Tim Graf (TG): This is Street Signals, a weekly conversation about markets and macro brought to you by State Street Markets. I'm your host, Tim Graf, head of Macro Strategy for Europe. Each week, we talk about the latest insights from our award-winning research, as well as the current thinking from our strategists, traders, business leaders, clients and other experts from financial markets. If you listen to us and like what you're hearing, please subscribe, leave us a good review, get in touch, it all helps us to improve what we offer. With that, here's what's on our minds this week.

In theory, there's a level at which people would lose confidence in Treasuries. It’s really, really hard to get there. Three reasons. One of the reasons is fading a little bit, and that's because the US has the most policy credibility. The other is that we live in a world where, you know, finance, it's evolved into a world where lending is collateral-based. And the number one most pristine form of collateral in the world is US treasuries. That utility makes it much harder for people to lose confidence. And then there's a third element that people don't think of.

Want to know what that third thing is? Well, you're going to want to get comfortable and listen to this week's episode. And even if you don't want to know about that, there's so much else that gets covered this week by a guest who I've wanted to have back on the podcast ever since I hit the publish button the last time we had him on.

He's Mark Dow. He's built a long and successful career in macro markets as a policymaker, investor and trader. He runs a family office now in addition to offering his thoughts on all things macro and markets on Twitter @mark_dow and his fee service is @BehavioralMacro.

This week, I think we covered the widest range of topics I've ever had in a single episode and somehow covered even more than we did the last time I spoke to him. We talked about stuff like the risk cycle and where we are in it, uncertainty versus volatility, the Fed, questions of its independence, fiscal dynamics, debt levels, gold, the dollar, the euro, a bit of Bitcoin and Argentina. We also finished with Mark's current approach to trading markets. There really is something for everyone this week, as long as you have even a fraction of interest in global macro.

I've gone on long enough. Enjoy the next hour.

Hey, Mark, how's it going?

Mark Dow (MD): Good, how are you?

TG: I'm great, great. Good to see you.

MD: Good, good, good, yeah.

TG: It is great to have you back, Mark. I wanted to throw this out to you at the start. You were on the podcast last in February 2024. At that point, we had just fully retraced the drop in the S&P 500 from 2022. And we talked a lot about how, as long as the Fed then kept rate hikes off the table, we were probably in for a good ride in equities. Safe to say, that was a pretty good call.

But we're going to talk a lot more about the Fed. We're going to talk a lot about how you're trading markets right now. But we are 35 percent higher from those levels when we last spoke. I wanted to kick things off with you and see where you see us in the risk-taking cycle now.

MD: I think we're pretty advanced in the risk-taking cycle in one sense. In the sense that valuations are higher and a lot of time has passed. So that's how these cycles kind of play out. On the other hand, it's really hard to see the kind of event on the horizon that would cause a significant crash. So we're in a position where no one would be surprised if we had a 5 to 10 percent pullback because there was some tariff story that got out of control or we had a bad run of economic data.

But the kind of thing that we fear in the back of our minds, particularly us guys that have been around for longer where you get some selling and then there's a cascading of that selling because stops are triggered and people are forced to cash out and you get that waterfall type effect. That seems unlikely now. And the main reason is that the economy is in pretty good shape, notwithstanding all the noise and the tariffs and all that kind of stuff that we can talk about. The fundamental truth is it's really hard to beat. And this should be the conclusion of anyone looking at economics over the past 20 years. We're running a large fiscal deficit and private sector balance sheets are good. That's really it. Corporate balance sheets are good. Household balance sheets for the most part are good. Financial balance sheets for the most part are good. People worry about the government balance sheet. I don't worry about that so much. And if you're in that camp or you don't think it's as important as others do, you should be pretty constructive.

Again, there are headwinds out there, there are tariffs. There's the slower growth in the labor force from the immigration policy. There's a lot of economic uncertainty because as we saw this morning, Trump wakes up and says, “Oh, tariffs.” And he may well be because he heard an anecdote from someone he trusts three days before and extrapolates to the whole sector and then all of a sudden he comes, we don't really know the origin of these things. They come out of the blue seemingly. And that creates a degree of uncertainty that makes it difficult for businesses to plan.

