Podcast Transcript: Jon Turek on the New Fed Put, the Brainard US Curve Steepener and the Dollar

This is an edited transcript of our podcast episode with Jon Turek. He gave his views on how to approach the Fed’s new framework, the Brainard steepener, why the FED balance sheet is overstated, and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.

Jon’s Background and Interests

Bilal Hafeez (02:00):

I have to say, I didn’t know much about you until very recently I came across some of your work and I was really impressed by the sophistication of your analysis. And only through our conversations have I realized how young you are, which I think goes to show how smart you are. So it’s great to have you on. And that also begs the question of how did you get to where you are now? How did you end up looking at the markets the way you’re looking at markets now? What’s your origin story, so to speak?

Jon Turek (02:28):

Yeah, so I always had a little bit of a niche for markets even going back to high school, but where I am now is that I was at an international school in Israel for university. And for two years prior, I worked at a fairly prominent New York macro fund. And then also I had been running this Cheap Convexity blog that allowed me to engage with a lot of very interesting market participants. And that’s led the way to me starting my own research endeavour, also by continuing the Cheap Convexity blog on Substack, and also more weekly institutional product that caters more to hedge funds.

Bilal Hafeez (03:06):

Okay, great. Just out of interest, you tend to focus more on rates and effects and monetary policy and so on. Why did you focus on that rather than say equities, which some people go down the equities part?

Jon Turek (03:18):

Yeah. So I came at markets more from an economic perspective. Actually, my senior year of high school, I competed in the Fed challenge, which is a high school competition that takes place at the Federal reserve in New York. So more of my introduction was from the policy side and economic side. And I found that also the market effects and the intersectionality of it all was really interesting. So as opposed to a lot of people to come into markets, I started more on the econ side as a primary interest. And going through Fed speeches and reading Keynes and stuff like that was more of my origination.

How to Think About the Fed’s New Framework

Bilal Hafeez (03:53):

Yeah. Okay, that’s great to know. Let’s jump into some of your views on things. We can perhaps start with the Fed and their change of framework that they introduced last year. It was one or two years in the making, but it was and it is quite a fundamental change. How do you view that change and how did you view some of the players behind it in terms of their contribution to it, whether it was Brainard or Clarida or Powell, even?

Jon Turek (04:23):

Yeah. So I think, as you say, it is a very fundamental change. And I think that a few interesting things, but one of them is that it really started pre-COVID. In 2019 we had an economy that was pretty close to full employment in the United States. We had inflation that was stubbornly below the 2% goal of the Fed, but within the realm of price stability that’s acceptable. And the Fed started cutting rates and ended up cutting rates three times in 2019. And I think that what the Fed review and the Fed macro framework changed, was really adjusting to a structurally low r* world, the neutral rate of interest. And that laid the groundwork for a lot of their 2020 moves. And I think that what the Jackson Hole meeting last year showed is that the Fed has a new reaction function entirely to how it responds to upside risks.

And there’s an immense asymmetry in their view in terms of the distribution of outcomes, and they heavily favour downside risks. As in now, the Fed is saying that, “Okay, if anything were bad to happen, we would be on that like a hawk, and we’d be very pre-emptive about it.” But on the flip side, is that with good things happening, as we’ve heard even yesterday from Jay Powell – and in the last few weeks, the outlook for this year and next year has improved on the vaccine rollout etc. – that they will only respond to realized outcomes, not expected ones. And I think that framework view is how they’re really going to attack. Monetary policymaking going forward is that the reaction function on the downside is going to be very oriented to preventing left tail risk. And on the flip side, on the upside, it’s to accentuate right tail positive outcomes by basically letting policy pro-cyclically expand for them, even if that means that things will overshoot.

Bilal Hafeez (06:07):

Yeah, understood. And that implies lower r*, which is the neutral rate, neutral long-term rate. What do you think their justification is for a lower r*?

Jon Turek (06:18):

Well, I think that even going back to 2019, in the academic community, it was quite perplexing that 3.7% unemployment rate would have pretty much no impact on inflation. And I think it’s become, there was a really fantastic paper at Jacksonville in 2019, looking at all the global interlinkages between how r* in places like Europe and Japan effect even the US rate. And I think the combination of the fact that generally the neutral rate of interest is very low on the back of all these structural dynamics that everyone’s talked about, whether technology, globalization etc., and the fact that the Phillips curve, the trade-off between unemployment and inflation has become so flat that the Fed basically had to entertain this idea that it is a different r* world. What that means for policy is that to ease policy, you have to basically be within the neutral rate.

So that the path to accommodation is a little harder is that the Fed and central banks around the world have to remain dovish for longer. And I think that’s a big story for the Fed now, especially that there is this big global component to the neutral rate of interest setting in the United States. And that was something they probably underestimated in 2018, where the Fed was hiking on the back of the 3% growth rate in the US, while European PMIs were starting to go into the forties. And I think that the Fed has post-2019 taken a much more global view of how their policy interacts and the rest of the world’s policy interacts with the domestic policy setting.

Bilal Hafeez (07:55):

And what do you think about the specific framework they’ve adopted, average inflation targeting, or some people have called it a temporary price level targeting? They could have chosen lots of different ways of doing this, but they’ve decided on this and they’ve got a maximum employment component thrown into the mix as well. Does this particular expression, is that important? Or is it just more what you said earlier, just they’re going to react more to bad news than to good news?

Jon Turek (08:22):

Yeah, I think that the implementation does matter a lot because a lot of this policy now will basically function through forward guidance. And forward guidance is basically amplified by a strong policy backdrop. And we’ve seen this with the ECB three or four years ago when they were entertaining the idea of slowing QE or even beginning to normalize policy, is that a large part of policy at these very low interest rates is forward guidance and anchoring slope of the yield curve, etc. So, I think the implementation, especially if it’s average inflation targeting or temporary price level targeting, whatever the nomenclature, it’s a bit of a shift between the two, but it’s basically a way for them to not allow these circuit breaker effects that have happened in the past to change the scope for the economy.

One of the things they definitely learned from the 2010 to 2020 decade was that a lot of the net effects of the market basically pre-empting their policy response curtailed a lot of the moves they wanted to see in their infancy. And we saw this in 2013 with the taper tantrum, is where the economy started to knock into what was then the Evans rule of a 6.5% unemployment rate. The market was able to discount Fed reaction function from there via tapering of asset purchases, tapering of asset purchases mean that rate hikes are sooner than later, and that basically was all priced in a very short time horizon, and it curtailed a lot of the progress that was going on by these financial feedback loops of higher rates, higher dollar etc. So I think the Fed now is very focused on basically laying the groundwork through some of these more academic jargons that basically don’t allow these circuit breakers to take place, and allow the recovery to basically hasten.

Bilal Hafeez (10:08):

Yeah. Yeah. I see. One of the things I’ve found interesting is that when you listen to speeches by various Fed members, Clarida, Brainard, Bostic, just all the assortment of characters that you have, they all seem to have their own way of interpreting this shifting framework. They don’t all seem to be singing from the same hymn sheets. What’s your interpretation of that?

Jon Turek (10:30):

Yeah. It’s been very interesting to start the year, even, we’ve seen this kind of dynamic, with Bostic talking about, “Well, the upside looks a little better. Maybe we can change policy later this year.” I think that the board, especially the leadership which has been fairly consistent. If we look at Clarida, Brainard and Powell, I think they’ve been pretty clear in terms of that this is the new reaction function, we’re going to enforce it. And I think it’s been laid out very well and Brainard’s speeches, all these transition periods where, “Okay, we responded to a shock, now how do we go from stabilization to accommodation?”

And it’s very much laid the groundwork to basically let the economy pro-cyclically ease for them, because by them not responding and the economy improving, is in that there’s this pro-cyclical expansion of policy that they want to happen to basically make this a different recovery than 2009, 10. And in terms of the messaging, I think it will become important for them to basically proactively also expand with it, because as regional bank presidents, such as Kaplan and Bostic have noted that as the outlook gets to a certain level of relative robustness, is that the bar for them to reinforce their reaction function goes higher.

And I think that’s one of the things they learned so far in January is that, well, it’s easy to say in 2023 we see the dots unchanged and rates will be unchanged, when 10Y breakevens are at 1.5%. But when 10Y breakevens are at 2%, the market’s going to look for more to reaffirm and recommit to there. So I think that the Bostic miscommunication actually ended up being good for them in that we saw new things such as Clarida saying it would take at least a year of 2% inflation before they would contemplate lift-off. And the combination of this repricing on the back of the Georgia elections and the Bostic “miscommunication” (or at least out of sync with the rest of the key FOMC) allowed them to basically be more aware that the market’s not going to let them have this luxury of just saying, “Okay, we set policy and forget it.”

The Rates Trade that Captures this Shift – the Brainard Steepener!

Bilal Hafeez (12:37):

Yeah. And I’ve seen in some of your research that you have one or two ways that you like to express a market’s view of this new framework, through the curve. Can you talk a bit more about that? How would this map onto rates markets then?

Jon Turek (12:51):

Sure. I coined it cheekily and I called it the Brainard steepener. And where that comes from is basically this idea that governor Brainard in the speech in July and in September, basically, has been talking about this transition of policy that in the recovery period, the Fed can actually become easier by doing nothing. And I think it’s a pretty powerful force, and we’ve seen that in real yields, probably from the summer of last year on that had become increasingly negative. And I think basically what this reaction function does in a market sense is that, as markets pro-cyclically expand on the back of this recovery, real yields continue to fall in the belly of the curve because basically, say five-year yields, the nominal component can’t really respond on the back of the Fed saying we’re not hiking ever, and on the back of massive asset purchases.

But the inflation part, the inflation component is rising on the back of an expected recovery. So real yields continue to fall, and then in the back-end, you can effectively be short the nominal because if the recovery is expected to continue and real yields reach a rate of extreme level of accommodation that can really fasten this recovery, then the term premium element of the trade has to kick in somewhere. And the Fed really wants it to be in the backend, so it doesn’t upset the financial conditions they’ve laid in. So basically, you can take the Feds goals and say that they want a term premium response. They just don’t want it in the belly. And you can play those two things against each other by basically five thirties go higher, but it’s really the real part. So it’s really the real yield part of fives and the nominal part of thirties.

Bilal Hafeez (14:29):

Yeah. I like that expression actually, because if you look at say fives thirties, they have broadly been steepening over the past year or two, but they stopped, it stopped steepening over the last say six months, after maybe from July onwards. But I suppose if you switched the five-year to real, then I suppose, fives real, thirties nominals have continued to steepen because five-year real yields just carries on going down. So you caught that. So I can see the logic in that. And maybe that’s quite a neat way of playing as a core trade to hold onto for a year or two years, even, because this should do quite well, even if you get a recovery. I suppose the question is, how would the trade do if you had a taper tantrum?

Why a Taper Tantrum is Less Likely this Time

Jon Turek (15:13):

Right. But the question is, in a taper tantrum, would there be enough of a real response in the belly that would offset your gains from the nominal component? And I’m not sure, I think that the nominal part in the back-end could keep up because I still think in a butterfly, the tens part of the curve would probably lead in a tantrum. But I think the fives is probably too close policy rate for it to really contribute meaningfully. But I think that in terms of a taper tantrum, I’ve been on the camp that it’s much more unlikely and less inevitable than people think. I think that before this week, and maybe going into last week, we had a Bill Dudley article sensing that there’s no way the Fed can avoid a taper tantrum.

And I don’t think that’s entirely true because I think that QE going forward will be much more about its linkages to the policy rate and the forward guidance component that it basically reinforces. So I think one of the things that’s got lost in tantrums in the past, especially in the 2013 one, is the Fed lost control because there was a response basically in the red and green Euro dollars that was commensurate with what was going on in the back-end of the bond market. As the market took the fact that the Fed was going to taper as the sense that the Fed will then soon raise rates. And I think that it’ll be a big focus of this FOMC to decompress that correlation or connection.

Bilal Hafeez (16:36):

Yeah, so it’ll separate the two from each other.

Jon Turek (16:38):

Exactly, and breaking those linkages. And we’ve seen this with varying success in other central banks. We saw the ECB in 2017, 18, where Benoît Cœuré was out writing about how asset purchases are most important in a recovery on the forward guidance sense, is that they don’t let the market price in rate normalization. And I think that’s going to be more of a theme going forward, and whether the Fed can recalibrate off the 120 billion a month, that will be an interesting question, I don’t know if it’s one for this year. But I think as long as they can convince the market that recalibration doesn’t change the path forward interest rates, then that can solve itself.

Bilal Hafeez (17:15):

Yeah. I also think, if you look back, go back to 2013, a lot of things were just new. The Fed was dealing with how to wind down their QE program, which was a novelty for them. The way Bernanke first talks about the taper tantrum was an accident anyway, in terms of the way he let it slip in a clunky sort of way. And we’ve had a lot of time and a lot of research since then to understand how to avoid such a thing. Now you mentioned the ECB. How do you see policy by the ECB and the BOJ? Because obviously they also have their own ways of doing things and they seem more trapped in this low forever QE forever much more so than the US. How do you view them?

Why the ECB Could be More Comfortable with Euro Strength

Jon Turek (17:52):

Yeah, I think it’s a very interesting dynamic for them is that the ECB and BOJ have become a lot more passive outside of crises, because basically outside of dealing with a March situation in terms of European fragmentation or liquidity risks, there’s not much marginal easing that the BOJ or ECB seemingly can add. We’ve seen that in the past where they could expand their asset purchases and that does a lot for books, but in terms of financial conditions more broadly, it doesn’t change that much. And I think really the interesting thing will be to what extent the BOJ and ECB accept themselves as more passive players, because one of the things that could be different this time in terms of the recovery is if the ECB says, “Okay, the euro’s at 120, the euro’s at 125, the euro’s even at 130.”

That’s okay because the spill overs of dollar weakness in terms of global trade are offsetting that and allowing our manufacturing sector etc. to expand for us. And I think that’s one of the interesting things going forward in terms of this recovery, is that central banks around the world who have usually been very protective of currency levels to protect their export manufacturing sectors, will they exhibit more allowance to let dollar weakness permeate and have all those positive spill overs the dollar weakness is shown to have in terms of trade, credit, etc.

So I think we’ve had grumblings this week out of the ECB that they’re not so comfortable with the level of pricing in terms of rate cuts, and we’ve seen a bit of a push to get the euro at 120. But actually, I’m not sure – maybe they can get a little more price in the Euribor curve than possible. But I really don’t think that the ECB is looking to upset the outlook card in terms of the dollar move. And I think that especially post this shock, the past is very different in terms of the exchange rate. And I think the ECB is more worried about the path for your appreciation than the destination. And I think it’s much more about, is it orderly, it’s not a shock, it’s not a sharp financial conditions tightener, but it’s this gradual Euro-Dollar higher situation that allows the European economy to benefit from the positive externalities of the weaker dollar.

How the Georgia Senate Elections Complicated the Weak Dollar Trade

Bilal Hafeez (20:12):

And so now that we are talking about currencies, is there a broader implication of Fed’s policy in this Brainard steepener? You alluded to dollar weakness, does it follow that the dollar should be weaker in this environment, or is it more nuanced?

