Last updated on June 28, 2022

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Deer Point Macro joins the podcast to discuss his view that the U.S. Federal Reserve will only hike interest rates once more before easing.

Content Highlights

• The Fed is not some magical organization that can control all parts of monetary economics (2:50);
• The Fed can create demand for credit, but banks have to provide supply. And banks are pushing back (5:03);
• What to make of the Fed’s rate hikes this year? How has that affected bank portfolios? (9:37);
• The eurodollar market plays a significant role in Fed policy and its implications. An explanation (13:24);
• The Fed stands to raise once more, at its next meeting in July, before having to cut rates in September (16:21);
• Inflation is stubbornly persistent. Doesn’t this force the Fed to raise rates? (19:57);
• Background on the guest (30:14);
• Markets don’t really react to ADP employment data, but for economic detective work it can be vitally important (31:48);
• How this all translates to asset prices: good for bonds but commercial banks are maybe not as safe as some would think. But regional banks may be a better bet (35:11);
• What about cryptocurrencies? (36:34);
• Quick discourse on the so-called ‘Fisher effect’ that posits that inflation rises as Fed funds increase — over the long term (39:14).

More on the Guest

• Substack: DeerPointMacro.substack.com;
• Twitter: @DeerPointMacro;
• CommonStock: DeerPointMacro.

Transcript

Nathaniel E. Baker
Here with Deer Point Macro, who is joining the Contrarian Investor Podcast to discuss his view that the Fed — the Federal Reserve — will back off of raising interest rates this cycle. Of course, the question is exactly when the Fed will back off, and how high the Fed will go with interest rate hikes, which are the Fed funds rate is currently what 1.5 to 1.75%. And Deer Point Macro here has a bunch of very contrarian views on this, obviously, the premise that the Fed is going to stop this tightening cycle at any point soon. Is it self contrarian at this point in time, as we record this on Wednesday, June 22. Right, as Jay Powell is testifying in front of Congress, but enough for me, dear point, macro over to you tell me, why will the fed back off in your view,

Deer Point Macro
I think the first thing that people have to kind of think about when they think about interest rates, is kind of maybe get rid of this idea that the Fed has some magical organization that has the power on the liquidity side to kind of be able to set interest rates wherever they want them. If you scan Twitter, sometimes they’re just sentiment people are like Powell should just raise interest rates, you know, five 6%, and just just really get this ball moving. The issue is, the Fed doesn’t really have the ability to do that. And this goes back to the great economist, Milton Friedman, who said, after the US experienced during the Great Depression, and after inflation, a rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s. I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies Never Die Hard. And so I’m sure for anybody who’s just now for the first time hearing this quote is like, did this manager say that high interest rates are identified with periods of, of loose monetary policy? And that is exactly what Milton Friedman was saying.

Nathaniel E. Baker
Hmm.

Deer Point Macro
And so he was kind of vague in the way that he went about kind of explaining this, but something that was based on maroon macro’s research, and then I’ve kind of updated was looking at the year over year volume of credit issuance. And so what I found, based on his research, is that every time you had sustained higher interest rates, you hadn’t an uptick as a pretext in the year over year volume of credit issues, whether you’re looking at total credit loans or debt securities. And we haven’t really seen banks increase, year over year volume of credit issuance, they have not really been extending credit. And it’s kind of been this way, more or less since the GFC. And so this idea that people have, where they think the Fed is going to be able to sustain higher interest rates, I think is kind of a false premise. Because in my research, and what I’m believing is the banks are going to push back so hard on this, and the banks don’t really have any incentive to to extend credit. That idea of sustained interest rates is not going to be able to actually come to fruition.

Nathaniel E. Baker
Okay, so there’s a lot to unpack. So this idea of credit issuance. And the premise is that when interest rates are low, there is more demand for credit. And you are not disputing that part, right?

Deer Point Macro
Yes, yes. I’m not disputing that part. Exactly. When interest rates are low, there’s more demand for credit. That’s the demand side. The other part of that equation is the supply side, which is the banks, institutions, investors, who have to decide who to lend to at these lower interest rates. And that’s usually what’s missed when people discuss low interest rates.

