Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Aloway

and I'm Joe Weisenthal. 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 burn crash across the year. And we're recording this, let's see, October 17th, and the dollar is down yet again. Although it is down, there's been a little, you know, we hit a low in mid-September.

Don't make apologies for the dollar, Joe.

No, I just keep going, and then I'm

all right.

Keep going. Then I might add something.

Fall in the dollar.

Yeah, there's that. The fall in the dollar is very big so far this year.

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, resilience, whatever you want to call it, enthusiasm about AI and 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 form of its currency.

You know what I really regret doing, Tracy?

I really regret.

Did you have a hoard of gold that you got rid of or something?

No. No. I took out a gold-denominated mortgage. I feel so stupid. I feel so stupid. Why did I do that? I get paid in dollars, and I took out a gold-denominated mortgage. What was I thinking? No, I didn't. But had I done it, that would have been a very bad trade.

Yes.

Remember those stories from, you know, a little bit of a tangent? Remember all those stories from the Hungarians? They took out those Swiss-denominated mortgages back in the 2000s. And then

that was very much a Europe thing for a while. Yeah.

Yeah. That was a really funny little 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 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 for this year are turning a little bit. And I say that, the 10ear Treasury as the time we're recording this October 17th has fallen below 4%. 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 for markets in many respects right now.

There's definitely a lot to talk about. Congrats on managing your personal FX liabilities.

I'm doing a good job. Yeah,

getting paid in dollars and paying your mortgage in dollars. Well done, Joe.

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?

There could only be one

when we talk about these big trends.

And who is the one person that is always in town? Cuz 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 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 ran into you 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 Hunin. He is the economic adviser and head of the monetary 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 policy makers right now. So Hun, thank you so much for coming back on OddLots.

Thank you Tracy. Thank you Joe. It's great to be back. Since Joe doubts my entire premise for this episode,

I don't doubt the entire premise at all.

No, 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 safe haven of the greenback in times of turmoil and stress. And now, 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 time?

Well, it 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 falling in unison. And that's very unusual because in a risk-off episode, you know, which April was, typically the dollar would rally, you know, there would be a kind of safe haven 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 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 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 were trying to reduce some of those exposures, and we can get into some of the details on how, you know, that kind trade might transpire. And it just so happens that this is also the year that the BIS conducts its triannual survey of FX markets, and we've just published the results, and I think we can also shed some more light on the events in April. Let's keep it big picture still and then we'll drive down into specific months and weeks. What is people work for the BIS? They probably must take out mortgages and Swiss Frank, but living there in Basel. Anyway, sidetrack. What are some of the big takeaways from this year's survey?

Yeah. Yeah. So, I think well actually before we go there.

Sure.

Joe, um, I mean it's worth, you know, thinking about how FX markets really 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

in euros.

Yeah. You know, beneficiaries in euros, 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 to invest in in dollar assets. But of course what you want to do is to 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 and as you do that you also promise to unwind that transaction at a known exchange rate at a fixed, you know, 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 on, you know, how high the 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 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. 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 expos hedging story, 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

Mhm.

but you're concerned about the dollar falling, then what you would do is you would put on a hedge expost. 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 there would be, you know, lots of downward pressure in those situations where institutional investors are trying to, you know, raise their hedge ratios, but exposed. So back to the trienal, what do we see there that, you know, puts additional light on this episode? Oh, by the way, on on the trienal, you know, this, it just so happened 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,

I bet,

on really the, you know, the events of the, of the April episode. But the headline numbers are really quite, um, you know, quite notable. It's $9.66 trillion daily flow. This is like something like almost 30% higher than the previous survey in 22. The dollar is still very much the dominant currency. It's 90% of all of the transactions have the dollar on one side. It's even higher than what we saw in 22. So, you know, in spite of the the the survey being affected perhaps by these, you know, stress events in April, you know, we think we've got a very very good sort of take. One of the things that we noticed this year is of course, you know, as well as the FX swaps which is by far the largest segment of the of 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 a in an FX swap, you know, we the investor would borrow dollars by pledging euros and then 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. We can just go to a dealer and say look, you know, just sell me a outright forward so-called and then I would actually then have a dollar obligation

a swap or a swap is like a spot trade plus a forward

exactly 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 the swap and selling the dollars 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 there, you know, there's going to be a spot sale anyway. And so that combination would actually lead you to a situation where both a spot and a forward transactions go up a lot and that's exactly what we see.

Interesting. 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, you know, gather. But it's also notable that if you look at the actual portfolio flow numbers, the international portfolio flow flow numbers, there was 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 were certainly no, um, you know, concerted portfolio outflows, you know, from the US. So that's really the I think perhaps the most, um, you know, compelling evidence that the so-called sell America trade was not, uh, you know, was not the story behind the April episode.

Why should we care either qualitatively or quantitatively if this was a hedge America story and not a sell America story outright

over the long term? It is possible that, you know, long-term investors would then reassess their 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 been, you know, translated into actions, but I think what, you know, does flow very, you know, 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, you know, 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 to actually, you know, be part of that, you know, ecosystem. So if you have this kind of neo network effect it's very difficult to, you know, have this wholesale shift away. One of the things that I think is unusual and I 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, I 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 profitable, impressive, cutting edge companies in the world that everyone would love to have exposure to in some way are in the US. And it strikes me as 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 expo more exposure to Nvidia and Microsoft and all of these companies that are making money handover fist without having exposure to the US itself and hence I might want to hedge. I mean certainly, you know, the equity market story I mean that really is in 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, 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 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 fungeible across currencies.

Mh.

And you know, money is ultimately something to do with banks. So, you know, the central bank, you know, issues highowered 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 fungeible across currencies. So, you know, every piece fits into every other piece in that sense, and so, you know, we should think about this in terms of the the mutually reinforcing pieces of this, you know, this network.

What have you observed in 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 expost as you described. Did that mean that the cost of actually doing so actually increased or was it still relatively cheap?

Well, actually it's, um, 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 dollar assets. And so it's really about, um, how high that short-term interest rate is relative to the yield you're getting on the, uh, on the asset itself. And so if you have a flat yield curve, you know, which is what we've had or even inverted yield 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 systematic survey, but it's fluctuated between 40 and 60%. 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, um, in the last year or so was, uh, the hedge ratios had gone down gradually. Some firms were not even hedging at all. You know, they were trying to win both on the stronger dollar but also on the high yields. Yeah.

Yeah.

Actually let me just me, um, mention a very interesting point here actually. Um, it's actually, uh, worth thinking about the parallels between this story about, you know, advanced economy investors holding US dollar assets with the story 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 into a large emerging market sovereign bond trade, you would actually buy the instrument on an unhedged basis. And you do that because, you know, you think, um, the emerging market currency will appreciate as well as the yield fall. 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 you know scramble to, you know, hedge expost and that's exactly, you know, the same type of thing that we saw, you know, in this, uh, in this episode and you and there were actually, uh, emerging market investors especially from Asia who were, you know, caught with very low hedge ratios and there was this expost hedging going on. So there's actually a very interesting parallel between, uh, you know, what was, you know, going on this April and the much older trade which is the emerging market trade.

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 a local emerging market bond.

People are like, I think I'm gonna buy some local currency US debt.

That's right.

Um actually but like so what was it about April then that caused the like what I mean we know there was yeah they launched a trade war and there were like massive tariffs etc but like what was it about that such that people's uh impulses to hedge more expose factor as you've described it what was the thing that said oh we want to uh change our uh the our sort of our exposure to dollars even if we don't want to sell them

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. Um actually if you look through your, you know, Bloomberg news database, you'll find plenty of stories from 23 24 where, uh, let's say life insurance companies announce that they will not be hedging, you know, there so you know, they would be holding, uh, 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-off 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, you know, in this double whammy fashion, you know, you would actually try and, um, you know, either hedge expost or reduce your exposure. It looks like, uh, from the evidence that it was very much the expost hedging story. 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 shortterm, um, hedge whether it's a forward or a swap or whatever mismatched to a longer term asset. I mean this is this is what the BIS does on a day-to-day basis is worry about potential risks. So, are you worried here?

That's a really great comment, Tracy. And, uh, um, I think this was, uh, you know, where I was going to go next. Um, 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, 1 month to 3 months. But, uh, it's a short-term, it's a short-term liability that you need to roll over.

And from time to time you might get caught in a in a liquidity, uh, 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 2020, uh, when there was also a scramble for dollars and, uh, you know, when you're a long-term investor, you've hedged using, uh, a short-term FX 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 assets, which is going to be very difficult at a fair price, or you have to join the scramble for dollars, uh, with all 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, uh, you know, dollar obligation. And so, you know, we we are swapping one, uh, well, we are actually, you know, exchanging one type of risk for another. We're actually changing currency mismatch for maturity mismatch. And, um, uh, you know, empirically if you look at the evidence over the years, it's when the dollar is falling for a long period of time that these hedge ratios become very very high. So, you know, good example is the period before the GFC when, uh, you know, dollar was, uh, you know, really falling, uh, you know, quite considerably. Yeah.

But then what happened at the GFC was of course, you know, dollar really spiked

right

because there was a scramble for dollars. So you there's always this trade-off. you either have to bear some currency risk or you bear this maturity risk and then the, you know, bear this maturity mismatch risk I should say and and so we, you know, it's really, uh, you know, um, changing one type of risk for

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. But

this is sarcasm by the way for those who don't know. I hate currency markets.

She hates currency markets because you never know whether we should be it's the numerator den.

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."

But but em and you mentioned um em and uh em bond funds, em indices and currency is doing very well. And so this gets to the question of like is this a numerator story? Is it about dollar weakening or is it about uh so we've been talking a lot about financial flows. Has something changed though in the sort of underlying economic fundamentals of a lot of EM? I've heard some rumblings about this. People excited about EM in a way that I don't think they were excited about to the same degree during the 2010s at all. And I just while we were chatting, I pulled up a bunch of lines of EM related funds, currencies 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 fact that the uh dollar is weak?

So, this is very timely, Joe. And as it happens on Monday, we published a bulletin exactly on this question. Um you are the emerging markets doing well because of better policy, better fundamentals or is it really about the the global financial market trends? And the short answer is it's a bit of both.

Tracy loves this

and you would, and you would, you know, not think of otherwise.

Um why is it better fundamentals? Well, I think it's, uh, uh, certainly, uh, there's been much better policy, uh, especially, uh, monetary policy

and also the emerging markets have, uh, have really been boyed by actually, you know, uh, the weaker dollar. The weaker dollar has been a tailwind, um, for much of the year.

This is why emerging market assets have really, you know, rallied quite hard, and there's there's a parallel with credit spreads as well because, you know, when credit is doing well, we also tend to see emerging market assets also doing well. Um and if we break it down, so why would, uh, uh, 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, uh, has invested in local currency assets, you know, there's this currency mismatch, but then there's a windfall when the when the dollar weakens. That's a very simple story. It's probably not the most important. 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, um, of the loans to all of these, you know, currency mismatch borrowers, the improved credit risk on these borrowers really, you know, shrinks the tail risk in the credit for the, you know, for the lender.

Uh so, if you like, the value at risk goes down, and that really opens the door to to more credit. So there's this very very strong relationship between a weaker dollar and faster growth of dollar denominated credit, and because of 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 weaker dollar exports have gone up in these very highly sophisticated goods and much more so than the goods that are much more affected by just a simple the simple trade effect and the exchange rate. So semiconductors 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 this year. And, um, 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 little hedging going on. And so when you're caught in one of these downdrafts, you get hit both from, you know, the weaker dollar and also the and also the high yields. And so we saw a lot of this, uh, you know, scrambling, uh, 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 this new element which I think we need to keep an eye on.

What do you see when you look at the price of gold? So we are recording this on October 17th. It's coming down a tiny bit this morning but still above $4,000 an ounce. What is that telling you about how investors are feeling about various global currencies at the moment?

Well, Tracy, uh, I mean, we we hear a lot about the so-called debasement trade. Um, but I think that's probably overdoing things. Uh, you know, a debasement is really about the value of money relative to, you know, goods and services. We don't really see a surge in inflation. Um, we don't see a surge in the price of,

you know, even commodities. I mean, look at, uh, you know, look at oil, look at other commodity, you know, uh, everything other than gold. And I so I think we should probably look for a more tailored explanation for gold other than simply, you know, this broader, uh, sort of sense of, um, you know, uh, you know, flight from, you know, fiat currencies and, uh, you know, I think one thing which goes back to our initial conversation on, uh, the role of the dollar and 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 a very sort of firm, you know, backdrop to, uh, you to the market and other people have jumped on the bandwagon.

In a way, it's actually behaving like a risk asset. Uh and the events, uh, and the events today and you know last week as well

uh rather than there being a flight, uh, to gold during stress times, what we're seeing is it's behaving a bit like Bitcoin, um, and, uh, and the risk assets. So it sort of tells you that there's been a little bit more of a speculative element, uh, you know, here, but it's certainly behaving in a way that's very different from the from the historical norms.

You know for a long time Traces talked about this for a long time you could sort of model the price of gold via real rates and when they were 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. Like is and when you talk about central banks accumulating gold being woken up to the fact that your money is never really your money if it's in a bank that seems like it could be part of it.

Well, Joe, I mean, uh, certainly there are very few assets which are not the liabilities of someone of someone. And, uh, 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. Now I think, um, 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 Bretonwoods in the early '7s, 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. Um I think it, um, it's probably something even before the Russian invasion of Ukraine, Joe. Um so, you know, we've seen the trend where something, uh, you know, uh, like this has also sort of happened actually a few years back even, uh, you know, even before the Russian invasion of, uh, Ukraine in 22, but I think it's, um, you know, this this element this, uh, this attribute where it's not the liability of any particular, uh, you know,

uh legal entity or individual I think, you know, is giving this a particular Yeah.

So, I'm looking at the the top menu on Bloomberg right now, and you know, it it's feeling a little bit nervy at the moment. So, the number one story is banks trio of alleged fraud sparks fear of broader issues. So, this is the idea that this is Jamie Diamond's cockroach idea that 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?

Well, Tracy, I mean certainly this week is a very newsrich environment. Um one way you are we love it. We love you are, you know, contributing to that and I think it's great. Um, you know, we we we hear a lot of these comments, uh, you know, on credit certainly credit standards have been eroding for a long time and we have been one of the many voices, uh, you know, even before this week, uh, you know, just pointing out that credit spreads have fallen to historical lows. Um

but if you look at the the trajectory of uh credit to the private sector and compare that to what's been happening to government debt, uh, there there really isn't, um, a comparison. So it's certainly before the GFC, uh, the big growth was in the credit of the private sector, especially in the form of mortgages, but after that, what we've seen is credit to the private sector has really, uh, been very subdued, um, and instead it's really been the government, uh, uh, you know, bond market which has grown tremendously. Now what we're seeing now is, uh, you know, some signs of the erosion of credit standards, you know, coming back to bite. But if you're worried about something very systemic, if you're, you know, worried about systemic risk, uh, the first thing to ask is how fast has this grown in the recent past. And typically something that's grown very rapidly will, you know, give you some cause for concern.

In this case, um the really rapidly growing element has not been credit to the private sector. It's been credit to the government and in particular the the government bond market. So we should have, you know, we should of course worry about, uh, um, you know, these, uh, you know, these events and of course the headlines, you know, create, uh, you know, it's as I said, it's a very news-rich environment, uh, we hear that and we hear the same stories in the panels if it's really a concern about, you know, uh, is this the precursor to the next, uh, you know, systemic crisis it's probably not the case

actually this brings to 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. There was actually a 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, they don't I don't think they 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. That 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 we're worried about getting back at all. But I'm curious from the perspective of someone who professionally 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 is a lot of speculative exit. Like is there much modeling work being done on equity and risky assets specifically as a source of broader risk?

Absolutely. I think I think the, you know, the main channel would be through the real economy.

Yeah.

Through through real economic activity rather than through let's say a deleveraging episode or a liquidity episode.

I think it's worth thinking back to the dotcom bubble of 2000. You know that was a period of course when the valuations were even more extreme and when the stock market fell in 2000. Of course, we did see some effect. Um, and of course, a lot of investors lost money. Um, but there was nothing like the same kind of impact on the real economy that we had

with the GFC. And very simplistic way of putting this is whenever you have debt of various kinds, that's when you should be worried because Joe, as you said, it's when you're promised one $ one, but then you don't deliver. That's when, you know, there are sort of you repercussions throughout the economy. Now clearly with the equity markets there are wealth effects. So, you know, if you have a very large portfolio, you feel richer and then you spend more, and so there is a real economy effect of, um, of the stock market. So if they if we see a pullback in the stock market very sustained pullback, we will see, you know, some effect like that. Now the estimates of the wealth effect on consumption for example has varied over the, um, over the years, but, uh, given the if you like the democratization of stocks, we could 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 deleveraging episodes.

