October 23, 2025 • 46 mins
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.
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Episode Transcript
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Speaker 1 (00:02):
Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2 (00:18):
Hello and welcome to another episode of the Authoughts podcast.
I'm Tracy Alloway.
Speaker 3 (00:22):
And I'm Joe Wisenthal.
Speaker 2 (00:23):
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 US dollar, which has been this sort of slow
burned crash across the year. And we're recording this. Let's
(00:44):
see October seventeenth, and you know, dollar down yet again.
Speaker 3 (00:48):
Well it is down, but however there's been a little
you know, we hit hiss low in mid September.
Speaker 2 (00:53):
Don't make apologies for the dollar, Joe.
Speaker 3 (00:56):
You know, I just like keep going, all right, keep going.
Then I might add something fall in the dollar. The
fall in the doll is very big.
Speaker 4 (01:05):
So far.
Speaker 2 (01:06):
There's here 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
(01:28):
form of its currency.
Speaker 3 (01:29):
You know what I really regret doing tracing. I really regret.
Speaker 2 (01:34):
Did you have like a horde of gold that you
got rid.
Speaker 3 (01:36):
Of over I took out a gold denominated mortgage. You know,
I feel so stupid. I feel so stupid. Why did
I do that? I could get paid in dollars and
I took out a gold denominated mortgage. What was I thinking?
Speaker 4 (01:47):
No?
Speaker 3 (01:47):
I didn't, But had I done, that would have been
a very bad trade.
Speaker 2 (01:50):
Yes, I remember those stories.
Speaker 3 (01:52):
From like, you know, a little bit of a tangent,
remember all those stories from like the Hungarians they took
out those Swiss denominated mortgage back of the two thousands.
Speaker 2 (02:01):
And that was very much a europe thing for a while.
Speaker 3 (02:04):
Yeah, that was a really funny list. 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
(02:25):
for this year are turning a little bit. And I
say that tenure treasury is the time we're recording this
October seventeenth has fallen below four percent. 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.
So it is a very interesting moment from markets in
(02:48):
many respects right now.
Speaker 2 (02:49):
There's definitely a lot to talk about. Congrats on managing
your personal FX liability.
Speaker 3 (02:54):
I'm doing a good job.
Speaker 2 (02:57):
Getting paid in dollars and paying your mortgage dollars. Well
done show, 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 when we talk about
these big trends, And.
Speaker 3 (03:14):
Who is the one person that is always in town
Because 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.
Speaker 2 (03:23):
Same time, 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 run into 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 Hun Sunction.
He is the economic Advisor and head of the Monetary
(03:45):
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 Hun, thank you so
much for coming back on our thoughts.
Speaker 4 (04:00):
Thank you Tracy, thank you Joe. It's great to be back.
Speaker 2 (04:03):
Since Joe doubts my entire premise.
Speaker 3 (04:05):
For this episode, the entire premise at all.
Speaker 2 (04:08):
Now, 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
(04:30):
safe haven of the green back 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 Well, it.
Speaker 4 (04:41):
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, yeah, falling in unison.
And that's very unusual because in a risk off episode,
you know, which April was, typically the dollar would rally.
(05:04):
You know, there'll be a kind of safe have and 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 have the data, we can piece together
(05:27):
in a more kind of coherent way what was going on.
And in short, I think it was a kind of
hedging story where investors who had lots of exposures to
the US dollar, we're trying to reduce some of those exposures.
And we can get into some of the details and
(05:47):
how you know, 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 f X markets,
and we've just published the results, and I think we
can also shed some more light on the events in April.
Speaker 3 (06:08):
Let's keep it big pictures still, and then we'll drive
down into specific months and weeks. What people work for
the BIS, they prey must take out mortgages and Swiss
Frank there living there in bars anyway, sidetrack, what are
some of the big takeaways from this year service?
Speaker 4 (06:23):
Yeah, yeah, so I think well, actually before we go there, Joe,
I mean, it's worth you know, thinking about how FX
market is really a figure in the investment strategy. So
you know, 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 you know, local euros beneficiaries in euros,
(06:47):
but you have a very large balance sheet and so
you need to have a very broad exposure to global assets,
you know, 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 in dollar assets.
But of course what you want to do is to
(07:08):
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
and then with those dollars then go into dollar denominated assets.
(07:30):
And as you do that, you also promise to unwind
that transaction at a known exchange rate that affixed 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,
(07:54):
on you know, how high the hedging costs are. 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 know, you're borrowing dollars in order
to invest in dollar assets. So when the short term
interest rate is very high, that's typically a time when
(08:16):
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 you know, trending down.
And you know to the extent that some investors you know,
didn't hedge at all, And why would you if the
dollar is surging and the hedging cost is so large.
(08:38):
And so when the turbulence broke earlier in the year,
a lot of investors were basically caught with very large
dollar exposures, you know, having not hedged. And I think
one piece of evidence that you know this was that
the events of April was very much an expost hedging story,
(09:00):
you know, hedging after the fact was that, you know,
we saw a lot of the telltale signs of swaps
being taken out and dollars being sold happening in the market.
So what would happen is, you know, if an investor
is holding dollar assets, you know, without a hedge, but
you're concerned about the dollar falling, then what you would
(09:21):
do is you would put on a hedge X 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 so rather than investing those dollars
into dollar assets, you simply sell it in the spot market.
What that kind of dynamics would would imply is that
(09:43):
there would be you know, lots of downward pressure in
those situations where institutional investors are trying to you know,
raise their head ratios. But expost So back to the triannual,
what do we see there that to you know, puts
additional light on this episode. By the way, on the triangle,
(10:04):
you know this, it's just so happens that the sampling
period was April this year, amazing, so you know, it
may be slightly distorted by the events of you know,
the April episode. On the other hand, the silver lining
is that we have some great data on really the
you know, the events of the of the April episode.
(10:24):
But the headline numbers are really quite you know, 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
(10:48):
than what we saw in twenty two so you know,
in spite of the survey being affected perhaps by these
you know, stress events in April, you know, we think
we've got a very very very good sort of take.
One of the things that we noticed this year is,
of course, you know, as well as the FFX swaps,
which is by far the largest segment of the of
(11:09):
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. You know,
when you engage in US in an effect swap, you know,
the investor with borrow dollars by pledging euros, and then
(11:31):
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 deal and say, look, you know, just
sell me a outright forward so called, and then I
would actually then have a dollar obligation.
Speaker 3 (11:50):
A swap is like a spark trade plusure forward exactly.
Speaker 4 (11:53):
Okay, it's that combination. 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
(12:14):
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 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.
Speaker 3 (12:35):
Interesting.
Speaker 4 (12:35):
So this is another piece of the evidence that this
was very much exposed 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 gather. But
it's also notable that if you look at the actual
portfolio flow numbers, the international portfolio flow numbers, there was
(12:57):
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 was 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,
(13:18):
you know, was not the story behind the eight episode.
Speaker 2 (13:36):
Why should we care, either qualitatively or quantitatively if this
was a hedge America story and not a sell America's
story outright.
Speaker 4 (13:45):
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 you know, translated into actions. But
I think what you know does flow very you know
(14:06):
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 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. So actually, you know,
(14:29):
be part of that ecosystem. So if you have this
kind of need network effect, it's very difficult to have
this whole sale shift away.
Speaker 3 (14:38):
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 it can come up
with a long list of reasons to be concerned, which
we don't need to come down recapitulate now. On the
other hand, the most affitable, impressive, cutting edge companies in
(15:02):
the world that everyone would love to have exposure to
in some way or in the US. And it strikes
me is 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 in
Video and Microsoft and all of these companies that are
(15:24):
making money hand over fist without having exposure to the
US itself, And hence I might want to hedge.
Speaker 4 (15:32):
I mean, certainly, you know the equity market story, I
mean that really isn't 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, that 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
(15:54):
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 currencies. And you know, money is ultimately something
(16:18):
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 service of making money fungible across currencies.
So you know, every piece fits into every other piece
(16:40):
in that sense. And so you know, we should think
about this in terms of the mutually reinforcing pieces of
this you know, this network.
Speaker 2 (16:51):
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 x
post as you described. Did that mean that the cost
(17:11):
of actually doing so actually increased or was it still
relatively cheap?
Speaker 4 (17:16):
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
(17:38):
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 asset itself. And so if you have
a flat yield curve, you know, which is what we've had,
or even inverted yel curve, then hedging costs are very high.
And so in fact, you know, investors have typically hedged,
and hedge ratios have fluctuated. There's no system matter survey,
(18:01):
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,
(18:22):
they were trying to win both on the stronger dollar,
but also on the high yields. Yeah, actually they just
meant mentioned 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 DOT assets with the story
(18:43):
about local currency emerging market bonds. You know, that's actually
a very very you know, important asset class 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 in to a large emerging market sovereign BONDERNT trade,
you would actually buy the instrument on an unheedge basis.
(19:08):
And you do that because you know, you think the
emerging market currency will appreciate as well as the YEL
four 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 know scramble to you know hedge ex
post and that's exactly you know the same type of
(19:30):
thing that we 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 a
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
(19:51):
April and the much older trade, which is the emerging
market trade.
Speaker 2 (19:56):
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 allow emerging market.
Speaker 5 (20:08):
Pond were like, I think I'm going to buy some
local currency US day. That's right, actually, but like, so
what was it about April then that caused the like
what I mean, we know there was yeah, the Launcher
trade war and there were like massive tariffs, et cetera.
But like, what was it about that such that people's
(20:28):
impulses to hedge more expost factor as you've described it.
What was the thing they 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.
Speaker 4 (20:42):
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 twenty
three for where let's say life insurance companies announce that
(21:05):
they will not be hedging, you know there, 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 of environment, what typically happens that you
want to take some chips off the table, and that
just means reducing your exposure. Yeah, and if you're exposed,
(21:29):
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 expost hedging story.
Speaker 2 (21:43):
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, mismatch to a longer term asset. I mean,
(22:07):
this is this is what the BIS does on a
day to day basis, is worry about potential risks so
are you worried here?
Speaker 4 (22:14):
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
(22:36):
short term liability that you need to roll over, and
from time to time you might get caught in a
liquidity you know, stress episode where it's difficult to source
the dollars to actually repay. And this was, for example,
what happened during the GFC. It's also what happened during
March twenty twenty when there was also a scramble for dollars.
(23:00):
And you know, when you're a long term investor, you've
hedged using a short term effect 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 assess which is going to be very difficult
at a fair price, or you have to join the
(23:21):
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. And so
you know we are swapping one well, we are actually
you know, exchanging one type of risk for another. We're
actually changing currency mismatch for maturity mismatch. And you know, empirically,
(23:47):
if you look at the evidence over the years, it's
when the dollar is falling for a long period of
time that these head ratios become very, very high. So
you know, a good example is the period before the
GFC when a dollar was you know, really falling, you know,
quite considerably. But then what happened at the GFC was
(24:08):
of course in a dollar really spiked because there was
a scramble for dollars. So you know, there's always this
trade off. You either have to beart some currency risk
or you bear this maturity risk, and then the bear
this maturity mismatch risk, I should say, and and so
we you know, it's really you know, changing one type
(24:30):
of risk or another.
Speaker 3 (24:47):
Tracy really loves currency markets because she loves the fact
that when the line moves, it's you can never tell
whether it's the numerator or denominator that's at fault.
Speaker 2 (24:57):
But this is sarcasm, by the way, for those who don't.
Speaker 3 (25:00):
No, I hate you hate currency markets because you never
know whether we should be telling it's the numertor.
Speaker 2 (25:05):
Do 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.
Speaker 3 (25:11):
But EM and you mentioned EM and many EM bond
funds indices and in currency is doing very well. And
so this gets to the question, is this numerator story
is it about dollar weekening 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
(25:33):
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 twenty tens at all. And I just while we
were chatting, I pulled up a bunch of lines of
EM related funds currency all doing very well. In your research,
are there fundamental changes in the EM world that are
like people are excited about for reasons other than the
(25:56):
fact that the dollar is week.
Speaker 4 (25:59):
So this is right 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 or is it really about the global financial
market trends? And the short answer is it's a bit
of both. And you would and you would you know,
(26:22):
not think of otherwise. 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 week of dollar,
(26:43):
the week ofd 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 a parallel with
credit spreads as well, because you know, when credit is
doing well, we also tend to see emerging market as
it's also doing well. And if we break it down,
(27:06):
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 currenty mismatch.
But then there's a windfall when the when the dollar weekends.
That's a very simple story. It's probably not the most important.
(27:27):
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
current sy mismatch borrowers, the improved credit risk on these
borrowers really you know, shrinks the tail risk in the
(27:50):
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 two more credit. So this
is very very strong relationship between a week of dollar
and faster growth of dollar denominated credit. And because of
(28:11):
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. And what you've
seen is actually, in spite of the week of dollar,
exports have gone up in these very highly sophisticated goods,
(28:34):
and much more so than the goods that are much
more affected by just a simple the simple trade effect
and exchange rate. So semiconductor 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
(28:54):
this year, and anything that has to do with global
supply chains you would also see. But there's a you know,
there's a sting in the tail here because, as we
talked about earlier, emerging markets increasingly are becoming net creditors
to the rest of the world, and there was very
(29:16):
little hedging going on, and so when you're caught in
one of these down drafts, you get hit both from
you know, the wiki 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,
(29:38):
this new element, which I think we need to keep
an eye on.
Speaker 2 (29:41):
What do you see when you look at the price
of gold. So we are recording this on October seventeenth.
It's coming down a tiny bit this morning, but still
above four thousand dollars an ounce. What is that telling
you about how investors are feeling about various global currencies
at the moment.
Speaker 4 (29:58):
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. We don't see
surge in the price of you know, even commodities. I mean,
(30:21):
look at you know, look at oil, look at other commodities,
you know, everything other than gold. And so I think
we should probably look for a more tailored explanation for
gold other than simply the you know, this broader sort
of sense of you know, you a flight from you know,
fiard currencies, and you know, I think one thing which
goes back to our initial conversation on the role of
(30:44):
the dollar in the global financial system. Certainly central banks
have been big buyers of gold, and there has been
you know that sort of you know, set of 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.
And the events today and you know, last week as well.
(31:08):
Rather than there being a flight to gold during stress times,
what we're seeing is it's behaving a bit like bitcoin
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 historical norms.
Speaker 3 (31:29):
You know, for a long time, Trace has 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. It kind
of seemed like it changed not long after Putin had
a bunch of his money seized. And when you talk
about central banks accumulating gold, being woken up to the
(31:51):
fact that your money is never really your money if
it's in a bank, it seems like it could be
part of it.
Speaker 4 (31:57):
Well, Joe, I mean, certainly, there are very few assets
which are not the liabilities of someone 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 of any particular individual.
(32:17):
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
you know, gold wasn't doing very much. I think it's
probably something even before the Russian invasion of Ukraine, Joe.
(32:38):
So you know, we've seen the trend where something you know,
like this has also happened actually a few years back,
even even before the Russian invasion of Ukrainian twenty two.
But I think it's you know, this this element, this
this attribute where it's not the liability of any particular uh,
(33:00):
you know, legal entity or individual. I think you know
is giving this a particular Yeah.
Speaker 2 (33:07):
So I'm looking at the top menu on Bloomberg right now,
and you know, it's feeling a little bit nervy at
the moment. So the number one story is banks trio
of alleged frauds, sparksphere of broader issues. So this is
the idea that this is Jamie Diamond's cockroach idea that
(33:28):
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?
Speaker 4 (33:43):
Well, Tracy, I mean, certainly this week is a very
news rich environment. We love you are you are you know,
contributing to that, and I think it's great. You know,
we we we hear a lot of these comments, uh,
you know, on credit. Certainly, credit standards have been eroding
(34:05):
for a long time, and we have been one of
the many voices, you know, even before this week, you know,
just pointing out that credit spreads have fallen to historical lows.
But if you look at the the trajectory of credit
to the private sector and compare that to what's been
(34:25):
happening to government debt there, that really isn't a comparison.
So it's certainly before the GFC, the big growth was
in the credit to the private sector, especially in the
form of mortgages. But after that, what we've seen is
credits the private sector has really been very subdued, and
(34:46):
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 or 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
(35:08):
grown in the recent past. And typically something that's grown
very rapidly, will you know, give you some course for concern.
In this case, the really rapidly growing element has not
been credit to the private sector. It's been credit to
the government and in particular the government bond market. So
we should have you know, we should of course worry
(35:29):
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, yeah,
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
(35:50):
not the case.
Speaker 3 (35:51):
Actually just brings a 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.
Speaker 4 (36:03):
There was actually a.
Speaker 3 (36:03):
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, I don't think the
(36:23):
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. Crises emerge
from assets that we think are going to be redeemed
from a dollar's worth we're going to get a dollars
back or whatever, or worried about getting back at all.
But I'm curious, from the perspective of someone who professionally
(36:45):
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's a lot of speculative acts, Like
is there much modeling work being done on equity and
(37:05):
risky assets specifically as a source of broader risk?
Speaker 4 (37:10):
Absolutely, I think I think the you know, the main
channel would be through the real economy, through through real
economic activity, rather than through let's say a de leveraging
episode or an equidity episode. I think it's worth thinking
back to the dot com bubble of two thousand. You know,
that was a period, of course when the valuations were
(37:31):
even more extreme, and when the stock market fell in
two thousand, 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 very
(37:52):
simplistic way of putting this is whenever you have debt
of various kinds, that's when you should be worried, because,
as you said, it's when you're promised one dollar but
then you don't deliver. That's when you know there are
sort of ripercussions throughout the economy. Now, clearly with the
equity markets, there are wealth effects. So you know, if
(38:14):
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, very sustained pullback,
we will see 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
(38:37):
democratization of stocks, we could expect a slightly larger magnitudes.
But on the scale of things, that effect tends to
be very small compared to the kinds of effects that
are associated with de leveraging episodes.
Speaker 2 (38:52):
Do you see any pockets of leverage out there that
aren't getting enough attention at the moment?
Speaker 4 (38:57):
Well, I think you're very good at shining a light
on those all those pockets. Actually, I think probably, I
don't think I can really say anything here that you
haven't heard of, but I think it's certainly worth bearing
in mind the broad magnitudes. Yeah, in 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
(39:20):
that even you know, safe acets can be a source
of stress in the market, because it's not default that
you know, propagates stress. It's more than de leveraging. 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,
(39:40):
that would be a really big deal for the real economy,
and that would happen even without any defaults.
Speaker 3 (39:45):
By the way, when we started this conversation, the tenure
was below four percent. It's above it now. So keeping
our listeners up to date on what's going on in
the treasury market. October seventeenth, twenty twenty.
Speaker 2 (39:56):
Five, very good. I mean, the other interesting thing is
if all the acting like a speculative asset, Now, what
happens when all of that starts reversing and you know,
the thing that you thought was worth four thousand dollars
is no longer worth four thousand dollars, and gold is
typically used as collateral.
Speaker 3 (40:11):
I always say, you know, it's really scary when you
see people like intensely buying gold because like what's up?
Speaker 4 (40:16):
Like what?
Speaker 3 (40:17):
But what's really scary is why they start selling, right,
Because again, no, you's true, right, because actually no one
has you have to be a real psychic 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 vic spike and people are
(40:37):
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.
Speaker 2 (40:48):
Rough, all right.
Speaker 3 (40:49):
I think that was a comment, that question comment not
even a question.
Speaker 2 (40:55):
Thank you Joe for your comment. And it's always lovely
catching up. This is been fantastic. Thank you so much
for coming back on the show.
Speaker 4 (41:02):
Thank you very much, tra Sick, and thank you Jeff,
Thank you so much.
Speaker 3 (41:05):
As us.
Speaker 2 (41:18):
Joe, I always enjoy catching up with him. 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
(41:40):
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, Yeah,
that doesn't seem great necessarily for the US.
Speaker 3 (41:58):
I mean no, I mean, look, it's sort of 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.
Speaker 2 (42:12):
Play more games, or eat more pizza.
Speaker 3 (42:14):
Or 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.
Speaker 2 (42:23):
And yeah, yeah, this.
Speaker 3 (42:25):
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.
Speaker 4 (42:31):
Yeah.
Speaker 3 (42:31):
And so I think, because this is why, you know,
like how are you getting 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 could sort of understand why I
don't want to leave town. I just don't want to
have arcade exposure.
Speaker 2 (42:52):
Absolutely. I guess what we kind of need. We need
another big crisis so that we can observe what gold
does during that time. Yeah, and also what the dollar
does during that time.
Speaker 3 (43:01):
I think I'm gonna run with this our actually I'm
gonna win.
Speaker 2 (43:04):
It's a really good analogy because like, if.
Speaker 3 (43:06):
You think like or you know, Chuck E Cheese has
a lot of fun games. But also I don't really
think the business swallow Chuck E Cheese. It's like that
good like how dare you?
Speaker 4 (43:15):
Well?
Speaker 3 (43:15):
A lot of them have closed out, 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 they go
to 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.
Speaker 2 (43:33):
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.
Speaker 3 (43:42):
Thank you. Finally all right, 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 back.
Speaker 1 (43:55):
You know.
Speaker 2 (43:55):
I'm pretty sure somewhere in like a box somewhere I
still have a bunch of like Chuck E Cheese, these
tickets or something like that. Maybe I should take them
out anyway.
Speaker 3 (44:04):
So this is another interesting question because what is the
exchange ratio between a token and a ticket?
Speaker 4 (44:10):
Right? Yeah?
Speaker 2 (44:11):
And I don't know.
Speaker 3 (44:12):
This is sort of like one of those communist countries, Chucky.
This is a paper that someone write, Chuck E che
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 us
a planned economy.
Speaker 2 (44:30):
Do you think I can find someone to provide like
a swap on a token versus a ticket or something.
Speaker 3 (44:36):
I think there's something here. I think we're I think
we're hitting on something important.
Speaker 2 (44:39):
Okay, I think we should end. We should leave it there,
all right. This has been another episode of the Authoughts podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3 (44:48):
I'm Joe Wisenthal. You can follow me at the Stalwart.
Follow our producers Carmen Rodriguez at Carman armand dash Ol
Bennett at dashbot and Kelbrooks at Kelbrooks. From where odd
Laws content, go to Bloomberg dot com slash odd Lots
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Speaker 2 (45:09):
And if you enjoy odd Lots, if you like it
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Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 2 (00:18):
Hello and welcome to another episode of the Authoughts podcast.
I'm Tracy Alloway.
Speaker 3 (00:22):
And I'm Joe Wisenthal.
Speaker 2 (00:23):
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 US dollar, which has been this sort of slow
burned crash across the year. And we're recording this. Let's
(00:44):
see October seventeenth, and you know, dollar down yet again.
Speaker 3 (00:48):
Well it is down, but however there's been a little
you know, we hit hiss low in mid September.
Speaker 2 (00:53):
Don't make apologies for the dollar, Joe.
Speaker 3 (00:56):
You know, I just like keep going, all right, keep going.
Then I might add something fall in the dollar. The
fall in the doll is very big.
Speaker 4 (01:05):
So far.
Speaker 2 (01:06):
There's here 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
(01:28):
form of its currency.
Speaker 3 (01:29):
You know what I really regret doing tracing. I really regret.
Speaker 2 (01:34):
Did you have like a horde of gold that you
got rid.
Speaker 3 (01:36):
Of over I took out a gold denominated mortgage. You know,
I feel so stupid. I feel so stupid. Why did
I do that? I could get paid in dollars and
I took out a gold denominated mortgage. What was I thinking?
Speaker 4 (01:47):
No?
Speaker 3 (01:47):
I didn't, But had I done, that would have been
a very bad trade.
Speaker 2 (01:50):
Yes, I remember those stories.
Speaker 3 (01:52):
From like, you know, a little bit of a tangent,
remember all those stories from like the Hungarians they took
out those Swiss denominated mortgage back of the two thousands.
Speaker 2 (02:01):
And that was very much a europe thing for a while.
Speaker 3 (02:04):
Yeah, that was a really funny list. 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
(02:25):
for this year are turning a little bit. And I
say that tenure treasury is the time we're recording this
October seventeenth has fallen below four percent. 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.
So it is a very interesting moment from markets in
(02:48):
many respects right now.
Speaker 2 (02:49):
There's definitely a lot to talk about. Congrats on managing
your personal FX liability.
Speaker 3 (02:54):
I'm doing a good job.
Speaker 2 (02:57):
Getting paid in dollars and paying your mortgage dollars. Well
done show, 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 when we talk about
these big trends, And.
Speaker 3 (03:14):
Who is the one person that is always in town
Because 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.
Speaker 2 (03:23):
Same time, 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 run into 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 Hun Sunction.
He is the economic Advisor and head of the Monetary
(03:45):
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 Hun, thank you so
much for coming back on our thoughts.
Speaker 4 (04:00):
Thank you Tracy, thank you Joe. It's great to be back.
Speaker 2 (04:03):
Since Joe doubts my entire premise.
Speaker 3 (04:05):
For this episode, the entire premise at all.
Speaker 2 (04:08):
Now, 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
(04:30):
safe haven of the green back 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 Well, it.
Speaker 4 (04:41):
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, yeah, falling in unison.
And that's very unusual because in a risk off episode,
you know, which April was, typically the dollar would rally.
(05:04):
You know, there'll be a kind of safe have and 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 have the data, we can piece together
(05:27):
in a more kind of coherent way what was going on.
And in short, I think it was a kind of
hedging story where investors who had lots of exposures to
the US dollar, we're trying to reduce some of those exposures.
And we can get into some of the details and
(05:47):
how you know, 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 f X markets,
and we've just published the results, and I think we
can also shed some more light on the events in April.
Speaker 3 (06:08):
Let's keep it big pictures still, and then we'll drive
down into specific months and weeks. What people work for
the BIS, they prey must take out mortgages and Swiss
Frank there living there in bars anyway, sidetrack, what are
some of the big takeaways from this year service?
Speaker 4 (06:23):
Yeah, yeah, so I think well, actually before we go there, Joe,
I mean, it's worth you know, thinking about how FX
market is really a figure in the investment strategy. So
you know, 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 you know, local euros beneficiaries in euros,
(06:47):
but you have a very large balance sheet and so
you need to have a very broad exposure to global assets,
you know, 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 in dollar assets.
But of course what you want to do is to
(07:08):
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
and then with those dollars then go into dollar denominated assets.
(07:30):
And as you do that, you also promise to unwind
that transaction at a known exchange rate that affixed 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,
(07:54):
on you know, how high the hedging costs are. 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 know, you're borrowing dollars in order
to invest in dollar assets. So when the short term
interest rate is very high, that's typically a time when
(08:16):
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 you know, trending down.
And you know to the extent that some investors you know,
didn't hedge at all, And why would you if the
dollar is surging and the hedging cost is so large.
(08:38):
And so when the turbulence broke earlier in the year,
a lot of investors were basically caught with very large
dollar exposures, you know, having not hedged. And I think
one piece of evidence that you know this was that
the events of April was very much an expost hedging story,
(09:00):
you know, hedging after the fact was that, you know,
we saw a lot of the telltale signs of swaps
being taken out and dollars being sold happening in the market.
So what would happen is, you know, if an investor
is holding dollar assets, you know, without a hedge, but
you're concerned about the dollar falling, then what you would
(09:21):
do is you would put on a hedge X 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 so rather than investing those dollars
into dollar assets, you simply sell it in the spot market.
What that kind of dynamics would would imply is that
(09:43):
there would be you know, lots of downward pressure in
those situations where institutional investors are trying to you know,
raise their head ratios. But expost So back to the triannual,
what do we see there that to you know, puts
additional light on this episode. By the way, on the triangle,
(10:04):
you know this, it's just so happens that the sampling
period was April this year, amazing, so you know, it
may be slightly distorted by the events of you know,
the April episode. On the other hand, the silver lining
is that we have some great data on really the
you know, the events of the of the April episode.
