Hello my friends. Today is August 8th and this is markets weekly. All right, so last week was actually a very exciting week in the markets. We had basically the major indexes crash up with the S&P 500 make new all-time highs. And in addition to that, we also had a joint US Japan currency intervention, something we haven't seen in decades. So first, let's talk about what could be leading the market to crash up. And secondly, let's talk about this yen intervention and why they did this and what else they could do because it doesn't seem like it's working all that well. All right, starting with the markets. So over the past few weeks, the market has looked to me pretty weak. Now the major indexes had been rangebound, so not making new highs, losing momentum. The AI trade had shown signs of crumbling with the CSP, the vanguard of the AI trade imploding 40% in one month and basically losing its mojo. And of course, looking at interest rates, they had been trading higher, driven in part by the higher energy prices from the Iran conflict. Now, despite all that and despite looking pretty dicey right after the Fed meeting, in a few short days, the indexes basically went straight up. In fact, you had this very interesting spot up vol up dynamic where you had the index prices going up and implied V going up as well. This is something that we often saw in single stocks where people or speculators would basically load up on calls and squeeze stocks like SanDisk or AMC higher and higher as market makers had to buy the underlying to hedge their exposure. But this time it was on the index level. It could be speculators just loading up on calls, fearing to miss the upside. Smart options people like Jim Carson Swan have also suggested that investors with call overriding strategies, so selling calls for income basically had to cover contributing to the squeeze. But in any case, these spot up dynamics are pretty unstable and can lead to these VTOPs and sometimes it can go on for weeks. during the dotcom boom. It went on for months, but it is in my personal view definitely something you see on the later cycles of a bull market. [snorts]

Now, what drove this sudden change in sentiment? I think there are a few pretty big things that happened. Well, first off, you have the evergreen idea was coming. A deal was close with Iran. Now the president backed off on his escalation and there's more and more noise that suggests that some kind of deal or memorandum of understanding version two was was happening. Now we have increasing reports that the US has basically spent is in a lot of its interceptor stockpile and so they really don't have the ammunition to go into any real conflict. Now, we already have many reports where the Iranians are shooting missiles on US bases and hitting targets and hurting people. Part of that is because there is just not that many interceptors left. Now, the way that, you know, government works, there's a ton of people in the government. Everyone has different views, motives, and before the war even began, we had people, very high level people in the military leaking to the press that this is going to be a disaster. And it seems like again uh you have people within the um institutions who realize that this is a disaster and this can't go on seemingly trying to make their case again leaking to the press that guys uh this is this is not good and uh that that seems to be working. It seems like within the administration there is more and more of an urge to get out uh realizing that there is no military solution. Now, the Iranians seem to be emboldened by this, realizing that they do indeed hold the cards and so reports suggest that they're asking for pretty hefty transit fees through the straight of Hormuz. And you know, at the the endgame is basically the US having to acknowledge in some form that the Iranians control the straight of Hormuz. That would be a very clear defeat. Uh but but it would end the conflict and you do seem oil prices kind of wavering a bit. So, but that is inevitably the direction that we're heading towards. And so, I think that in increased peace talk thing is uh is taking away a headwind from the markets and suggests that you know maybe interest rates won't have to keep trending higher and higher. Now, related to the interest rate front, we also had a very interesting non-farm spirals report. Now, the market was expecting maybe maybe 80,000 jobs created. Uh we actually had a loss of 20,000 jobs. though looking at the headline number that is a bad jobs report. The US is losing jobs and the knee-jerk reaction from the market was to price in uh less probability of rate hikes. So incrementally a more doubbish Fed. But that's just that's uh I think that might be a little bit too simple in interpretation of the jobs data because the other interesting Rinko is that the unemployment rate actually trended lower again. So we had the same thing happened last drops report whereas the unemployment rate trended lower. Now what the Fed has been talking about over the past few months is that we have these big demographic shifts in the labor market. You have say aging boomers less immigration and so forth. So they're not really sure what a good uh monthly jobs creation number is. uh they are leaning towards monthly job creation numbers of of zero being good enough for the economy given current trends in the labor market. So having a negative print here and there isn't out of the wouldn't be uh unexpected. So for them their emphasis has been the unemployment rate and the unemployment rate is unambiguously trending lower. Now that suggests that the labor market is actually tightening. So from that perspective, this would have actually been a hawkish drop print because it suggests that the labor market is is uh potentially overheating. Now one very strong push back against that is that wages haven't accelerated. If you were expecting the labor market to overheat, unemployment rate continue to trend lower, you would expect employers to bid up um labor costs and so accelerating wage growth. We're not seeing that. And you know, looking at other labor measures like the Jolts report, job openings per uh per employee, it's not really per person looking for work, it's not really heating up either. So, you know, it's not a super clear jobs report to me. Now, there will be people on the internet that say that this is a terrible job report and you have to discount the um declining unemployment rate because labor force participation is falling. People are just so desperate they can't find jobs and driving out dropping out of up the labor force. Now guys, doomers uh I want to be totally clear are almost always wrong and often low by Q people. So if you look at the labor force participation rate, it has dropped a lot. But we have to also be very thoughtful now. We have an aging population and you have a lot of boomers retiring in part because their stock market portfolios have exploded higher. So you would expect overall labor force participation to be declining as population ages and as there's less immigration flows. What you want to focus on if you have this narrative of people just desperate and dropping out of the labor force is prime age labor force participation. That is the labor force participation rate of people in their prime working years. And that participation rate has declined a bit over the past few months. But if you zoom out, you can see that it is comfortably above pre-andemic levels and historically within range. So I don't think that narrative is correct.