Do you see any pockets of leverage out there that aren't getting enough attention at the moment?

Well, I think you're very good at, uh, shining a light on those, you know, all those pockets actually. So, I think probably I don't think I can really say anything here that you haven't heard of. Okay.

Uh but I think it's certainly worth, uh, bearing in mind the broad magnitude. Yeah. One of the things that we've, um, uh, you know, we've talked about a lot this year in our various, uh, official publications is the fact that even, you know, safe assets can be a source of stress in the market because it's not default that, uh, you know, propagate stress. It's more the deleveraging and I think, um, you know, if let's say long rates were to, you know, shoot up and therefore mortgage rates, uh, also shoot up, you know, that would be a really big deal for the real economy and that would happen even without any defaults.

By the way when we started this conversation the tenure was below 4%. It's above it now.

So just keeping our listeners up to date on what's going on in the Treasury market on October 17th 2025.

Very good. I mean, the other interesting thing is if gold is acting like a speculative asset now, what happens when all of that starts reversing and you know, the thing that you thought was worth $4,000 is no longer worth $4,000 and gold is typically used as collateral, right?

Well, I always say, you know, it's really scary when you see people like intensely buying gold because like what's up? Like what? But what's really scary is why they start selling gold, right? Because again, it's true, right? Because actually no one has

You have to be a real psycho to have a gold denominated mortgage. you have dollar denominated mortgages etc. And so when you see like usually I one of those things you notice is that in a real credit event when you really get that VIX spike and people are 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 rough.

All right,

I'm just throwing things out here. I don't

I think that was a comment rather than a question.

It was a comment not even a question. Thank you, Joe, for your comment. Uh, Hun, it's always lovely catching up. Uh, this has been fantastic. Thank you so much for coming back on the show.

Thank you very much, Tracy. And thank you, Joe.

Thank you so much. That was awesome.

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. I 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 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. I mean,

no, I mean, look, it's sort, 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 if like the token is going up and you can play the games at the same time.

Play more games or eat more pizza

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.

And uh yeah, this 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.

Yeah.

And so I think cuz and this is why, you know, like how are you get what 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, as 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.

Absolutely. Um I guess what we kind of need, we need another big crisis so that we can observe what gold does during that time and also what the dollar does during that time. I think I'm gonna run with this arc. Actually, I'm gonna run with a really good analogy because like like if you think like or you know Chuck-E-Cheese has a lot of fun games, but also I don't really think the business model of Chuck-E-Cheese is like that good. Like

how dare you?

Well, a lot of them have closed down, but the 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 out they go out of business or something like that. Doesn't make the games less fun in the 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.

I'm gonna 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. It makes sense.

Thank you. Thank you. Finally. Thank you.

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 him back. You know, I'm pretty sure somewhere in like a box somewhere I still have a bunch of like Chuck-E-Cheese tickets or something like that.

Maybe I should dig them out.

Anyway,

well, this is another interesting question because what is the exchange ratio between a token and a ticket, right? And they're fundamentally different than I don't know. This is sort of like one of those communist countries. Chuck-E-Cheese, this is a uh paper that someone wrote. Chuck-e-Cheese 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 a planned economy.

Do you think I could find someone to provide like a swap on

Yeah.

a token versus a ticket or something?

I think there's something here. I think we're I think we're hitting on something important.

Okay. I think we should end We should leave it there.

We can leave it there.

All right. This has been another episode of the All Thoughts Podcast. I'm Tracy Aloway. You can follow me at Tracy Aloway.

I'm Joe Weisenthal. You can follow me at the stalwart. Follow our producers Kerman Rodriguez at Kerman, Dashel Bennett at Dashbot, and Kalebrooks at kalebrooks. For more OddLots content, go to bloomberg.com/odddlots.

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Yeah. Hey. [Music]