Nathaniel E. Baker
Right. And now, is this just a matter of banks don’t want to lend at low interest rates because there’s less in it for them? There’s less of a spread of a profit margin, I guess? Is it as simple as that or what else goes into that?

Deer Point Macro
So for me, I think that It’s a lot of things, I think there are so many other things that banks can do now that are relatively risk free, why would they want to go out and lend? One of these big things, and I didn’t actually talk about this of my sub stack, but one being kind of what’s been happening at the reverse repo window. So, you know, there’s, there’s been, you know, quote, $6 trillion or so that has has been extended on the fiscal side. But about $2 trillion of that has now been kind of tied up in the reverse repo window. So none of that is actually being lent out in the economy. It’s just kind of tied up in the banking sector. The other issue was, after the great financial crisis, we used to have a floor system for the interest paid on excess reserves. So that’s any money that’s parked at the Fed. The issue was, after the GFC, they changed this to to kind of a corridor system. So they raised the, like the rate paid on interest on excess reserves. And so banks have not really had any reason to lend. Because right now, I believe that rate, when I looked at about two weeks ago, was about 90 basis points. So why would you go and lend or even go and buy a one month treasury, when you can just earn 90 basis points, pay them interest on excess reserves, and they actually have an arbitrage opportunity there, where they can actually go in arbitrage between the LIBOR or now the so far right and earn another 150 basis points. So, you know, you’re talking somewhere in the ballpark of 250, 240 basis points, relatively risk free.

Nathaniel E. Baker
Yeah.

Deer Point Macro
And I think this is the larger incentive that banks have had not to really go out and extend credit.

Nathaniel E. Baker
Okay, so this is something I remember hearing about after the financial crisis about how all these banks were unwilling to loan to extend loans, but I was not aware that this was still going on. Now, what about non bank lenders, because you have other sectors, other things that have cropped up over the last couple of years, that are that are making loans? I mean, some of them are on the corporate side or hedge funds, right? So what about that to pick up to, you know, make up for the supply, the the lack of supply has that been something that has at all materialized if that is part of this equation or not?

Deer Point Macro
It has materialized but it’s not to the same like, like loans, if you if you look at small, like even like, you know, be lenders etc, is not the size of the, the loan growth that goes on on the actual commercial banking side. And, I mean, you have seen that throughout kind of the pandemic, because, you know, some people were working part time, or they had to take, you know, lower paying jobs because they got laid off. And so you did see, like, kind of this turn to, I don’t want to say like loan sharks, but you know, like these sharks, more or less, where people are paying these atrocious interest rates, but again, that’s, that’s a much smaller of overall sorry, proportion of loans that are actually issued, most of this is driven by by commercial banks. So they’re the real important player in the game.

Nathaniel E. Baker
Okay, now, what I’m still struggling with here is how this translates to the Fed’s inability to raise rates. So the Fed has now you know, over the just this year raised rates, a whole bunch, obviously. And normally that would cut credit, at least the demand and credit. So But how is your how is this working out? In your view?

Deer Point Macro
Yeah, so the thing that I think is most important when you kind of look at this is, first, what I’ve been looking at this is how banks have kind of structured their portfolios. And so basically, what they’re doing this, they’re borrowing short and lending long, you have a yield curve, inversion, this kills profitability for banks. So banks, again, who actually are more active in the bond market, because they’re actually the ones buying from the primary brokers have a lot more ability to kind of fiddle around in the bond market, that belly of the curve, to actually be able to kind of set interest rates, more or less where they want them. And you saw this, I think this was back in 2018. The banks, they didn’t pass their their audit. And actually the funny thing about this as the audit that they actually have to go through is actually they’re given everything that they actually have to do to pass the audit. They still failed. The Federal Reserve tried to raise rates on them. And what actually happened was the banks pushed back and then the Fed ended up dropping the that was the interest on excess or not the interest on excess reserves. They dropped the was the reverse repo window. Yeah. And so anyways, they they dropped one of the His rates because the banks push back on them so hard. And so within this, you always see the ability of banks to actually be able to set interest rates, obviously, because when they’re more active in the bond market, so that belly of the curve, they have more ability to set. And they are also from from the actual credit point. In the profitability standpoint, if the Fed continues on this, and the yield curve, inversion gets worse, banks are going to bleed so hard. These are going to be the people coming to the Fed and saying, either you’re going to have to bail us out, again, because we’re having compression or solvency issues, not all banks, right. But I mean, there are banks, I don’t want to mention exact names within the US that even after oh eight really not really didn’t get back to being well capitalized. That would just suffer so bad, you could end up into a position where you could I don’t want to say see another GFC. But where you do start to see the possibility of bank failures.