(10:24):
But the headline numbers are really quite you know, 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
(10:48):
than what we saw in twenty two so you know,
in spite of the survey being affected perhaps by these
you know, stress events in April, you know, we think
we've got a very very very good sort of take.
One of the things that we noticed this year is,
of course, you know, as well as the FFX swaps,
which is by far the largest segment of the of
(11:09):
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. You know,
when you engage in US in an effect swap, you know,
the investor with borrow dollars by pledging euros, and then
(11:31):
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 deal and say, look, you know, just
sell me a outright forward so called, and then I
would actually then have a dollar obligation.
Speaker 3 (11:50):
A swap is like a spark trade plusure forward exactly.
Speaker 4 (11:53):
Okay, it's that combination. 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
(12:14):
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 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.
Speaker 3 (12:35):
Interesting.
Speaker 4 (12:35):
So this is another piece of the evidence that this
was very much exposed 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 gather. But
it's also notable that if you look at the actual
portfolio flow numbers, the international portfolio flow numbers, there was
(12:57):
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 was 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,
(13:18):
you know, was not the story behind the eight episode.
Speaker 2 (13:36):
Why should we care, either qualitatively or quantitatively if this
was a hedge America story and not a sell America's
story outright.
Speaker 4 (13:45):
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 you know, translated into actions. But
I think what you know does flow very you know
(14:06):
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 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. So actually, you know,
(14:29):
be part of that ecosystem. So if you have this
kind of need network effect, it's very difficult to have
this whole sale shift away.
Speaker 3 (14:38):
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 it can come up
with a long list of reasons to be concerned, which
we don't need to come down recapitulate now. On the
other hand, the most affitable, impressive, cutting edge companies in
(15:02):
the world that everyone would love to have exposure to
in some way or in the US. And it strikes
me is 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 in
Video and Microsoft and all of these companies that are
(15:24):
making money hand over fist without having exposure to the
US itself, And hence I might want to hedge.
Speaker 4 (15:32):
I mean, certainly, you know the equity market story, I
mean that really isn't 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, that 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
(15:54):
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 currencies. And you know, money is ultimately something
(16:18):
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 service of making money fungible across currencies.
So you know, every piece fits into every other piece
(16:40):
in that sense. And so you know, we should think
about this in terms of the mutually reinforcing pieces of
this you know, this network.
Speaker 2 (16:51):
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 x
post as you described. Did that mean that the cost
(17:11):
of actually doing so actually increased or was it still
relatively cheap?
Speaker 4 (17:16):
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
(17:38):
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 asset itself. And so if you have
a flat yield curve, you know, which is what we've had,
or even inverted yel curve, then hedging costs are very high.
And so in fact, you know, investors have typically hedged,
and hedge ratios have fluctuated. There's no system matter survey,
(18:01):
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,
(18:22):
they were trying to win both on the stronger dollar,
but also on the high yields. Yeah, actually they just
meant mentioned 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 DOT assets with the story
(18:43):
about local currency emerging market bonds. You know, that's actually
a very very you know, important asset class 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 in to a large emerging market sovereign BONDERNT trade,
you would actually buy the instrument on an unheedge basis.
(19:08):
And you do that because you know, you think the
emerging market currency will appreciate as well as the YEL
four 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 know scramble to you know hedge ex
post and that's exactly you know the same type of
(19:30):
thing that we 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 a
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
(19:51):
April and the much older trade, which is the emerging
market trade.
Speaker 2 (19:56):
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 allow emerging market.
Speaker 5 (20:08):
Pond were like, I think I'm going to buy some
local currency US day. That's right, actually, but like, so
what was it about April then that caused the like
what I mean, we know there was yeah, the Launcher
trade war and there were like massive tariffs, et cetera.
But like, what was it about that such that people's
(20:28):
impulses to hedge more expost factor as you've described it.
What was the thing they 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.
Speaker 4 (20:42):
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 twenty
three for where let's say life insurance companies announce that
(21:05):
they will not be hedging, you know there, 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 of environment, what typically happens that you
want to take some chips off the table, and that
just means reducing your exposure. Yeah, and if you're exposed,
(21:29):
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 expost hedging story.
Speaker 2 (21:43):
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, mismatch to a longer term asset. I mean,
(22:07):
this is this is what the BIS does on a
day to day basis, is worry about potential risks so
are you worried here?
Speaker 4 (22:14):
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
(22:36):
short term liability that you need to roll over, and
from time to time you might get caught in a
liquidity you know, stress episode where it's difficult to source
the dollars to actually repay. And this was, for example,
what happened during the GFC. It's also what happened during
March twenty twenty when there was also a scramble for dollars.
(23:00):
And you know, when you're a long term investor, you've
hedged using a short term effect 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 assess which is going to be very difficult
at a fair price, or you have to join the
(23:21):
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. And so
you know we are swapping one well, we are actually
you know, exchanging one type of risk for another. We're
actually changing currency mismatch for maturity mismatch. And you know, empirically,
(23:47):
if you look at the evidence over the years, it's
when the dollar is falling for a long period of
time that these head ratios become very, very high. So
you know, a good example is the period before the
GFC when a dollar was you know, really falling, you know,
quite considerably. But then what happened at the GFC was
(24:08):
of course in a dollar really spiked because there was
a scramble for dollars. So you know, there's always this
trade off. You either have to beart some currency risk
or you bear this maturity risk, and then the bear
this maturity mismatch risk, I should say, and and so
we you know, it's really you know, changing one type
(24:30):
of risk or another.
Speaker 3 (24:47):
Tracy really loves currency markets because she loves the fact
that when the line moves, it's you can never tell
whether it's the numerator or denominator that's at fault.
Speaker 2 (24:57):
But this is sarcasm, by the way, for those who don't.
Speaker 3 (25:00):
No, I hate you hate currency markets because you never
know whether we should be telling it's the numertor.
Speaker 2 (25:05):
Do 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.
Speaker 3 (25:11):
But EM and you mentioned EM and many EM bond
funds indices and in currency is doing very well. And
so this gets to the question, is this numerator story
is it about dollar weekening 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
(25:33):
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 twenty tens at all. And I just while we
were chatting, I pulled up a bunch of lines of
EM related funds currency all doing very well. In your research,
are there fundamental changes in the EM world that are
like people are excited about for reasons other than the
(25:56):
fact that the dollar is week.
Speaker 4 (25:59):
So this is right 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 or is it really about the global financial
market trends? And the short answer is it's a bit
of both. And you would and you would you know,
(26:22):
not think of otherwise. 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 week of dollar,
(26:43):
the week ofd 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 a parallel with
credit spreads as well, because you know, when credit is
doing well, we also tend to see emerging market as
it's also doing well. And if we break it down,
(27:06):
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 currenty mismatch.
But then there's a windfall when the when the dollar weekends.
That's a very simple story. It's probably not the most important.
(27:27):
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
current sy mismatch borrowers, the improved credit risk on these
borrowers really you know, shrinks the tail risk in the
(27:50):
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 two more credit. So this
is very very strong relationship between a week of dollar
and faster growth of dollar denominated credit. And because of
(28:11):
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. And what you've
seen is actually, in spite of the week of dollar,
exports have gone up in these very highly sophisticated goods,
(28:34):
and much more so than the goods that are much
more affected by just a simple the simple trade effect
and exchange rate. So semiconductor 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
(28:54):
this year, and anything that has to do with global
supply chains you would also see. But there's a you know,
there's a sting in the tail here because, as we
talked about earlier, emerging markets increasingly are becoming net creditors
to the rest of the world, and there was very
(29:16):
little hedging going on, and so when you're caught in
one of these down drafts, you get hit both from
you know, the wiki 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,
(29:38):
this new element, which I think we need to keep
an eye on.
Speaker 2 (29:41):
What do you see when you look at the price
of gold. So we are recording this on October seventeenth.
It's coming down a tiny bit this morning, but still
above four thousand dollars an ounce. What is that telling
you about how investors are feeling about various global currencies
at the moment.
Speaker 4 (29:58):
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. We don't see
surge in the price of you know, even commodities. I mean,
(30:21):
look at you know, look at oil, look at other commodities,
you know, everything other than gold. And so I think
we should probably look for a more tailored explanation for
gold other than simply the you know, this broader sort
of sense of you know, you a flight from you know,
fiard currencies, and you know, I think one thing which
goes back to our initial conversation on the role of
(30:44):
the dollar in the global financial system. Certainly central banks
have been big buyers of gold, and there has been
you know that sort of you know, set of 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.
And the events today and you know, last week as well.
(31:08):
Rather than there being a flight to gold during stress times,
what we're seeing is it's behaving a bit like bitcoin
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 historical norms.
Speaker 3 (31:29):
You know, for a long time, Trace has 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. It kind
of seemed like it changed not long after Putin had
a bunch of his money seized. And when you talk
about central banks accumulating gold, being woken up to the
(31:51):
fact that your money is never really your money if
it's in a bank, it seems like it could be
part of it.
Speaker 4 (31:57):
Well, Joe, I mean, certainly, there are very few assets
which are not the liabilities of someone 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 of any particular individual.
(32:17):
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
you know, gold wasn't doing very much. I think it's
probably something even before the Russian invasion of Ukraine, Joe.
(32:38):
So you know, we've seen the trend where something you know,
like this has also happened actually a few years back,
even even before the Russian invasion of Ukrainian twenty two.
But I think it's you know, this this element, this
this attribute where it's not the liability of any particular uh,
(33:00):
you know, legal entity or individual. I think you know
is giving this a particular Yeah.
Speaker 2 (33:07):
So I'm looking at the top menu on Bloomberg right now,
and you know, it's feeling a little bit nervy at
the moment. So the number one story is banks trio
of alleged frauds, sparksphere of broader issues. So this is
the idea that this is Jamie Diamond's cockroach idea that
(33:28):
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?
Speaker 4 (33:43):
Well, Tracy, I mean, certainly this week is a very
news rich environment. We love you are you are you know,
contributing to that, and I think it's great. You know,
we we we hear a lot of these comments, uh,
you know, on credit. Certainly, credit standards have been eroding
(34:05):
for a long time, and we have been one of
the many voices, you know, even before this week, you know,
just pointing out that credit spreads have fallen to historical lows.
But if you look at the the trajectory of credit
to the private sector and compare that to what's been
(34:25):
happening to government debt there, that really isn't a comparison.
So it's certainly before the GFC, the big growth was
in the credit to the private sector, especially in the
form of mortgages. But after that, what we've seen is
credits the private sector has really been very subdued, and
(34:46):
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 or 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
(35:08):
grown in the recent past. And typically something that's grown
very rapidly, will you know, give you some course for concern.
In this case, the really rapidly growing element has not
been credit to the private sector. It's been credit to
the government and in particular the government bond market. So
we should have you know, we should of course worry
(35:29):
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, yeah,
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
(35:50):
not the case.
Speaker 3 (35:51):
Actually just brings a 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.
Speaker 4 (36:03):
There was actually a.
Speaker 3 (36:03):
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, I don't think the
(36:23):
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. Crises emerge
from assets that we think are going to be redeemed
from a dollar's worth we're going to get a dollars
back or whatever, or worried about getting back at all.
But I'm curious, from the perspective of someone who professionally
(36:45):
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's a lot of speculative acts, Like
is there much modeling work being done on equity and
(37:05):
risky assets specifically as a source of broader risk?