Now the third thing that seems to be driving this revival in the stock market has to do with the AI trade. Now al although the bottleneck trades like the RAM trades uh are kind of languishing, you do have this rotation where the MAG 7 seems to be getting a second wind. You have these big stocks like Microsoft, like Amazon zooming higher and of course these have big weights in the major indexes and are able to carry them up. So the I trade not necessarily over but it seems to just have morphed a bit whereas memory is not going down and uh the the big tech guys are going up. So these themes just in a few short days have uh led to a manic reversal in the stock market and um well we we'll see what what happens.

All right the second thing that I want to talk about is this very interesting episode of y intervention. So, as we know, over the past few months, the Ministry of Finance in Japan has been frantically trying to save the yen. The yen has been depreciating pretty significantly over the past couple years. Now, not too long ago, it was about 163 yen to the dollar at multi-deade lows. Uh, weakness, multi-deade highs in USD JPY, which is of course yen weakness. Now, this is a problem for Japan because Japan imports a lot of stuff. Now, it's super good for their importers because of course, uh, cheaper currency makes their profits look good in domestic currency terms, but they also import a lot of stuff like oil and that could potentially feed into inflation. Now, inflation for Japan has been above target. And yet, the Bank of Japan still has interest rates at about 1%. So, real interest rates, as they say, are negative. It's a very curious place to be in because well inflation is high, your currency is rapidly depreciating and yet your interest rates are quite low. Now there are people that suggest that uh the Bank of Japan uh is politically constrained because the prime minister doesn't want them to hike rates. Now the bank of Japan will probably say that they have been in deflation or disinflation for so many decades that they are cautious and don't want to um you know do anything that might uh push them back into their uh deflationing malaise that they were in for many decades now. Again, I'm I'm not in the room with their discussion, so I don't know what's actually true. But at the end of the day, the low interest rates in Japan are making it very difficult for the yen to strengthen. So, what the Bank of Japan and the Ministry of Finance have been doing has been intervening, basically uh buying yen, selling dollars to try to strengthen it. Now you notice that over the past few months this works only temporarily because the fundamentals of yen depreciation are just too strong. So what they what seems to be new this time is that they are getting the US to intervene with them. So a joint intervention to try to um strengthen the yen. Now this is something that the US hasn't really done with Japan for many many decades and it is also something that sends a much stronger signal to the markets because now it's not just Japan it's also the US and of course the US uh can print dollars. Now what actually happened is that the US sold euros and bought Japanese yen. Now the U United States has actually a foreign exchange portfolio. Uh it is managed by the New York Fed. Now in that they had about 13 billion euros and it seems like what Besson did was that he sold those euros and use it to buy yen and that was their contri contribution to strengthening the yen. Now I I was thinking that this is probably all they could do as uh being from the New York working out the open markets that is the portion of the portfolio that I'm most familiar with. But actually as many people on the internet pointed out there's actually more things that the US secretary could do. The ESF, the exchange stipulation fund, actually also holds 22 billion in US dollars and 175 billion in NSDRs. Now, the dollars they hold, that's that's cash they can readily deploy. The STR though is a little bit different and it requires an extra step. What they would do is actually have to do is they would actually have to exchange those STRs for dollars from the Fed. So, the Fed would actually have to print dollars for them. they could then take those dollars and sell them and buy yen. So, it's an extra step. Now, is the US Treasury going to do that for Japan? Just kind of end up at the end of the day with a ginormous portfolio of Japanese yen? I I I don't know. I'd guess no, cuz you know, why would you want so much yen? Although it is historically undervalued. So, many people are wondering why the US Treasury is doing this. Now I think there are new stories that suggest that the president is doing this because Takahuchichi is a good US ally. They want to basically uh do her a favor. Now this is something that the Trump administration has done before. Remember just last year they helped out President Milei in Argentina giving him uh some some dollars. So this is something that they've already done before. It's kind of like a favor to shore up a US ally. Now the doomers would say something like it's protect the US Treasury market and honestly that's I think that's really stupid. Um oh actually let me caveat that now smart people at JP Morgan have noticed that there is a relationship between a weak Japanese yen and upward trends in the long bond in Japan. So the long N JGBs. So and if the long JGB's rise in yield that also puts upward pressure on the long bond in the US. So being able to stabilize the Japanese yen stabilizes the Japanese long end and could of course provide some support for the US long bond. So so that is a potential thing.