As you know, most of us have been around for a while, know this, businesses can deal with bad conditions. What they can't deal with is constantly changing conditions. Give the guy a bad tax rate, give the guy bad regulatory environment. Some guys will still say, “Okay, it pencils out for me.” And they will invest and they will run their businesses.

But if it's one day, yes, the other next day, no, or you have to be friends of the White House to get in line to beg for exemptions, then it's a more uncertain world and you're going to hold back. And it's not going to, and again, this is more of a long-term issue. It's not going to help us to continue to attract the best financial and human capital from around the planet, the way we've automatically done for forever, almost, right? I'm not going to say that that's gone away, but it's definitely tarnished.

So there are headwinds and I would expect us to have a run rate on growth that's lower than what we had in the past, notwithstanding all the stimulus. But I don't think we're in a position to fall off a cliff.

TG: You brought up, actually, I'm glad you did, because I didn't quite incorporate it in my thinking. The tariffs that were announced this morning, or well, we'll see where they go, but there was this headline on pharma tariffs and other products this morning. The notion of uncertainty that that creates, and the market reaction to that has just been really benign. Realized volatility just generally has fallen off of a cliff. And we have digested the past tariff news. We've digested a lot of those headwinds you talked about.

But how do you square that disconnect between getting this huge daily headline risk from time to time, with the fact that markets at this point just are very, very calm and quiet?

MD: Two things. One is behavioral and one is empirical. The behavioral one is that if you're driving down the freeway, and someone swerves into your lane, and you move at the very last second and avoid a potentially deadly collision, there's an exhilarating feeling from the fact you didn't die, right? We had a near-death experience in April where the tariff war seemed to be escalating, which was the bad scenario, right? No one thought that Trump wanted to tank the economy. The fear was that he would get into some kind of tit-for-tat that would lead down a path of unintended consequences, and we saw that with China when the tariffs were getting ratcheted up.

At that same time, he started to attack for the first time very significantly Jerome Powell, tried to pressure him to leave, right? I mean, we knew he had done this before, he had even done this in his previous term, but this time it really was a whole new level, and as we've seen in Trump 2.0, he's much more aggressive about basically skirting the rules or norms or anything to controlling every lever of power possible in government. So it was a real threat.

The combination of those was really a near death experience for the market, and there was the kind of effect, okay, there's nothing you can do when you... It's like the first time you see gasoline at US$4, you panic. The second time you see it at US$4, you're a little bit more relaxed about it, that kind of thing. But right now, the price isn't even going back anywhere near to US$4. So we feel good. That's the behavioral element, right? The missing, you know, the near death experience.

The second one is just the absolute levels people think, “Okay, it's not good, but it's manageable.” Right? So and we don't really know if he's going to follow through on it. So there's a bit of a lower levels of the tariffs it looks like we're going to have. And the Boy Who Cried Tariff. That combination says, okay, well, we'll believe it when it hits my industry and then that sector trades off. So I think that those two factors are why you haven't seen a bigger reaction out of the market.

I know a lot of people are saying, well, the tariffs didn't turn out to be as bad as everybody figured. Well, yeah, it's because Trump pivoted. If he had gone ahead with that trade war with China, with tariffs at 150 percent, which would effectively shut down trade with China and remove Powell at the same time or continue that campaign, then it would have been a very different story. Then those fears would have been realized. So I think that has a lot to do with it.

TG: Yeah. I want to come back to the point on inflation and what tariffs might mean for inflation when we talk a bit more about the US economy. But just to kind of close the loop on market price action and the risk cycle, we talked about this actually the last time we spoke, which is that we track institutional investor positioning. And actually the overweight institutions hold in US equities, in terms of the sort of percent of market cap they hold off benchmark, has not moved really in a couple of years. But of course, price and multiples have adjusted. And so it speaks to the influence of maybe it's retail, maybe it's speculative.