Nathaniel E. Baker
Interesting. Well, that’s that’s another thing. There’s because I always thought that the banks were well capitalized after the GFC. And the balance sheets were in a lot better shape, certainly than they were then. I mean, you have removed the whole prop trading desks. So there is that part that’s out of the equation? Of course, that’s not the balance sheet. But still, that’s really interesting. So where do you think that the Fed will stop here? With their with their hiking cycle?

Deer Point Macro
Yeah, so one thing that I’ve looked at as Eurodollar futures, and what you’ve seen on the Eurodollar futures, if you look at Eurodollar, futures, which I know, again, are based on the three month LIBOR, but if you look at those against the implied hike the spread, the spread, says the Fed will do another 99 basis points. And so you’re in that’s up until the end of 2020. So Euro dollar, pricing in another Yeah, 100 basis points, whether we get a 75 or pout comes out and surprises the market. Again, it does 100. But that’s kind of where my idea has been. They will pivot in September. So they’ll do one more in July, they’ll have to break in August, and then they’ll come back. And they will, they will actually end up backing off the Eurodollar market. And those things actually play a very significant role, also in Fed policy and the implications that it has.

Nathaniel E. Baker
Yeah, talk us through that for those that might not be aware of the Eurodollar market how that all works.

Deer Point Macro
Yeah so just think about when if, like, let’s say that the Bank of the United States (just so that we’re not using actual specific banks here) goes to the bank of of Germany — not central banks here, just just commercial banks. And parks money with the bank of Germany, people would be like, ‘okay, that money can’t really do anything.’ But because of the Eurodollar market, those liabilities that sit on the bank of Germany’s balance sheet, they actually have the ability to go and create loans against those liabilities. So they can basically almost engage in the fractional reserve banking system with US dollars and actually extend loans on the back of those US dollars. And so this is kind of a very important concept, because it shows that there’s this whole other market, and nobody’s actually been able to quantify this market because it’s completely outside of the Federal Reserve’s control. But this is kind of what the Eurodollar market is. So it’s kind of this ability to, to have either dollar liquidity to create liabilities, or just dollar liquidity in general, because even with Eurodollar markets, if even if you’re just like a manufacturer in Germany, and I’m have, you know, a manufacturer in the United States, I need to buy things from you and the transactions done is done in dollars, those dollars sit on your balance sheet, you as a manufacturer can’t do anything with those, but once you take those to your bank, they can and this is kind of the Eurodollar system.

Nathaniel E. Baker
Okay, so it’s a way for banks in Europe to access US dollars. Is that what it is?

Deer Point Macro
Yeah. And kind of create US dollar liabilities. Yep.

Nathaniel E. Baker
Right. Okay, cool. So now, what has this predicted in the past? Have you studied that?

Deer Point Macro
Yeah, so actually, every time the Eurodollar curve becomes inverted, you you actually end up seeing, usually as a pretext between three to six months after that, the Federal Reserve changing course because what that inversion kind of shows is obviously one, the Euro dollar market doesn’t believe the Fed is going to continue and to somebody somewhere. It’s probably a lot of people, but they’re hedging a deflationary or a or a possible fed pivot somewhere down the line. So it’s kind of showing also people hedging this or kind of taking the contrarian view to continue to Fed rate hikes.

Nathaniel E. Baker
Very interesting. So you’ve seen this in the past that it fronts the or, yeah, it’s about a six month or so, predictor of the Fed funds rate. And we have the fed funds now sitting at 1.75. And so you’re saying that they’re doing it if they’re going to do another 99? So bring it to three? I’m sorry, to 275. Yeah. And that will be it, do you think and sort of September, will then see a cut or just stand pat or maybe raised 25? Or?

Deer Point Macro
Yeah, for me, I think they’re going to have to cut. And this is, again, kind of something that I was looking at that I don’t think people are, again, factoring into a lot of this analysis of what the Fed does. And that is the implications of what happens abroad. And actually, my first substack I ever wrote was, is you’re doomed will the ECB pivot. And then like three days later, Lagarde came out and was like, I’m not really sure if we can do this, because like the PIIGS are blowing up, right? I mean, the the tenure of Italian bond, go, like, I don’t want to say parabolic, but almost like meme stock and so what I have actually been looking at is something that’s called the cross currency basis swap. These are a little technical. And, you know, again, like retail people, for example, like you have to have an ISDA to trade these, but they’re actually a very important indicator of dollars shortage. And so when there’s a perceived dollar shortage, that basis becomes more negative, and the basis across different tenors, whether you’re talking 1, 2, 3, or five year, tenors are all now more negative than they were during the beginning of the pandemic. And we remember what happened with swap lines. So there’s actually a massive shortage of dollars throughout the global economy.

Nathaniel E. Baker
Uh huh

Deer Point Macro
And this is what I believe is actually going to have to make the Fed pivot. Also, because if they do not, because the United States does kind of control global monetary policy, you could start to see contagion risk on a liquidity basis within Europe. I mean, credit default swaps for banks are blowing out in Europe. And I’m not even talking small banks. I mean, you’ve seen that with Credit Suisse and Deutsche, you have corporate credit default swaps blowing out, you have Euro high yield blowing out, you have like deterioration in subordinated tear to debt. So there’s there’s all of this, this, you know, which, which obviously, also hurts bank, bank quality. So there’s all of these kinds of factors that have started to kind of pull through, because the Europeans don’t actually have enough dollars to do you know, let’s say like daily transactions like they would prior I think that this is really the crux of the issue.

Nathaniel E. Baker
How about sovereign CDS, sovereign credit default swaps? How are those looking?

Deer Point Macro
The sovereigns? It’s, I mean, definitely for the PIIGS countries, they’re deteriorating, even for Canada, Canada’s Canada’s credit default swaps are actually pretty bad on this is on the five years. Last time I looked at them, I mean, Canada was trading like I think, between Portugal and Spain. And so yeah, you you’ve kind of had deterioration all all across the board. I know that France is are pretty high, but nothing like unusual. But yeah, usually it’s more just the pigs like Portugal, Spain, Italy, Ireland, Greece, all of those are pretty, pretty bad. Everyone else in Europe is kind of just I don’t think anybody’s really worried about Germany, France is, like I said, are a little bit elevated. And those are kind of probably the ones that I’d be most worried about.

Nathaniel E. Baker
Okay, that’s really interesting. I was not aware of that. I have not been monitoring that situation at all lately. But okay, here’s another another factor here that you haven’t mentioned yet, which is inflation. And, obviously, the Fed — Yeah, they they need to supply liquidity to the banking system, but they also have very real inflation. And, you know, the CPI and whatever 40 year highs, and then the PCE also at, you know, I think multi decade decade highs so and it’s not it’s not it hasn’t peaked either, because the most recent reading that we saw for the CPI actually increased a bit, I might have fallen a bit for the core CPI but and that’s what has obviously got the Fed hiking rates here in the first place. Now, what do you make of all that? And is that not something that is going to keep the Fed in a bind where they have to keep raising rates?

