Tim Graf: Thank you, Lee, for that introduction. Thank you all for being here. Lee has actually done quite a lot of the introduction I was going to do. So that that saves us a lot of time. But as he mentioned, this is a live edition of a weekly podcast we do called Street Signals. Every week I sit down with people on the strategy team and my colleagues there, as well as our colleagues and research partners at State Street Associates, business leaders and risk takers around the firm at State Street. And also starting this year, we've been able to talk to external, independent thought leaders and market practitioners who work all around the world. And I'm always on the lookout to to do new and interesting things with the podcast. Lee has talked about this debut of the live version, so that's very exciting. It's the first time we've ever done the podcast in front of a live audience. The editing software is not going to be as friendly probably this time around as it often is with my weekly episodes, so that's also new. It's also the first time, as Lee mentioned, that we've done a hosted version of the Shark Tank. We've done these sessions for years.
Tim Graf: As I'm sure if you've been to our retreats, you will have seen us do this. the way it normally goes is each of our three presenters has their idea. They wander around on the stage, they have some slides and visual aids, and then you, the audience, vote on the favorite idea that you have. And we are keeping a lot of that. My guests will still present an idea, but this is not on YouTube. It's an audio only podcast, so visual aids are a little bit pointless. So what we'll do instead is have them give their ideas for 3 or 4 or five minutes, maybe six minutes. We'll chat a little bit about it and then you still get to vote at the end. So let me get out of the way. A good host always gets out of the way and lets his guests start talking. We have Dan Gerard, Marvin Loh and Ning Sun, all senior, multi-asset and macro strategists on our team in Boston. Dan is going to go first. And Dan, let me just cue up the slide. You're taking a rather unique approach as the employee of a US financial institution with your idea, which is short US financials.
Dan Gerard: As Lee mentioned, if I if I don't win, I'm definitely out. Yeah, yeah we can.
Tim Graf: Be pretty confident of that. Yeah. Off you go Dan.
Dan Gerard: Great. And um yeah this is a great format without the slides. You know, I prepared some notes to try to keep me from rambling. In fact, when I was walking out the door, my my son asked me if I was ready and had my slides up. I said, you know, we're doing this one without a net. And he he handed me after a butterfly net and I was so good to see dad. Jokes are working both ways. so short us financials. It's a you know, it's one where I think we need to pay especially, good attention to the financial sector here. And just for the purposes of this discussion, we're going to think of financials as banks and financial services. The insurance part is, just a bit more unique because it has actuarial risk and demographics risk. So we'll stick with the banks and the financial services. But really, more than any other sector, this is the one that is the tie that binds valuations, growth, um economic growth, earnings policy rates all together and has that feedback loop into it. And you know this is something that we should be really watching because if we if we expect financials to do better from here, then we better hope we're past recession risk. We better hope there's going to be enough liquidity or the ability to earn the expected earnings that are already in the cake.
Dan Gerard: And, just to level set. We've had quite a rerating in financials since the, the the trouble we saw last spring. We've had something like a 50% rerating in valuations, 30% in price to book, and expected earnings growth of something like 15 to 17% over the next couple of years. So really solid double digit earnings growth. How are we going to achieve that? Do we expect to either get even richer than these kind of historically high valuations, or that we're going to get even better than that earnings growth that's already baked in. And if we do, we better see some some pretty solid drivers for that. In fact, I just think the opposite is likely true that we're likely to get a much more difficult liquidity situation coming. We've got a fed that is going to be in a bit of a conundrum. They won't necessarily have to raise rates. And we saw some great encouraging data from Alberto, but it's going to be very difficult to sufficiently cut rates, at these levels of, of prices without the threat of the looming recession. And that sort of defeats the purposes of financials without going through the cycle first. So, well, first let's think about the fed. The fed you know, the fed is supposed to be or supposed to add or control the tinder for the the overall growth scenario or the liquidity scenario right there. They're either, you know, swiping right to the real economy, swiping left to the to the financial markets. But you know, they're that's what they're trying to do is control that that liquidity provision. And in this case it's pretty hard to do either. Right. We have a system where for the first time in probably two decades or close to two decades, we're going to be back to commercial banks being the ones that provide liquidity based on rate policy. As the QE period has now really coming to an end, we say we have it's not exactly cute now because of the unwind of the reverse repo facility, which is down to about 375 billion left out of 2.5 trillion. That's finite. It is going to be very difficult to find extra liquidity minus more QE, which means that banks are going to either have to grow their asset books on on the loan side or the security side. Growing in the loan side requires us not to go into recession. And already we're seeing credit growth on banks down to about sub 5%. That in itself has been a historically great recessionary indicator over the past 75 years. When you starve the economy for credit, the demand is too low because rates are too high. You tend to get this move into recession. The flip side of that is when rates are high, you usually have a period where banks can expand their securities book with either treasuries or MBS. The mortgage market we know is troubled. It's going to be very difficult to add to that that sufficiently to the mortgage market.
Dan Gerard: That is especially true with the fed who every time we see a kind of pullback in mortgage rates, we see a surge in mortgage mortgage activity. We saw in the word cloud from Alberto that housing is a big part of that. how does the fed manage to not drive up 60% of core services basket with, with Lohr rates? so on the on the loan book side, we already see commercial and industrial lending. Negative sub 5% is typically recessionary. We see commercial real estate already in trouble. Businesses CNI commercial industrial, commercial real estate is no matter what happens with the fed and the 50 basis points are going to have to refinance at higher rates. the consumer has been the one that has really been holding up the story, but it's all in credit cards. Autos and consumer lending has been falling pretty fast. Credit cards at 22% rates is is now the really only asset growth that we're seeing at all at banks. And we're seeing charge offs rise up above pre pre-COVID levels. We're seeing delinquency rise. It's not extreme yet but it's that direction of travel is quite worrying. And um really what we what we're worried about is that achieving that earnings growth through either securities growth or lending growth is going to be extremely hard when such high expectations are baked into the cake. now institutions they're selling, they're starting to sell out of their overweight positions. Hedge funds that we see from our data shorts are starting to rise again. Not a great situation for the banks either. and a, let's see, what am I forgetting? that probably wraps up most of it. We've got, you know, very, very difficult margin, to make up in pretty high expectations baked into the cake.
Tim Graf: The one thing that really stood out to me in your comments is, well, just considering how well financials have performed this year, the broad index has kept pace with the S&P. Banks have actually outperformed the S&P, and that's in an environment where private credit has actually done relatively well. Everybody is thinking about private credit. Nobody quite knows what to make of it as a risk. But it's grown, which indicates there's willingness to lend. There is risk appetite. How are public financials addressing this? Can they address this in fact?
Dan Gerard: Well first to address the first part, you know that that outperformance is was driven by, you know, this period of 2022 where you had probably still a great, you know, economy going. They underperformed or market performed at least and really are playing catch up with higher valuations. Now. It's sort of maybe not appreciating the risk going forward. On the private credit side, it's actually quite fascinating. I think we're seeing a lot of the same stuff we're seeing. State Street has this benefit of seeing with our private equity index, tremendous insight into, quarterly valuations and daily cash flows across private markets. And when we look at the dry powder and private credit space, which is, you know, contributions and commitments together we're seeing that dry powder fall off really fast. And it's not because that, that the commitments are falling. It's because contributions are actually falling. They can't take more risk on the LP side, or they don't want more risk. They already have so much. And that liquidity that's now coming down is going to actually, start to really weigh into this, ability of private credit, I think, to expand the same way that public banks are having this ability to expand credit down the road. So it's something certainly we should be watching carefully as that peak is well past, or we're well past the peak at this point.
Tim Graf: The problem for everyone as opposed to just a problem. Exactly right. Institutions. Well, Dan, thank you very much. We are going to move now to Marvin Loh, Marv's specialist subject is US rate markets, Federal reserve policy. He has brought to us an idea of how to think about the US curve and duration over the rest of this year.
Marvin Loh: Excellent. Thanks. Thanks to him. so I'm going to start with an apology because as many of you know, I can be overly verbose. You're giving me 5 or 6 minutes. So I'm going to use my birth cart as a New Yorker and try to get this done in a New York minute. so yeah, underweighting duration, underperformance of duration. How do we get there? Inflation is still the main story. sticky inflation in my mind, is something that we're going to need to deal with over the course of the next 12 to 18 months, and we're going to wind up with a funds rate that bottoms out somewhere with a four handle rather than the three handle. That, however, is not going to get the bear steepening that I'm thinking about. We're going to need term premiums to get there, a rise in term premiums, if you will, just to set the playing field. A term premium is the amount of compensation that you, the investor, will need to buy more duration in the market and what's going to drive up term premiums. There are two things that I'm thinking about. One is inflation volatility. So for certain we all are watching just how aggressive the markets and the fed expect inflation to get back to 2%. What we're not necessarily focused on is how well behaved inflation is expected to be once we get there. The difference, if you will, between looking at the volatility in foreign inflation swaps versus the actual behavior, inflation has never been as wide.
Marvin Loh: And to me, that just seems a little bit naive given everything that we've been through, given the discussion that we're hearing about housing and whether or not the strange sized mortgages that we have, potentially a potential structural aspects of the labor market will allow inflation to be as sanguine as that. The other big component I'm looking at is really just the debt and the deficit. Both of those, in my mind, are contribute to the supply and demand imbalances within that market, as well as potentially contribute to inflation, either the actual amount or volatility around it. Let me give you a couple of scary statistics. And you know, we've all been worried and talking about debt sustainability for decades. But the US debt to GDP is going to be over 100% by next year. If the CBO is correct, we're going to have public debt, marketable public debt that exceeds $40 trillion by 2030. And the interest component of that debt, which is right now about two thirds of the total amount, exceeds the amount of defense spending. If I'm right, and interest rates wind up being about 100 basis points higher than than what the CBO expects, the amount of interest paid is going to go from about 1.5 trillion in 2032, if you will, to $2 trillion. That's an amount that has to be funded every single year.
Marvin Loh: It speaks to how hard it's going to be to pull the deficit down, but it also contributes to fiscal stimulus and is somewhat inflationary and contributes to inflationary volatility. So who buys that debt? You know, certainly we've been living off the generosity of our neighbors. If we kind of look at the data, we've actually been living off the generosity of our central banks. They're not in a position, in my mind to buy as much of this debt as it as it comes to market, whether it's China kind of pulling back as they need their reserves to support their economy, if it's the other reserve managers that ironically, the Em economies are the most fiscally, are the most fiscally astute at this point, they don't need as many reserves. And the fed stopping cute at 7 trillion plus won't have as much headroom as they've had in the past. So we're already seeing that we potentially are crossing the Rubicon. Treasury is, going through a buyback program at this point because there's not enough left, enough liquidity in the system. the auctions have been an issue since last summer, and they continue to be an issue. So we're already seeing those supply and demand imbalances make their way into the Treasury market. So how do you play it? You know, clearly a steepening of the curve is what you would expect, where the long end underperforms.
Marvin Loh: But waiting for twos, tens in this kind of market where the fed is on hold feels like waiting for Godot. instead, what I'm looking for is something that provides an opportunity where the long end underperforms. But there's a more volatile part of the. Curve that we could take an advantage of. Increasingly, I'm looking at the belly outperforming the wing. So this is a two fives ten long strategy. It's about -40 basis points now. It's improved by about 15 basis points. So if we had this a couple of weeks ago it'd be a great trade. Now it's an okay trade. I could see that getting to -60 to 70 basis points. Um Dvl1 is obviously neutral and the carry is not terrible at -40 basis points. twos tens will work. But really we have to wait till the fed starts to cut. And probably we need to wait till we're midway through the cutting cycle until, the market starts to realize. And these are the four most dangerous words that we have in our business. This time is different. But I do think this time is different. And there's a lot of, a lot of factors that are in the market right now that just make it hard for all this to package in a way where the post pandemic world is supposed to be as smooth as it was before the pandemic.