What do you think is driving price to such a level? And do you think that is a sustainable flow?

MD: Well, I think, to my way of thinking, and I remember this kind of occurred to me, I remember exactly when it occurred to me. And it was in 2013, that there was a debate about the role of passive flows.

TG: Yeah.

MD: I think just the model of how money is intermediated for investors has changed. So it used to be, you know, you had your stockbroker or you did it on your own, or what have you, just, you know, the retail guys. And you had mutual funds that were a lot of discretionary. You know, we were moving away from a more discretionary model to one of a more passive model even. And the mutual funds were coming out with more passive products and things like that.

It used to be that when you were more active and more discretionary, whether it was institutionally or at retail, people would say, they would care about the PEs. They would say, “Well, I'm buying Apple. I'm buying some Apple. I'm buying some Google. I'm buying some Tesla,” or whatever they're buying. And they would say, “What's the PE on that?” Well, now they just say, “No, I want 10 percent to come out of my paycheck every month to go into this asset allocation pie.” Right? And that's the first thing that RIAs do, because RIAs have kind of taken over a lot of the financial intermediation. That's the big rush, the big growth over the past 20 years.

So the first thing is that people don't care so much about valuations when they put their money to work. The second thing, and this is the main job of the RIA, apart from all the tax planning products that people find useful, is they hold your hand. Their job is to put out think pieces that say, stay the course. Look, over time it works. And it has worked over time, for a long time. Stocks go up, and more than just inflation, right? Earnings increase, stocks increase, the line is up.

The odds are against you if you're a professional short seller. So that sale has been made. We see now a different behavior in retail. Back when I was managing institutional money at the Mutual Fund level, which was in the 2000s, and even to some extent in the 2010s, retail was the dumb money, right? These guys were the ones who panicked at the bottom. It's not the case anymore. It's the institutional guys that mark the bottom. The retail guys are buying all the way along, because they're allocating 10 percent every month out of their paycheck. To their 401k or their investment account or whatever it is. That's really it, and it explains a lot.

So the consequence of that, of course, is that you have a higher equilibrium multiple. If there were such a thing as an equilibrium multiple, could people care less about the valuations, and they panic less when things are adverse. By virtue of seeing that time and time again, it makes others more willing to buy the dip, raising the bar for a meaningful sell off further.

There's another factor below the surface. It doesn't have to do so much with retail behavior, but institutional balance sheets. Financial institutes aren't out over their skis with risk. It used to be you had these big prop desks and all kinds of financial institution trading, right? And if the price went down enough, they got tapped on the shoulder by the risk manager and they had to liquidate. And I know this because as a hedge fund, that's what I wanted to buy into. When there were these cascading sales from the financial institutions, you wanted to be in a position to be on the other side. Your P&L had to be good enough to be able to step in aggressively. That's an important factor as well. Those guys aren't there anymore. The capital on their balance sheet is regulated differently. That is to say, the money that they have to hold, the reserves that they have to hold, the capital they have to hold against this risk taking is higher. So they're doing less of it. That makes for less swing.

So on balance, it makes for less volatility, all of these passive flows, it makes for less volatility and higher equilibrium multiples. I don't buy into the notion that, oh, one day watch when these flows reverse. A lot of guys say that. And but part of my thesis is that they're less likely to reverse, right? The bar is much higher for them reversing. And we've seen that now. I mean, how many shocks do you get like COVID? Right?

TG: Yeah, no, it's a really good point. Yeah.

MD: So, that's kind of how I feel about where these things are. And everyone talks about multiples being related to interest rates. We know that's not true now. I've been arguing against it since forever, but it was hard to prove when rates were at zero.

You know, and not many people seem to remember that in the.com bubble, the policy rate was five. And those were the highest multiples we'd ever seen. And they were on companies that had nothing.