Speaker 4 (37:10):
Absolutely, I think I think the you know, the main
channel would be through the real economy, through through real
economic activity, rather than through let's say a de leveraging
episode or an equidity episode. I think it's worth thinking
back to the dot com bubble of two thousand. You know,
that was a period, of course when the valuations were
(37:31):
even more extreme, and when the stock market fell in
two thousand, 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 very
(37:52):
simplistic way of putting this is whenever you have debt
of various kinds, that's when you should be worried, because,
as you said, it's when you're promised one dollar but
then you don't deliver. That's when you know there are
sort of ripercussions throughout the economy. Now, clearly with the
equity markets, there are wealth effects. So you know, if
(38:14):
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, very sustained pullback,
we will see 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
(38:37):
democratization of stocks, we could expect a slightly larger magnitudes.
But on the scale of things, that effect tends to
be very small compared to the kinds of effects that
are associated with de leveraging episodes.
Speaker 2 (38:52):
Do you see any pockets of leverage out there that
aren't getting enough attention at the moment?
Speaker 4 (38:57):
Well, I think you're very good at shining a light
on those all those pockets. Actually, I think probably, I
don't think I can really say anything here that you
haven't heard of, but I think it's certainly worth bearing
in mind the broad magnitudes. Yeah, in 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
(39:20):
that even you know, safe acets can be a source
of stress in the market, because it's not default that
you know, propagates stress. It's more than de leveraging. 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,
(39:40):
that would be a really big deal for the real economy,
and that would happen even without any defaults.
Speaker 3 (39:45):
By the way, when we started this conversation, the tenure
was below four percent. It's above it now. So keeping
our listeners up to date on what's going on in
the treasury market. October seventeenth, twenty twenty.
Speaker 2 (39:56):
Five, very good. I mean, the other interesting thing is
if all the acting like a speculative asset, Now, what
happens when all of that starts reversing and you know,
the thing that you thought was worth four thousand dollars
is no longer worth four thousand dollars, and gold is
typically used as collateral.
Speaker 3 (40:11):
I always say, you know, it's really scary when you
see people like intensely buying gold because like what's up?
Speaker 4 (40:16):
Like what?
Speaker 3 (40:17):
But what's really scary is why they start selling, right,
Because again, no, you's true, right, because actually no one
has you have to be a real psychic 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 vic spike and people are
(40:37):
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.
Speaker 2 (40:48):
Rough, all right.
Speaker 3 (40:49):
I think that was a comment, that question comment not
even a question.
Speaker 2 (40:55):
Thank you Joe for your comment. And it's always lovely
catching up. This is been fantastic. Thank you so much
for coming back on the show.
Speaker 4 (41:02):
Thank you very much, tra Sick, and thank you Jeff,
Thank you so much.
Speaker 3 (41:05):
As us.
Speaker 2 (41:18):
Joe, I always enjoy catching up with him. 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
(41:40):
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, Yeah,
that doesn't seem great necessarily for the US.
Speaker 3 (41:58):
I mean no, I mean, look, it's sort of 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.
Speaker 2 (42:12):
Play more games, or eat more pizza.
Speaker 3 (42:14):
Or 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.
Speaker 2 (42:23):
And yeah, yeah, this.
Speaker 3 (42:25):
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.
Speaker 4 (42:31):
Yeah.
Speaker 3 (42:31):
And so I think, because this is why, you know,
like how are you getting 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 could sort of understand why I
don't want to leave town. I just don't want to
have arcade exposure.
Speaker 2 (42:52):
Absolutely. I guess what we kind of need. We need
another big crisis so that we can observe what gold
does during that time. Yeah, and also what the dollar
does during that time.
Speaker 3 (43:01):
I think I'm gonna run with this our actually I'm
gonna win.
Speaker 2 (43:04):
It's a really good analogy because like, if.
Speaker 3 (43:06):
You think like or you know, Chuck E Cheese has
a lot of fun games. But also I don't really
think the business swallow Chuck E Cheese. It's like that
good like how dare you?
Speaker 4 (43:15):
Well?
Speaker 3 (43:15):
A lot of them have closed out, 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 they go
to 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.
Speaker 2 (43:33):
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.
Speaker 3 (43:42):
Thank you. Finally all right, 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 back.
Speaker 1 (43:55):
You know.
Speaker 2 (43:55):
I'm pretty sure somewhere in like a box somewhere I
still have a bunch of like Chuck E Cheese, these
tickets or something like that. Maybe I should take them
out anyway.
Speaker 3 (44:04):
So this is another interesting question because what is the
exchange ratio between a token and a ticket?
Speaker 4 (44:10):
Right? Yeah?
Speaker 2 (44:11):
And I don't know.
Speaker 3 (44:12):
This is sort of like one of those communist countries, Chucky.
This is a paper that someone write, Chuck E che
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 us
a planned economy.
Speaker 2 (44:30):
Do you think I can find someone to provide like
a swap on a token versus a ticket or something.
Speaker 3 (44:36):
I think there's something here. I think we're I think
we're hitting on something important.
Speaker 2 (44:39):
Okay, I think we should end. We should leave it there,
all right. This has been another episode of the Authoughts podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3 (44:48):
I'm Joe Wisenthal. You can follow me at the Stalwart.
Follow our producers Carmen Rodriguez at Carman armand dash Ol
Bennett at dashbot and Kelbrooks at Kelbrooks. From where odd
Laws content, go to Bloomberg dot com slash odd Lots
with the daily newsletter and all of our episodes, and
you can chat about all of these topics twenty four
to seven in our discord discord dot gg slash lots.
Speaker 2 (45:09):
And if you enjoy odd Lots, if you like it
when we talk to Hymnsumtionin about upcoming risks in the market,
then please leave us a positive review on your favorite
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Hosts And Creators
Joe Weisenthal
Tracy Alloway
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