Tim Graf: Marv, you've. You've gotten through that very, very quickly. So I have lots of time for questions now. Well done. two things that I wanted to ask about. You didn't mention the fed too much, other than some of the policies and the rundown of the balance sheet, but I wanted to think about the predictability of fed policy, because at the beginning of the year, we had 6 to 7 cuts priced. This year we swung completely the other way to almost nothing. We're now getting some softer labor market data, or at least data that's a bit more balanced in the labor market. And we're starting to swing the other way and maybe thinking about a cut before the election. Amazingly, what does your idea say about the predictability of the fed in this environment for the rest of the year?
Marvin Loh: Say traders got a trade right? Ultimately, we would have saved ourselves so much grief if we just looked at what the fed said and kind of took that as gospel and kind of got to the middle of the year. you know, what? The economic models that are out there are incredibly challenged right now. You know, we're dealing with still data volatility that we've not seen before. You know, 5 to 7 standard deviation moves from expectations. I think that that makes the predictability that much more difficult. So yeah, you know hold on to your seats. I do think a hedged approach to a lot of the ideas that you're going to hear from us and that that we really write about is kind of the, the correct approach, because the volatility that we're dealing with with this data, in my mind, has not, has not passed yet.
Tim Graf: And then you mentioned as well the kindness of strangers. And I wanted to hearken back to, to our own institutional flows. I mean, it's really the kindness of domestic strangers as well. Domestic real money have been persistent buyers of treasuries on a duration weighted and unweighted basis. The front end flows are very strong. The long end flows are very strong. What gets them? They've been able. We had a guest a couple of weeks ago talking about this. You know, they're using this as an opportunity to diffuse liabilities. The pension community, particularly even if yields are heading higher, they're still doing it. What gets them to step out of the way? What really scares them off?
Marvin Loh: Yeah I mean so so so yes it's been it's been really interesting and it's been a wonderful, I guess, ability to feel comfortable with your long treasury positions when you see, you know, real money, whether it's the foreign buyer or the domestic buyer, aggressively, continuing to buy treasuries, particularly from duration weighted perspective, particularly at the long end, what our data is starting to show is that there is a little waning of that. Those cross-border flows, the foreigners buying into the US market are the Lohst that we've seen in years. So it's it's actually showing selling relative to benchmarks. the broader figures are now close to neutral. They probably will be at neutral within the next couple of days. And we're doing it from a position where treasuries are no longer as overweight as they were before. So I think there is a real thought process around it that's going on right now. And, you know, we do have the opportunity of the tailwind created by a cutting cycle, not only the US but across the world. You know, that gives us an opportunity to really think about how we want to approach asset allocation and where kind of duration kind of fits in that broad, broad scope, particularly if we have a higher yields and, you know, the belly of the curve really offering yields that we haven't seen before. So yeah, that's kind of the crux in terms of what I was thinking to get to this underweight duration view.
Tim Graf: Got it. Thanks so much Marv. We are going to now finish with Ning Sun. I'm going to advance the slides here. Ning, Marv and Dan have been a little bit downbeat, but I think when people see the slide there it is. You're going kind of high octane here. What's your view for the rest of the year?
Ning Sun: Okay so long Turkish lira and shorts and that's my trade idea. So so far this year for investors we have had the past has been a roller coaster. And why is that? I think it's because the US Treasury market is pretty much driving everything. And to be honest, I think the path, the future path of the fed easing cycle remains unclear to me. And what do we do? And as a strategist, how to find a good strategy in this environment? Highly uncertainty. So now imagine you're going to a music concert. You have two choices in front of you. So one is a symphony orchestra with the conductor called the fed. Another one is a solo violin performer who doesn't need a conductor to finish her job. So how do you do? I think the problem of the first choice is that this conductor could be grand and the best, but the problem is his next move is going to be highly unpredictable for all the players in his in his group. And then if that's the case, I mean the chance to deliver a good performance, I don't think is that high. Okay. So instead I would go to the second group. I advise clients to go to the second group, you know, and just sit back, enjoy the solo performance and your job. And my job is to identify this star performer. Okay. So right now I think this star performer, which is your alpha is. Era. So I have three strong reasons here. So for the strong three reasons, I give you three numbers 50 and four and 70.