Jon Turek (20:26):

It’s both. I’ll start with in terms of the Brainard steepener. I think at its fundamental level, it is a dollar weakener trade because the feedback loop in which it’s working through is that the Fed is able to generate lower real yields, which has pressure on the currency. The dollar goes down, which brings up things like export-oriented economies, commodities, etc. Because nominal yields are capped, real yields go even more negative because the inflation component is pricing in the dollar aspect. And you basically have this virtuous cycle between real yields and the dollar. Now that was definitely taking place Q3, Q4 last year, and it’s changed a little bit now. And I think the change is really the Georgia elections. And I think the reason that’s changed now is that the market, especially in real yields, is saying that there’s a level where we’re going to have a bifurcation in terms of the response in the curve. On one hand, if we accept the Fed’s new reaction function, if the economy is to improve, the real yields will continue to fall, especially in the five-year component. But on the other hand, now we’re starting to get to levels of accommodation and pricing in this more fiscal permanence that the term premium element is offsetting the reaction in the back-end.

And that for the dollar means, and this will also be very especially relevant to precious metals, is that the TIPS curves not moving in unison anymore. 5Ys can continue to come lower but 10Ys and 30Ys can, if not drift higher, stabilize and don’t want to go any lower, because the more they priced it in, the more term premium response they have and nominals react. So we’ve come to this acceptance that we’re going to have probably another trillion plus US fiscal bill and US fiscal is going to become like the Fed, less counter cyclical and much more accentuating good outcomes, etc.

We, probably for the first time in a while now, the dollar consequences are, you can’t blindly short them, as that was the feeling in Q3, Q4, last year. And because there is this rates element of the zero lower bound premium coming out, which we basically had in Q3, Q4 of last year, when people were thinking “What if we all go Japanese type pricing dynamic?” with all the pressure on the dollar in the space of all these outcomes. But now we’re starting to transition into, there are a few that it may not be in three years, but it may be in five years, that are going to get off the lower bound, and there are those who won’t. And that relative dynamic will start to matter again in FX, I think, and it will less be just about beta. Where you could have USDCHF selling off the same way that AUDUSD was rallying, even though those relative dynamics should be different relative to the growth environment. And I think those things will change and currencies that are more risk friendly versus those that are traditionally more defensive.

Why Precious Metals May Struggle Even with Low Rates

Bilal Hafeez (23:18):

So the risk friendly ones in G10 would be things like AUD, NZD, CAD, maybe the Scandies, and then EM in general, I suppose.

Jon Turek (23:26):

Yeah. I think in EM, I actually think that it will be more favourable to some of the G10 risk-on currencies. I think that EM will become a little bit more bifurcated because this dynamic upsets the outlook card in a lot of some in some EM like Brazil, maybe even South Africa to some extent. Where this distributional change in terms of, “Well, even if it’s five or 10 years, whatever it is, the Fed is not going to be at zero forever. Well, you have a harder time pricing Brazilian interest rates at two.” So those dynamics also then create these frictions between a central bank that is not really in the mood to hike, which we’ve seen in Brazil, but is being forced into it. So those will have, at least in FX terms, I think will make it differentiated between places like Indonesia versus Brazil, stuff like that.

And then I think the other place where this could manifest is very much in precious metals. And the summer trade of gold and silver last year was, I did a chart in one of my recent notes, is that the TIPS curve was moving in unison. And that was really the juice that gold needed, where we had this real yield correlation with precious metals. And in theory, that’s still happening, and all the dynamics that go over rallying on in terms of more fiscal and a Fed that’s passive, and basically allowing these overshoots to happen, is still in theory, going to happen. The question is, is that the market response has changed to what it was in July? And I think that makes it much more neutral, those things, in terms of gold and silver.

Why Technical Issues Around the Fed Balance Sheet are Overstated

Bilal Hafeez (24:56):

Yep, understood. Yeah. Many people in the market focus a lot on the Fed balance sheet. Its composition, its size, it’s too big, there’s the Feds stuffing excess reserves in the system too much, and that will lead to transmission issues in the broader economy. So there’s technical side of it, there’s also just philosophical things about the size of the balance sheet, how that’s distorting markets. How do you think about the balance sheet and the quantity side of policy?

Jon Turek (25:21):

Yeah, I think it’s a great question, and one that’s especially relevant now. We basically do have a little bit of overkill in reserves right now where excess reserves have ballooned. We’re past the point of running an ample reserve system and with the Fed on this path of 120 billion a month, there’s definitely this feeling that there’s almost too much liquidity, and we’ve seen that in the front end of the curve and things like the FRA-OIS rate going lower and especially in overnight repo rates, etc. And I think that’s maybe where the policy recalibration can come.

I’m sure there will be first more regulatory elements that deal with this. Yeah, I’m sure that in terms of SLR ratios and extending that more reform, which begins in March, if I’m not mistaken. And allowing banks to digest these reserves, I think will be critical. But I think that this dynamic will speak to that the Fed wants to be in this QE until our goals are met, not until when we think our goals will be met. And that can still happen even if it’s not at 120 billion a month.

And when the Fed gets to that discussion, maybe it’s towards the end of this year, I think that QE at this point – its marginal impact is on the rate distribution in terms of not allowing the market to price in height. And I think the Fed is cognitive to that, so it’s calibration can be changed going forward. The question is, can they communicate it effectively?

Bilal Hafeez (26:50):

Yeah. And I guess if you look at the BOJ where they have yield curve control and a quantity target as well, that you find that actually the quantity side isn’t that important in the end. They can dramatically reduce JGB purchases and the yield curves remains controlled. And obviously you can’t target both price and quantity, it doesn’t make sense, but they’ve somehow tried to dance around that all.

Jon Turek (27:11):

Well, I think also with these, I think that one of the themes, especially as central bank dominance was the key of the 2010 to 2020 decade, was that a lot of these perceived technical hiccups become less scary when they actually happen. I think outside of really the repo thing of September ’19 and even including it to some extent, is that these are constraints that once they begin to matter, they’re easily dealt with. I wouldn’t want to overemphasize the easy part, but it seems that in terms of the plumbing and in terms of liquidity, is that the Fed is able to move it around where it needs to go. I think that the ultimate test of this was in March of last year. I was getting worried that the dollar swap program was looking much more 2009-like than it needed to be in 2020, because the end participant was different.

In 2009, it was about getting liquidity down the channels to European banks. And now that’s easy because European banks have a counterpart at ECB. In 2020, getting it to Taiwanese life insurance companies and Japanese life insurance companies who have an intermediary between them and the BOJ or the CBC or the BOK in Korea, much more difficult. And the Fed was able to basically pass through that liquidity on, having good counterparties in terms of the central banks who were cognizant of where the issues and where the vulnerabilities were. But I think that was a real test case to, in terms of these plumbing related concerns, that central banks are really all over it.

Risks to Low Short-end Real Yields and the Brainard Steepener

Bilal Hafeez (28:43):

Yep. Yep, understood. Now, if I listened to what you’ve said and what we’ve been discussing, a big part of this is that real yields will stay low more towards the front end of the curve, say the zero to five-year. So what would we need to see for that to change, for five-year real yields to shoot higher? Because that will lead to quite dramatic consequences, because everything seems to be geared towards keeping that very low. What types of things would you need to see for five-year real yields to have a tantrum, so to speak?

Jon Turek (29:13):

Yeah. I think an interesting test case will be coming up in this summer where inflationary pressures will begin to build a little. And that’s already been pre-emptively dealt with in the sense that policy makers have already said that they’ll be transitory, they’re supply side based, or that there’s pent up demand. And basically every excuse has already been given for why they won’t respond to inflationary pressures. But the question is, how sticky will these prints be?

And if you get into Q4 and these prints are still a little sticky on the upside, and obviously there’ll be a very different dynamic than it has been in EM, but we’ve seen EM central banks talking about how even outside of supply side concerns, that inflation has been stickier on the upside. Is that if those factors, the supply side constraints, the pent up demand, increased fiscal spending, all lead to these things being less transitory. And if the market right now is under the assumption that they will be transitory, and quite rightly probably, I think that those things were to persist and show signs of being a bit more durable, than the market would have to look into, Well, 2022 could be a year of 2% for the whole year and then 2023, the Fed has something to do.”

Bilal Hafeez (30:30):

Okay, yeah. Do you think we could get much term premia added to, say, up to five years or not? Or is that just really unlikely?

Jon Turek (30:38):

I think it’s unlikely because the catalyst for real term premium response is this extreme accommodation in terms of both fiscal and monetary. And it’s basically a knock-in (option) almost, that they have to overdo it for enough time that, in the 7, 10, 15 year part that you can get that term premium reaction. I think it would be very hard for us to materially change our nominal GDP expectation in terms of the range in the shorter term.

Are Equities Expensive?

Bilal Hafeez (31:09):

Yeah, understood. That makes sense. And do you have a view on broader risk markets on equities? Because obviously many people are saying equities are expensive, yet other people say because yields are so low that justifies these valuations, so yield adjusted or using the Fed model, equities are not so expensive. Do you have a take on that?

Jon Turek (31:29):

Yeah. Yeah. It’s something I’ve been thinking about a lot, especially in the context of some of the craziness we’ve been seeing this week with the retail brows and the wall street bets. But I think that the Fed has been noting that they’re less worried about frothy equity markets because the equity risk premium is very high. And I do think that is a stark contrast between the 1999 tech bubble, is where you had risk-free rates that were highish and you had equity risk premium that was very low.

And you’ve flipped that dynamic this time. And I think that will matter in terms of macro context. And then the other thing I think is that we’ve had this distributional change where policy is immensely focused on cutting off left tail, whether that’s the Fed in terms of liquidity events or that’s the fiscal authorities in terms of providing the necessary support to create this bridge to pass COVID, et cetera. Is that it becomes very hard for the market as a collective move lower because you basically have these rotations. And these rotations can feed on themselves as long as the market is comfortable and not pricing such a left tail risk. And we’ve seen that even in the last few where post-vaccine news, we have this move out of tech more into cyclically related assets. And then maybe going forward, as we have distribution issues in terms of the vaccine, we have variant risk in terms of the virus, is that the market basically rotates back to tech.

Now that will create different levels and relative moves within the index, but I think at the index level, that could actually lead to some relative robustness. Because basically in a curtailed left tail world, the authorities have basically turned the NASDAQ into the 10Y (Treasury). And in terms of looking for safety, the trade goes from, I move more into cyclicals, something upsets the cyclical backdrop, I go back into tech. Because if these virus mutations were to, let’s say offset vaccine success, or the vaccine distribution is so poor, that just means we have an economy more like 2020. Which is that there’s a lot of excess savings, household balance sheets are relatively robust, and you go back to this stay-at-home trade, and that will have negative ramifications for a lot of cyclical assets. But at the index level, it’s a relatively healthy dynamic that the market can rotate within itself relative to how the economic recovery unfolds.

Will US/Euro Rates Divergence Trades Work?

Bilal Hafeez (33:52):

Yeah. And do you have any views on Euro area rates markets, or Japanese rates markets? Because they seem a lot more dull compared to US markets. Are there any interesting trades there that you’re thinking of?

Jon Turek (34:03):

Yeah. I think that Japan is an interesting one. I thought that in the middle of last year it would be interesting that Japanese back-end would lead this, because they’ve had this weird response to wanting the steepening yield curve as opposed to a lot of other central banks. Now, whether that trade can continue, I’m not sure because there are a lot of these FX hedging dynamics that make it more advantageous now for the Japanese to repatriate into backend JGBs. So I think that trade’s probably exhausted, but I did think that was the right way to play the recovery in terms of the first mover being the Japanese back-end because that would be the only central bank that wanted it.