Deer Point Macro
Yes, this is actually something that I’ve studied very in depth. And I think that we actually haven’t seen CPI start to come down. I think there’s a little bit of a lag. But one thing that I have been looking at was between April of last year in April of this year, you had about 1.6 or 1.7 trillion in consumer spending. This came on the back have about a 1.5 trillion or 1.6 trillion, I don’t have the data in front of me drawdown and consumer savings, and a about $120 billion increase in consumer credit card debt. So so there you can see everything kind of adds up the, the $1.6 trillion or $1.7 trillion we can we got for consumer spending came on the back of draw downs and savings, plus the additional increase in credit card debt. So, this is showing that, like, you know, consumers are not really in a good place to be able to continue consumption, and the way that they’re doing that is on the back of either drawing down savings, or going to the credit card. And so how this kind of factors into inflation is that if you started to look at what happened, beginning of the pandemic, it became very much a supply issue. But now we’re starting to see demand cool, as the supply chains kind of get worked out. And we’re also kind of seeing retail inventories, if you’ve looked at wholesale or retail inventory numbers are extremely elevated on a month over month basis. I think retails at all time highs and wholesale might be the second highest number on record, or it might be the inverse of that. But so so kind of what you’re starting to see now, is these rising, like, you know, inventories. And so for me, that’s obviously one deflationary. And two, you’re kind of having the already the consumer start to start to more or less wane. And so I think that this is going to start to pass through to corporations saying, okay, consumers are no longer able to to afford higher prices, what do we do, because really, the ability to continue to pass those costs on is going to start to decline. And then I’m, I’m projecting that, you know, once you start to look at margins, margins are going to start to get compressed, not even from a stock market standpoint, but just from a regular corporate standpoint. And therefore, you know, one of the largest inputs in hiring is future projections of profitability growth. And so if margins are getting compressed, I think that we are going to actually see a, like kind of a stoppage of hiring, which we’re already starting to see in a lot of these tech companies. And then the whole unemployment factor is going to start to actually pull through, I think we’re already starting to have the wheels turning on that. This actually just hasn’t been pulled through into the CPI and the PPI and even the unemployment data. And even with employment data, usually what I look at is the APR, or the ADP sorry, the ADP, payroll data.

Nathaniel E. Baker
Oh really, you look at that ahead of the other one, the Bureau of Labor Statistics one?

Deer Point Macro
Yeah, I look at the ADP, because they, they actually have the, I would say the most in depth, like kind of up to date research. Because if you go to almost any office in the United States, you log into an ADP system. And so what you saw his companies with 149, or one to 49 employees, so small businesses lost in in May 123,000 jobs in April, they lost 91,000 jobs, the new number hasn’t come out for this month. But you’re already starting to see deterioration kind of in the backbone of the economy, these these small businesses that have to cut costs, and usually employment costs being the highest. And so I think that this is also kind of a pretext to what’s going to end up happening at the corporate level. And then I do think inflation is going to come down, it’s probably I’m not saying it’s going to get back to the 2%. But I think that we’re going to see a pretty drastic rate of change. Maybe we see it at three or four, soon, I’m assuming by the beginning of next year. So you know, we’re looking at like maybe a six month period, because you know, everybody knows that kind of, or people might not know this, but like the CPI lags about 12 months. So so we might already actually be in kind of this deflationary environment, but because the CPI is a lagging indicator, that data hasn’t really all been pulled through yet. And so this is kind of why I’m thinking maybe give it six months and we’ll start to see the CPI drop.

Nathaniel E. Baker
Will that really allow the fed enough to declare victory over inflation? I mean, if we’re looking at September and the CPI is still printing 5, 6, 7 percent whatever it is, what can the Fed say, ‘this is a lagging indicator, and it’s gonna come down trust me’?

Deer Point Macro
Yeah and this is why I might be wrong. But you know, when I look at it, I you know, this bout of inflation isn’t monetary. You know, when the when the federal government sent out those semi checks, they that was a complete fiscal injection. So this is nothing that the Fed really did. And in so like, you know, this, this idea that they can really do something about what we have with like, you know, inelastic supply supply curves, they don’t really have any ability to be able to control that. Sure, they can try to hit consumption and destroy demand. But like even right now, I mean, yes, people have drawn down. And you know, that 1.6 trillion, like I said, came from credit card, increase in credit card spending and drawing down savings. But the thing is, it’s like, if you actually look at, you know, retail sales, the divided by personal consumption expenditures, still 48% of of consumer consumption was spent on goods, and the historic average is 23. So we’re still well, well elevated above the historic average of what consumers spend on goods. And so like, even now, you’re just not seeing consumers really care what the Fed is trying to do to destroy demand, you’re seeing it in the housing market, but on the actual, like consumer level, where will it be enough to hit that seat component of GDP, being consumption and get us a negative consumption number? I’m not sure if they’ll be able to, to get us there. And again, because this bout of, of inflation isn’t monetary raising rates, it I don’t think is really going to do much besides putting more pain on banks and put more pain on just the average American consumer, who, you know, now with credit cards, for example, has to pay a higher interest rate on their credit card bill.