Ning Sun: Okay. Each matched a good reason. So the number 150. That's I think that's pretty famous. That's the nominal interest rate you are going to earn as an investor by holding long the Turkish leader position. Because the central bank rate at 50 I think they might not be the end of the cycle. There could be a possibility they can hike again. Why is that? Because underlying interest rate I mean the inflation is 75% year over year. That's pretty scary right? But you have a 50. You have a 75. That's negative real interest rate. But I think the real question is are they going to with that tightening Lohr inflation by the end of the year I think the chance is pretty high. And then that goes to our second number which is four. So what is the magic four number. That is the actually the number of years president Erdogan doesn't have to worry about elections okay. And that is important. Why? Because I'm thinking for the past several years, the central bank governor is de facto actually President Erdogan. He actually always, always Lohr interest rate just to stimulate growth, to get himself into the job, to win the election. Right. That has created all sorts of troubles for us. All right. And now he doesn't have to worry about inflation for four years, and he put the right person into the job. I think the longevity of this right person, which is Minister Simsek, is going to be decently good enough for investors to be long Turkish assets. And now we go number four. Number three number is 70.
Ning Sun: What is that? That is the highest peak of foreign investors exposure in local Turkish bonds. 72 billion. That was right before the bad things happened. What we have now I can tell you what happened last year. The Lohst level is only $900 million. So foreign investors were spooked. They left the market. So right now I think they're warming up to the game. We had inflow pretty strong inflows last week or indicators show that as well. So right now the exposure jumped to 10 billion. But compared with that 70 billion back then which was just two years ago, there's still a lot of room to go. So don't be afraid. I know that Turkey has delivered a lot of good performance already, but there's still plenty of room to go. I want to finish the Turkish argument with another one. So Turkey is famously have a deep mis distortion in the economy, but I can say that the fix of that is not that difficult. Why is that? Because Turkey, even with all those distortions, still maintain a very solid banking sector. So one, a country has a very solid banking sector. When you put the right policies in there, the banks are going to work hard to make the recovery easier. So the second one is that Turkey still has a very competitive export sector. So when you have the exchange rate and inflation, you know, get corrected, the the export sector will be will be the, I think, a very important engine to drive the recovery and and the third one, which is I think is the most important one, is fiscal balance.
Ning Sun: So even though the fiscal deficit has been widened during the past several years, but the debt level of Turkey is remains low, it's only, I think, still below 40% of GDP by any standard, even emerging market standard. This is really low. So with all of that, I think with the right person, no pressure on the politics and the still good underlying economy. I think the turnaround story for Turkey is going to be a big one this year. And so this is my long side of the story. And flipping to the short side as a strategy, we have to have a good short to support the long. I pick China chnge. So even though we saw that there's some improvement on the CPI front, but underlying growth recovery of Chinese economy remains pretty weak. So that means that this economy doesn't need a strong currency. So I think even if in case in the future, you know, this is a weak dollar environment, I think there is the Chinese CNY still should have this depreciation bias. And at the same time they also need to cut their interest rates. I don't think inflation is going to be a problem for them. They worry about deflation right. So that means that room for cutting interest rates should still be there. That means we just see that as a cheaper alternative funder for a long position versus the dollar. So with that, I think the Turkish lira is the star performer for investors. Long Turkish lira short CNY chnge is the best trade idea.
Tim Graf: Very good. A couple of questions on that. Alberto didn't cover Turkey in his presentation, but I was curious to hear what the trends in inflation are because this is you know, we've been here before with Turkey. We've trusted that, okay, this time is different. They're going to stay out of the way a little bit. And policymakers then generate inflation and the whole thing blows up. What are the current trends online that you're seeing in Turkey.