But now in terms of Europe, I think one of the things to watch will be, one of the dynamics that we can’t really have, or the market has proven that it can’t really deal with, is this divergence trade. Where the market prices in the US will get back to its 2019 levels of economic activity, plus all this additional robust fiscal. While Europe can’t figure out its vaccine distribution, next gen EU disbursements are slow, and the fiscal response is insufficient. And that would manifest itself where the belly in the US is selling off and back-end Bunds and Bobls will just grind higher or stay flat. And that’s not a good environment for things like the Euro, etc.

But I do think that it will be different this time, and not in terms of, Europe maybe matching the US in terms of its fiscal path or potential growth. I think it’s still much more likely that we’ll have a pretty wide gap between where US growth is at the end of this year and where Europe approach is at the end of this year. But the thing I think that is different, as opposed to divergence trades of the past, is that they’re both headed in the same direction, and European countercyclical policy is real this time. In the sense that we’ve had basically a lost quarter in Q1, but it has been met by increased measures from Germany, France, et cetera. And the countercyclical side is not that. In 2018, it was like, “Okay, German PMIs were 45.” And German finance ministry is saying, “We still want to run a budget surplus for this year.” And I think that dynamic is over, even if it doesn’t mean that European growth is going to be 5% to 6% this year, while the US it will be.

Productivity Habits and Favourite Books

Bilal Hafeez (36:27):

Yep. Yep. No, that’s great. Okay, I think we’ve covered a lot of ground, and I think it’s been a really interesting conversation. I do like to end my conversations with some more personal questions. And one, that’s always very close to my heart and I ask everybody, is how do you manage your information flow and your news flow and research flow? Because it’s quite easy to be overwhelmed. I see you on Twitter often as well, so I imagine that it’s quite distracting. So what’s your strategy around that?

Jon Turek (36:53):

Yeah. So I think Twitter is both distracting and unbelievable in the sense that it’s probably information I wouldn’t find elsewhere, have access to in such an easy way. But it’s also overwhelming, especially when there’s a lot of noise going on, like this week. I think that I try to break down the day in terms of that I spend the morning first catching up in terms of news twitter is useful for. But more so in terms of going through the relevant economic data, any central banks that were overnight, going through what they had to say, and then forming what happened, what’s happening, data, etc.

And then the afternoon is much more focused on writing and thinking without the Bloomberg Twitter stuff going on. And that’s usually how I structure it. I try to read more books than sell side stuff. I think that my friend James Akin was always pushing that, always read more, so I definitely try. But yeah, I like to start with going through the data and central banks, communication, et cetera. Especially speeches, which can be pretty time consuming. But I think understanding the policy backdrop is so important. And then talking to people about it and then using the afternoon, later in the day to think what it all means.

Bilal Hafeez (38:16):

Okay, great. And you mentioned reading books, are there any particular books that really influenced you in your work or even in your personal life?

Jon Turek (38:23):

Yeah. I think one that even came out this year, which was amazing. Well, I guess last year now. Which was the Trade Wars Are Class Wars by Matthew Klein and Michael Pettis, I thought that was amazing. And definitely getting my hands on, what are the motivating inertial factors that drive a lot of these policy decisions, it’s extremely interesting. I’d say on the market side, the usuals have been very influential in terms of Market Wizards, More Money Than God. That was an amazing one in terms of getting into… It did make you feel like you were watching an hour documentary on all these amazing traders. That book is amazing.

Bilal Hafeez (39:05):

Yeah, no those are good books. Yeah, the Michael Pettis, I’ve read that book. I agree, it’s very good. We also had him as a podcast guest last year as well. And he was great to have as a podcast guest. His Twitter account is also very good to follow, as well to follow China. So that’s excellent. And if people wanted to follow your work, what’s the best way they can do that?

Jon Turek (39:22):

Yeah. So I’m on Twitter. @jturek18. I also have a Substack, the Cheap Convexity blog. And if anyone wants to reach out, it’s [email protected].

Bilal Hafeez (39:35):

Great. And I’ll add those to our show notes so people can get to that quite easily. So on that, I’d just like to thank you, it was excellent conversation and good luck in these markets.

Jon Turek (39:42):

Thank you, you too. Thanks for having me.