Nathaniel E. Baker
Wow. Yeah. I mean, that’s really quite a conundrum. We’ve got the Fed. And then if all you’re saying holds true, yeah. Right, because they’ve been caught asleep at the wheel before, I mean, their whole mantra of the being transitory. Last year, which, who knows, maybe even been true, but it didn’t, certainly didn’t look good. When you had an 8% prints after that, or 9% prints or 10%, whatever it was. Cool. All right, Deer Point Macro, I want to take a quick break and come back and ask you some personal questions to the extent that we can, of course, as this is a you’re under a pseudonym, so we don’t want to violate that in any way. But there is some personal information that just about your background, and professional, I should say more than personal that you can provide our listeners. But before we do that, I want to take a quick break. If you are a premium subscriber, do not touch the dial, you will not get the break. And we’ll be right back. In fact, we already are everybody else hang out for a minute.

Nathaniel E. Baker
Welcome back everybody. Here with deer point macro. Has a sub stack. Is it Deerpointmacro.substack.com?

Deer Point Macro
Yes, it is.

Nathaniel E. Baker
Yeah. And you have we’ve talked a little bit about or a lot actually about interest rates and inflation. This is the segment of the show where we ask our guests about their background, how do they came to this station in their career? So obviously, you can’t divulge your employer or your name, nor are we going to ask, but I’m curious, just in general terms, what your background has been like to get you to this point.

Deer Point Macro
On the schooling side, my background is in economics. So I have my just like my BA in economics, nothing, I don’t have like a grad or PhD. After that I went to work for I am an American. But this time I was in Canada, I went to work for a bank in Canada, I worked on the capital market side, mostly dealing with, with like, equity research with regards to mutual funds, and kind of, you know, helping find companies that we were going to possibly put into, you know, future mutual funds that we ended up issuing. Then after that, I kind of went to work on the rights desk and FX desk. And now I came back to Canada, again to work on the mutual fund side. So I’m back in kind of where I got started. So that was kind of my, my whole background.

Nathaniel E. Baker
Nice. And so let’s talk about this. Now this this whole idea. First of all, I thought was interesting what you said about the ADP, payrolls, because on my daily show, I basically I’m telling listeners to ignore it, because markets don’t really pay all that much attention to that —

Deer Point Macro
You’re 100%, right, the bond market doesn’t care about the ADP data. But I think the ADP data is is kind of the more important data that to look at, but yet bond traders from their trading, they just care for that employment number, and then they go from there. But for actual economic detective work, I would say ADP, ADP data is pretty important.

Nathaniel E. Baker
Okay, but it is something new, I will have to pass on to my listeners when that is released. But luckily, it’s every month, not every week, like some of these other metrics. Speaking of which, what other kinds of things do you look at here? He touched on the Euro dollars, and some other stuff. What other types of stuff do you have? What kind of screens are you monitoring? And maybe, yeah,

Deer Point Macro
yeah, so So I monitor kind of a lot of things, but it’s mostly derivative products. So Like, I’ll monitor swap spreads, which is just a fixed like vanilla interest rate swap against a treasury of a similar tenor. So I monitor swap spreads, I monitor obviously, cross currency basis swaps. I monitor the Euro dollars to Eurodollar Futures Curve. And those are kind of the mostly the things that I look at there are some things like, you can look at the DIS swap on the on the Treasury curve. And that can kind of tell you what, what is being projected, because that area of did like the swap on the Treasury curve isn’t really controlled by the Fed. So it’s actually like, if you look at the swap, there’s there’s a pretty big, not a large discrepancy. But there is a discrepancy between that and the two stents curve. And so I look at those two and see whether or not it’s widening. And that also has implications. And so yeah, it’s mostly derivatives and rates, things that I monitor mostly.

Nathaniel E. Baker
Yeah. So this is something for professionals, not for, for retailers. But maybe just to quickly put this into context. So swap is when an investor wants to swap out an interest rate, the interest rate, and they’re getting on a certain instrument for another one, right. So in this case, the Treasury there. So you’re monitoring, basically the demand for swaps? Is that right? For demand for new interest rates? On these things? Is that what it is?

Deer Point Macro
Yeah, so So that’s what I’ve been monitoring, because that’s also a very interesting kind of implication of where like, you would think if the Fed was raising rates, you would actually have that swap spread, reinflating, however, it’s still still negative. So that, again, is kind of this this, this idea that people aren’t really like engaging in the swap market. There’s other like more technical reasons, that could also be happening. But that which kind of goes back to Oh, eight and balance sheets, actually never really been repaired. So that’s kind of Yeah, but exactly. That’s, that’s the swap market. And then the Euro dollar mark, or the sorry, the the cross currency basis swap market, like I said, it’s just a measure of very, like untechnical terms and marry a level of dollar shortages, as as perceived by an additional premium for that.

Nathaniel E. Baker
Interesting. All right. So as far as the all this translating into, you know, asset prices, I mean, you would think that all everything that you’re saying would be good for bond markets and deed today, bonds are taking are seeing massive bids, which is kind of weird, considering Powell was talking about further interest rate hikes. But so you would think for that, and then But then also, it doesn’t sound like you’re, you’re not a stock’s guy, obviously, but doesn’t sound like the banks are necessarily as safe as people might think. Do you think that’s a fair assessment?

Deer Point Macro
Yeah, that is, that is definitely a fair assessment. And I mean, I talk about that a little more length, but like, it’s just, yeah, I would be scared about banks, regional banks, however, just because they don’t participate in capital markets, or like, syndicated loans. If you actually look at the ratio, and anybody, I believe, can do that. The ratio between the the banking index, like the the large commercial banking index against the regional banking index, you’ll actually see regional banks have actually outperformed quite a bit. And that is because of that less exposure to to capital markets.

Nathaniel E. Baker
Okay, here’s just to throw something different, a little different at you here. cryptocurrencies. This is not something that we talked about on this show, except that I’m curious. And I’m wondering if this is something that you are watching at all the counterparty risk on these, and the fact that you’re going to have kind of collateral effects from all of these crypto exchanges and crypto brokers and crypto investors kind of potentially going belly up here, as the bottom falls out on on Bitcoin and other digital assets to the extent that it does. But in your work, how much demand are you seeing for crypto? I guess there’s two separate questions. But to what extent do you think that’s realistic to be concerned about that? And do you actually see any real use for Kryptos in your work?

Deer Point Macro
I personally don’t. I have a buddy who works for a bank, like an actual regular bank that did have a crypto fund, I guess you could say and it’s been an absolute disaster because according to basil, the basil accord, if you do hold crypto assets, for every $1 of crypto, you have to hold $12.50 In collateral. So this is a huge risk weight. Right? Obviously, is that deteriorates those risk weights. Yeah, yeah. And he’s like our value at risk models, which is kind of a weight to how would I explain value at risk? Since the risk of risky Yeah, just just yeah, the kind of the long term tail risk return. Yeah, they they have said that it’s been an absolute nightmare on overextension of what they were prepared to really be able to capitalize, or we’re projecting that did capitalize from the losses. So yeah, I don’t think in the near term, just with the volatility of crypto, any bank is going to be rushing out even with quiet demand to try to fill that I don’t even think there’s going to be client.

Nathaniel E. Baker
The other option the other. Right. So

Deer Point Macro
yeah, yeah, it’s been bad for banks who have, because, you know, they, these banks didn’t get in when it was like, you know, hey, a lot of these banks started in like 40 or 50. Right now. Sure. Sure. Sure. Yeah. So

Nathaniel E. Baker
and as far as the system, any systemic risk from this, if there is an implosion?

Deer Point Macro
Yeah, I just think at that point, they I’m not sure what they would do either shut down the fund or, because I mean, this would be such a or the bank would just end up shutting down the desk that’s dealing with with that, that would probably be the two things that the losses sell.