Um so one of the things that Secretary Besson uttered is that you know we want Japan to use the FEMA repo facility to be able to shore up. Now the whole point of this is to convey to the markets that we have a lot of ammo because if Japan could so in this uh storytelling in this story if Japan could access the FEMA repo facility they could they could which they do have access to to be clear uh and Secretary Besset wants to upsize it. If Japan could access an upsized female repo facility, what they could do is that they could pawn their treasuries for cash and they have a lot of treasuries, hundreds of billions of treasuries and then take those dollars and intervene in the currency markets. That would tell the market first off they have hundreds of billions of dollars they could deploy and secondly they could do that without selling treasuries so that uh it would not put upward pressure on the treasury. uh yields. So that that seems to be the story. Now that you know to my view is is just obviously nonsense because first off uh we have to think back what the female repo facility really is for. Now during the 2020 uh pandemic panic, you had the treasury market clog up because a lot of people were selling treasuries and to get dollars and that overwhelmed the plumbing of the system and cause the treasury market to crack. So the FIMO repo facility was a way to allow foreign sovereigns to get dollars with their treasury securities without actually selling them so as to not disrupt the treasury market. Now, this facility is really just targeted for um for central banks that don't have dollar swap lines. If you have a dollar swap line, you basically have unlimited access to dollars. For example, the Bank of Japan print yen, exchange that for dollars and they would have dollars and the F and the FX swap lines at times could have take up of up to half a trillion dollars during crisis. So it is basically a limited dollars to people who have access to a swap line with the New York Fed. But if you don't have access to a swap line, let's say you're China or someone like that, uh then you could then that becomes a problem. And so they created this FEMA repo facility so that countries in that situation could have access to dollars without selling their treasuries so as to not disrupt the treasury market. Okay. So fast forward to the context today. Japan has dollar swap lines. They have basically unlimited dollars that they could use uh to whatever way they they wanted to. Like some people say it's only for banks, but dude, it's an emergency facility. You could use it whatever you want. Um you think the US would say no to you when they're already obviously trying to help you intervene in your currency. So the Japan has basically unlimited dollars. Now secondly, do they want is it a concern about disrupting the treasury market? Well, if you are if you wanted to repo your treasuries without wanting to sell them, you actually had could do that very easily in the private sector. At the moment, the repo market it's it's not really congested. You have plenty of repo capacity and private sector repo rates are actually several basis points lower than what the Fed would charge you if you were to use the FEMA repo facility. So, it really doesn't make any sense. If the Ministry of Finance wanted to report out their treasuries, they could do that very easily and they don't really need the FEMA repo facility. And and honestly, it doesn't seem like dealer balance sheets are super clogged. So, if they were to sell them outright, I I don't think that it would actually have much impact on Treasury yields. But the last thing is, and this is something you would only know if you were, I think, super in the weeds, is that Japan actually has tons and tons of dollars stored in something called a foreign repo pool, which is basically a checking account at the New York Fed, a secured checking account at the New York Fed. Now, who exact? So, the New York Fed has a foreign repo pool. It's like a checking account for um foreign central banks. It's, you know, over 300 billion, fluctuates. Now who actually has an account like top secret okay you cannot know that but if you are familiar enough with the data you can tease out who it is from the publicly available data and this is not a secret from uh anyone who actually follows this very closely and there are very very very few people who do knows that it's actually mostly Japan that actually likes this facility and so they have a lot of liquidity in that bull that they could usually withdraw and deploy for intervention. So they don't really need a FEMA repo facility. So again, all of this in my perspective is just to create the impression that we have a lot of dollars. So don't you dare challenge us when we intervene. And yet if you look at the intervention, you can see that it's not super effective, right? It went from 163 all the way down to let's say 158. So this is surprising to me uh because if you think back a a couple years ago or actually look at the yen historically often times you would have bouts of severe strengthening and just several notches and you would have people who were in the yen carrier trade basically get carded out very disruptive but even though you had this monstrous intervention from Japan and even with US aid um not much happened. So this is telling me that the market is not really believing this because the interest rate differentials, they're just too large. The underlying fundamentals of a weaker yen are just too strong. So the only way you want to fix this is you need the Bank of Japan to start hiking more. And they're going to hike, but they they're going to have to hike at a more aggressive pace. So this looks like uh just kind of wasting dollars for both the US and for Japan until the underlying fundamentals are correcting. Uh I'm I'm actually super surprised that this hasn't had a kind of an riskoff effect. Um but uh I think that just tells you how convinced market participants are that the yen is weakening and they're not too scared. All right, so um that's all I prepared for today. Let's continue to watch how this yen trade developments. It's still possible that the US could, you know, go big, maybe even go to uh get their dollars from SDRs. I I do think that would be a big leap, though. It's kind of a big ask. It seems like the the easiest thing to do was just kind of shift their foreign currency portfolio a little bit, get rid of the euros, get some yen. So, it's more of a token thing. I think obviously everyone in Treasury understands it's a losing war unless you adjust interest rate differentials. All right, so that's how I prepared. Talk to you guys next week.