Today, these companies with high multiples have something. They have good earnings growth, right? And sometimes quality earnings growth. So it's a bit of a different animal, but it's really not about interest rates. Yes, at the margin, when the Fed is going to cut, people get excited and there's some behavioral reactions to these things. But fundamentally, I know technically, you discount cash flows differently at lower rates, and that means the company is worth more. But that gets swamped by risk appetite and the multiple, the people are willing to pay. And I think that has more to do with these other factors.

TG: Well, the Fed's an interesting element to bring in here because they've cut rates now or they've resumed a cutting cycle they started last year, of course. Is there a risk? And I want to think about that kind of stimulus response between central bank policy and the investor. Do you think the resumption of the easing cycle with markets, as we've talked about at all-time highs, with multiples a bit stretched, has that capability to overheat markets to a degree that, you talked just a bit ago about almost retail investors correcting some of their behavioral bias that they used to have.

Does that bring forward a risk that it might come back and you might get some panic if the overheating in markets just gets a little bit too extreme from a Fed easing?

MD: I don't think so, and I don't think... The Fed easing is kind of a temporary narrative. There's that old saying that, what is it? Patriotism is the last refuge of the scoundrel or something like that. The Fed is the last refuge of the scoundrel. It's the residual in all our narratives. We can't find something else to explain a market move. We say it was the Fed. Look, the Fed was twitching the wrong way at the wrong time and therefore, I just don't think it matters.

It matters in the way we react in the very short term, but long term, obviously, it doesn't matter for the reasons I mentioned. We had the biggest bubble ever, the highest valuations ever in the.com bubble, with policy rates at five, and we couldn't even spell QE. And then in the run up to the housing bubble, 2005, 2006, 2007, is when the nastiest, most aggressive, most leverage vintages of mortgages were issued, and policy rate was four to five percent. And again, we didn't know what QE was yet.

So, I just don't think it matters that much.

And we're again, in 2022, when they started to raise rates, everyone said, this is going to kill the market, it's for sure going to be a recession. And even more so when they saw how fast the Fed was raising rates. And I didn't believe that. Remember, I didn't think we were likely to go into recession, and ultimately it wouldn't matter for markets, and that's how it proved out to be. But in the short term, it's a powerful part of the narrative, and I always say that when something is simple and intuitively compelling, it's almost impossible to disabuse people of it, no matter how false it is empirically. And nothing is more intuitive than Fed cuts rates. When I got my MBA, I never got an MBA, but people say, when I got my MBA, they said in lower discount rate, higher valuations. And it's theoretically true, but I think it's insignificant compared to these to these other factors.

TG: Let's talk fundamentals then. And the Fed has cited this as being an insurance cut to kind of prolong the US recovery, which until really the uncertainty of the first half of this year was had been pretty impressive. And even still, I think the Atlanta Fed GDP now forecast for Q3 is looking really quite strong.

But what do you make of the labor market arguments for the Fed starting to cut and maybe add additional easing versus their previous projections as a consequence? You know, unemployment has risen, but it's not like a typical recession where it goes, you know, it spikes the sort of Sahm Rule effect - how do you how do you kind of gauge what they're doing and whether that is enough to mitigate the risk of that nonlinearity?

MD: First of all, they're, they're trying to get closer to neutral. That's fine. I don't think it matters much either way, except to the extent that you see any kind of move in inflation expectations, which you really haven't done. So the Fed cuts and then you see inflation expectations start to move. Then maybe you're going to worry a little bit. And I don't buy the story. There was last September, a year ago, the Fed cut, and the long end went higher. And everyone says, you see policy error, that's a mistake. But they kind of missed the context, because the two months previous to that, we were debating the Sahm Rule endlessly, and everyone was convinced we were going into recession, and they were angry with the Fed for not cutting in July.

And it just so happened that literally, on Wednesday, the Fed statement came out, cutting rates, they cut by 50 to catch up for not cutting in July. Two days later, we started to get positive economic data, and from then, they started to surprise to the upside. It was just kind of one of those serendipitous things, but it happened. That's what made the long rate go up, because look at what was being priced in at the time the Fed cut. Recession.