Ning Sun: Oh that's important. It's very important actually. So the latest print of CPI. 75% of your year. But you can look at month over month numbers in May. I think turkey print is something like 3.4 ish. That's a monthly number, very high. But you look at price stats which are showing the June number I just checked before I came over, it dropped down 1.5. Okay, so the trend is there. The gap is pretty wide, indicates there's a big potential for them to decline. And you see all the tightenings I think the monetary policy tightening fiscal tightening loan growth is coming down. That should also all supportive of the disinflation cycle in front of you.
Tim Graf: And one last quick one. So right now carry to vol ratios for currencies are really elevated. That's often a good mean reversion signal because either vol is too low or carries about to go away. And you have chosen about as big of a carry trade as you can get. So what insulates you if you do start to see mean reversion in volatility in particular, what insulates you from that volatility.
Speaker8: Yeah I think.
Ning Sun: Central Bank of Turkey in a little bit unique situation. So they're in the process of building reserves. The reserve building has been pretty fast for the past month. And actually we're seeing all the inflows from foreign investors that has been sending the tailwind for the appreciation of the Turkish lira and the central bank actually on the opposite side of the table. So they are actively buying dollar, selling lira, trying to depreciate, slow down the appreciation a little bit. Meaning another time there is surprising volatility right to build up effect reserves. To be honest the effect reserve has been low and is still low. This is still a work in process progress. So they understand that. So I think the buying of reserve to suppress volatility is not a problem actually your friend once you have higher reserve next time external shock hit you have you know better better.
Tim Graf: There's your insulation. Yeah. Very good. Well we are starting to come to the end of the session. I think we've gotten two pretty opposite sides of risk appetite here. And so we're going to come to vote now and we can bring the voting slide up. We have ning giving us a very healthy dose of, of optimism to balance out perhaps some of the more downbeat views from from Dan and Marv. So let's let's get our results in. We'll wait a little bit and then we'll see where things come out. So we have underweight us duration starting out with a little bit of a lead. Just it's pretty pretty balanced.
Dan Gerard: Question from Marv. Your situation doesn't seem great for banks, does it?
Speaker9: It depends which bank.
Tim Graf: Might cancel each other out here. It's getting very tight. There's no clear winner here.
Dan Gerard: I'm out. It's been nice working with you guys.
Tim Graf: I'm loathe to cut off the voting, although we've only got a couple of minutes left. I don't know if. If Ning's lead is going to be surmountable, though. We've got four people voting. Oh, it's. It's getting very, very tight. I don't know if I remember seeing one this tight.
Ning Sun: This feels like a Mexican election to me.
Speaker9: Yeah. The room maybe more like the.
Tim Graf: U.s. election, which is really interesting. Underweight duration is second ning though I think we've got 70 votes in. It's going to be pretty hard. We've got one person voting. They're done now. I think Ning we have to call it for you. You get the pride.
Speaker9: So I've got to keep my job right. Yeah, yeah. You get you get to.
Tim Graf: Keep your job. You get the pride of being the audience's choice. You also, though, get a special surprise. Today not only marks the debut of the live version of Street Signals, it also marks the debut of Street Signals merch. As the winner of the podcast, I present to you a.
Speaker9: Oh thank you. Pass that down.
Thank you everyone. The cut. Well done.
Speaker9: You've won the cup.
Tim Graf: As the product line expands, we'll be back and.
Speaker9: Hopefully you can.
Tim Graf: Compete for street signals, beer cozies, and t shirts and caps. To all the guests on the panel though. Thank you so much for your thoughts to the audience. Thank you for your participation. This episode will be out. Hopefully my editing software permitting will be out early tomorrow so you can listen to it then. If you haven't listened to Street Signals, as Lee mentioned, you know it's on all of the platforms. There are QR codes floating about here that you can. You can access it on Apple and on Spotify. Please do give it a listen, leave a review, hit that like button, do all of those things. It helps us to really build the audience. It helps us to grow. It helps us to improve and subscribe as well. That also helps quite a lot. We are fast becoming what I think is one of the best market focused podcasts out there, and with your feedback and help, we can we can definitely improve things even further now. New and improved with merch as well. So thank you to everybody.
Speaker9: Thank you, thank you.