Nathaniel E. Baker
Right, but it’s not like the mortgage desks in the mid 2000s?

Deer Point Macro
Oh, no, no, not that much exposure.

Nathaniel E. Baker
Right. Yeah. Maybe if you can talk us through the the this thing called the Fisher effect, which is the premise that inflation rises with Fed funds, which seems to be counter to everything that you’ve just been talking about. But if we have rising Fed Funds, how does that translate into higher inflation?

Deer Point Macro
Yeah, yeah. So this is this is in the long run, right. So like, for people who are assuming that, for example, you know, interest rates will stay or should stay higher for, let’s say, perpetuity. The theory is that, you know, you have the real interest rate, you have the expected rate of inflation, and they have the nominal rate. And so like over a period of time, in the short run, if you raise the nominal rate, you will have an increase in the real rate. However, you know, as time passes along, the real rate of interest will move back to whatever its equilibrium was. And the actual rate of inflation will increase one for one with the rise in nominal interest rates. And I do have a graph on my Twitter, as well as my substack, where you can actually kind of see that, like a theoretical version of that model. But then you can also see the year over year percentage change in the PCE index, and the effective federal funds rate. And what you actually see is that the slope is actually consistent with the idea that inflation tends to rise as the Fed rates increase as well. And I know, one of my buddies, he has his PhD in economics. And he was like, well, you’re looking at this on like, a very long term. So like, why not look at it on the short term, but then I came back and said, well, the Phillips Curve works in the short term doesn’t work in the longer term or the long term, right. So so you kind of have to look at things and Fisher was specifically talking about the long run, right, and how long the long run is, in economics, nobody knows. The short term for the Phillips Curve is a decade, right, which I don’t think anybody would say is a short term, but in economic terms, yet the Fisher effect only works on a decade period. So yeah, this is kind of what the Fisher effect states.

Nathaniel E. Baker
I was gonna say, when was the last time the Fed was able to keep interest rates? Higher for any sustained period? Yes, you can make this point there was during the Bernanke fed, maybe, I mean, he got up to like, what, five or 6%? there at some point?

Deer Point Macro
Yeah, like five or 6%. And then yet crashing back,

Nathaniel E. Baker
which isn’t high, historically. But yeah.

Deer Point Macro
But I do think that there may be the last thing and I’m sure anybody who’s familiar with Lacey hunts work. That’s also a kind of a good place to, to, to read about debt. And he talks a lot actually, about Irving Fisher. Because Irving Fisher kind of says, you know, in short terms that, you know, the creation of debt does represent an extension and broad money supply. The destruction of debt actually equates to contracting the money supply and so therefore, debt in and of itself is deflationary by nature, because at some point has to be repaid. And kind of my last point that I’ll make is I know that people quote Milton Friedman a lot on inflation as always, and everywhere a monetary phenomenon. And I love Friedman. When Milton Friedman wrote this, it was between the 50s and the 70s. But it this remained true up until about the 90s. The velocity of money was constant. So yes, an increase in the money supply per unit of output did lead to an increase almost a one for one increase. In CPI. However, now that we know that the velocity of money is no longer constant, increases in the money supply actually have no effect really, on the rate of inflation, they’ve completely diverged. Because all of that velocity is trapped within the banking sector. So it’s not out in the economy being spent. So those those were kind of two other points that are very interesting. substack.

Nathaniel E. Baker
Cool, very cool. Yeah. You mentioned it. So in closing, I mentioned the substack DeerPointMacro dot sub sect.com. You’re active on Twitter as well. Is that just DeerPointMacro?

Deer Point Macro
Yeah, just just add DeerPoint Macro. And then obviously, also common stock for anybody who has those

Nathaniel E. Baker
common stock also. Yeah. And that’s Deer point macro too?

Deer Point Macro
Yes. Deerpoint Macro. So yeah, cool.

Nathaniel E. Baker
I will link to those in the show notes. Wonderful. Well, this is very interesting, very enlightening conversation with your point macro, please do check out his work, to Deerpoint macro.substack.com Or @DeerPointMacro on Twitter, or the same name on common stock. And with that, we thank you all for listening. And look forward to speaking to you again next time.