ORDERED KAOS: Themes of the Week (3/26/23-3/31/23).
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ORDERED KAOS: Themes of the Week (3/26/23-3/31/23).
"Risk-Free" Fears / Death of USD Fears / China Risks / Risk Rip / Oil Prospects / Shadow Banking.
Trying something new this week.
Instead of repeating the Musings of the Day first, I’m just going to jump right to what I consider to be the most important Themes of the Week with relevant support sprinkled in.
Theme 1:
One of the worst conflations/bad takes I see amidst the punditry is the mistaking of “Risk-Free” to mean “Volatility-Free.”
I felt compelled to write a treatise to debunk the wrong takes:
The other important part of my Substack Post above is the notion of SUPPLY ELASTICITY being a prime requisite for GRC status.
The “Austrian Pipe Dreams” I refer to are the mistaken notions that SUPPLY INELASTIC commodities like BTC and Gold can replace the USD in a world that’s already deeply entrenched in SUPPLY ELASTIC FIAT.
Even if you “reset” the world’s monetary base to some “hard”/inelastic standard, it would slam the brakes on GDP growth in a way no country on Earth would accept:
Theme 2:
The other big, big theme (related to Theme 1) this week is the notion that the USD will be supplanted by a new GRC, given all the hoopla surrounding China’s recent “deals” with Brazil, Russia, etc.
To paraphrase Mark Twain, “the rumors of the USD’s death are greatly exaggerated.”
Some thoughts follow:
Everyone and their kid brother seems to have an opinion on when the USD Standard will give way to some newfangled Standard. Too bad that’s been happening for DECADES.
What’s going to replace the USD in the world of FIAT? RISC?
The issue is more than simply a lack of credible alternatives. It comes back to WHY the world has ORGANICALLY chosen the trust the USD — despite a recent over-reliance on sanctions.
Trust in the USD Standard is based on NATIONAL POWER, which has deep roots.
ICYMI, please have a look at my West Point Paper that describes how the USD Standard came about and why we don’t need to resort to financial sanctions to achieve our geopolitical interests:
There is a reason why the Saudi Riyal is HARD-PEGGED to USD. There is a reason why HKD is HARD-PEGGED to USD and why CNY is SOFT-PEGGED to USD.
When evaluating how someone like MbS might think in terms of putting his national treasure in CNY vs. USD, consider my Amazon Credit analogy:
Theme 3:
Of course, China seems to take center-stage these days in headlines as the frontrunner to overtake US hegemony.
My take is exactly the opposite: China and Hong Kong’s Minsky Moment could be approaching. I continue to think that the risk of CNY/HKD DEVALUATION is higher than it’s ever been.
I warned weeks ago that this is the MUCH BIGGER Global Elephant in the Room:
What about the often-cited bogeyman of China dumping its USTs?
Again, I have an out-of-consensus take on this. Not only do I believe that it’s NOT that big a deal, I actually think they would be doing the Fed a FAVOR by Bear Steepening the yield curve:
Read my original post about why a Bear Steepener would have been a “safer” way to fight Inflation than just hiking FFR alone:
Theme 4:
There’s also an overwhelming consensus that because we might be getting close to the Terminal Fed Funds Rate (FFR), the USD may be peaking generally. Once again, I have an out-of-consensus view and don’t think we’ve necessarily seen the cyclical highs in the USD.
I’ve been saying for months now that other CB’s are likely to OUT-DOVE the Fed and blink first in their respective Inflation fights. Here is more support of that thesis:
Another reason cited for “Peak USD” is the recent drawdown of FX Swap Lines.
If anything, I think the recent tapping of FX Swap Lines/FIMA is a sign that the STRUCTURAL SHORTAGE OF USD is acute.
Note that China does NOT have access to FX Swap Lines and despite several takes that China might have been the mystery borrower of the FIMA facility (similar to FX Swap Lines with the exception of the foreign CB posting its USTs as collateral instead of its currency), I have serious doubts about that.
Theme 5:
Despite being right about SURGICAL MEASURES like BTFP containing the Banking Contagion, I have been DEAD WRONG about how the market would react and did not anticipate this RISK RIP which may only have been exacerbated by quarter-end FOMO.
My view (so far, seemingly wrong) is that successful ring-fencing will lead to “business as usual” in the Fed’s “Higher For Longer” modus operandi to take Inflation down; the markets clearly do not share this view, as Risk Assets have gone straight up the last 2 weeks — especially High Duration Risk!
I am both humbled and surprised by what Risk Assets are pricing in at this stage of the cycle, and I sometimes wonder why I even bother with macro hedges when “Animal Spirits” remain so strong:
That said, it’s been somewhat a Tale of Two Markets, and I have been taking rifle shots at battered (non-Bank) financials that seem to be pricing in GFC-like conditions where I don’t perceive there to be “forcing functions” a la SVB.
Theme 6:
My view on Oil (and Procyclical Plays more generally) remains cautious at best as we stare down the barrel of what I think will be a fairly hard landing later this year.
Note that I am talking AGAINST my own “book” here, as I have a big allocation to an Oil Private Equity.
I am suspicious of Oil’s recent bounce, as I think it was due to a supply disruption rather than demand-driven:
Not only has the China Re-Opening proven to be a dud as predicted (see post below), I think global demand likely shifts down later this year:
Why do I remain bullish Oil longer-term?
Because I continue to believe that the Global Supply Curve becomes more INELASTIC over time (due to long-cycle capex starvation and diversion of resources to ESG) and that we will likely encounter a SUPPLY/DEMAND SINGULARITY in this next several years.
Theme 7:
As I’ve stated over the last several weeks, I continue to believe that the epicenter of the next crisis will NOT be in the Banking Sector — especially after BTFP.
I believe the icebergs will be somewhere in the Shadow Banking sector but have not been able to pinpoint the sector, so I’ve spent the week talking to a variety of folks from a wide variety of different types of “Shadow Banks”: RMBS funds, early-stage VC funds, life insurance companies, retirement/pension funds.
I have to think that someone is seriously off-sides somewhere, but FORCING FUNCTIONS OF ASSET/LIABILITY MISMATCHES ONLY MATERIALIZE WHEN THERE IS SOME KIND OF CRYSTALLIZATION TRANSACTION — like a Refinancing or a Project Financing.
CRE comes to mind as a big fragility, and I’ll leave you with this personal anecdote to ponder: