthur Burns. That's why he keeps listening to this image of Paul Volcker. Yeah. And then lastly, I guess, is, uh, price controls. Uh, even just this morning, President Biden talking about calling on Congress to crack down on companies, raising, uh, shipping prices by a thousand percent. We've seen other politicians talking about grocery stores are price gouging gasoline. Uh, there's price gouging going on. Uh, obviously in countries like Argentina, you get really high inflation, you get ignore, uh, ignorance of the problem, then you get, uh, transitory type, you know, uh, labeling, then you get the story of like,

• 37:30Speaker 00

  it's good for you. And then eventually you get blaming of corporations and price controls. Do you expect that to happen in the United States as well? I mean, I don't expect it to happen because we're going to have gridlock in Congress in an election year. But if it does happen, it's only going to prolong the inflation problem, right? What you're doing with price controls is you're, you're capping the right tail of inflation in the near term by and, and replace and just pushing it out to the further term. Because what, what happens when you have price controls is you have a reduction in aggregate supply, you know, whatever industry or whatever product that you put a price control in, you're going to reduce the amount of supply, right? Like if I sell research and the government tells me that my research has to be half off from now, well, guess what? I'm probably only going to work half the amount of time.

• 38:13Speaker 00

  I'm gonna put out half the amount of research. I'm not gonna put out the same amount of research if the government tells me I could charge only 50% of the price. And so you think about it from that perspective, you multiply that across the economy, price controls have been proven. I mean, even the the wonkiest of the wonky academics at the Fed and and other these other intergovernmental organizations. They all understand that price controls is a very, very dangerous thing to deal with because it's sort of, you know, we get short term relief for guaranteed long term pain, which I think is really counter to the Fed's inflation mandate. Yeah. Where can we send people to to find you on the internet? This this fantastic. I literally could talk to you for hours and hours about this shit, but where can we send you?

• 38:52Speaker 00

  Me too, man. No, this is good stuff, man. Absolutely. We'll have to have an event where we just get drunk and rant about politics and economics. Next, next year in Miami. So 42 macro. So we produce research for, I'd like to think for everybody. I think if if you've learned anything in the last six months is that macro matters and you can't just be endemic to whatever asset class you're trading. In fact, I got a great question on Twitter from somebody that said, hey, you know, do you do you put out research like a hundred? You should put out a new report that's just for crypto. And I go, we have clients that do just equities. We have clients that do just fixed income. We have clients that do just currencies. We have clients that do just private equity and venture capital. Why would I put out a macro product for just crypto?

• 39:36Speaker 00

  Our crypto people are immune to Federal Reserve policy changes or significant slowdowns in growth or, you know, lockdowns in China? No, we're all part of the same macro cycle together. So what we're doing at 42 macro is trying to help everyone navigate all these different changes with our data driven process. So come check us out. If you don't, then come find me on Twitter at 42macro. Awesome, man. Listen, thank you so much for for coming on every Thursday. I learn something every single time and we'll do it again next Thursday. Yeah, man. Keep keep flying the flag, man. You're doing a great service for a lot of people, but I appreciate you. Sounds good. Talk soon. Cheers, brother. Thanks so much for listening to today's episode. I really hope you guys enjoyed this one. Make sure you subscribe on Apple, Spotify, or your favorite podcast player. And if you're looking to try to transition to get a new job in the Bitcoin or crypto industry,

• 40:21Speaker 00

  we've got you covered. Head over to pompscryptocourse.com. We've developed a curriculum with the top teams across the industry. It's a three-week intensive training program with over 50 events packed into that three-week time period. Go to pompscryptocourse.com to learn more, and I'll meet you guys for the next episode.