So by not being in recession, we got the move in the long rates. It got exacerbated with the Trump presidency because of the uncertainty and the desire to diversify away from the dollar. Very difficult to do, and only at the margin, but the desire to diversify away from the dollar and treasury bonds increased, right? And the uncertainty about what's going to happen to monetary policy if Trump is successful in politicizing the Fed, which I think unfortunately he's going to be able to do over time.

That wasn't happening in September when the long rates were going up, but as we got through the new year, that started to be factored into the curve. So I think the yield curves are going to be steeper than they otherwise would be for these reasons. But it doesn't matter a whole lot what the Fed does, as long as it's within reason.

They're small moves, and nothing bad happens to inflation expectations. There is weakness in the labor market, and the unemployment rate would be higher if not for the slower growth of the supply of labor. So they're kind of offset. It's a little bit like the housing market, when demand for houses declined, but the demand to sell also declined because people didn't want to lose the mortgages they had. You know, demand declines, supply declines, you still kind of have an equilibrium. Same kind of thing here.

So, that's kind of suppressing a little bit, the unemployment. Austin Goolsby at the Chicago Fed, his team has come up with a couple of really good economic indicators for the labor market, composite indicators that show very clearly there is some weakness. It's not worth freaking out about, but it's definitely there. And I think for a lot of us who follow the data, these things will be good to track going forward. But yeah, there's some weakness there. And I think a lot of that has to do with the uncertainty.

Again, Trump throws around big numbers about all the foreign investment, but these are just promises. We saw this in the first term. Maybe there'll be a little bit more this time. We just don't know. But what we do know, you don't want to voluntarily invest a lot in the United States unless the case has to be that much more compelling now, because he can turn around and say, you're not helping me, you're not my friend, I need to tariff you.

So no one wants to be in that situation. And you look at India, you look at China, all these other guys are saying, you know, I don't want to have to, if they're going to be erratic like this and punitive and arbitrary, I need to reduce my exposure to that factor, because now that factor is more volatile.

You know, there was the problem with the tariffs in April that got really acute, and guys are saying, okay, some of that's normalized, but we still have this uncertainty. So that's still kind of plaguing us, not as much as it was a few months ago, but it's still there. And I don't know if, you know, with moves like this morning, the tariffs that came out of the blue again, it's really hard for that fear to subside enough to get investment back on the kind of track that we had previously seen.

TG: On the inflation side of things, I wanted to go back to the tariff question since you just brought it up. And, you know, the expectations channel, as you noted a couple of times, is really quite benign, especially you look at long-dated, like five-year, five-year swaps. They've basically not moved. But just thinking in your background, especially, you know, having worked at IMF, worked at Treasury and dealt with a lot of interesting countries that we'll hopefully get to talk about in a little bit.

The tariff experience, how…do you think we're kind of through this in terms of how tariffs are imposed, passed through, how exporters deal with them, how the retailers and wholesalers in the US deal with them? Where do you think we sit in this process?

MD: I think it's still fairly early. I don't expect to see a lot of inflation from it, but expect to see inflation from it. Let me back up for a second. My initial view was in April, OK, if these tariffs get imposed, it's really bad, we're going to see a spike in inflation. I think it's going to be a one-off, but it's still going to be really bad for real incomes, and that would have economic consequences. The base case when you see tariffs is that it's going to be transitory, and I think that's still the case. However, and this is how the Fed has been thinking about it, with just having had a bout of serious inflation - also transitory, I know people don't like to call it that, but it was, it just lasted for a longer period of time, as the tariffs now will. Having had that, businesses know how to raise prices now, and they have a better sense of when they can and when they can't.

We spent 15 years with businesses deftly afraid of losing market share by raising prices at all, and that's gone. So not only are businesses in a better position to pass through price increases if they think they need to or they want to, consumers also, they're still anchored, their inflation expectations are still anchored, but a little bit more tenuously, because they just lived through that inflation. It wouldn't take as much as last time to get the inflation fears to pick up again. When we had the COVID inflation, the strategy of the Fed, I don't think it's fully appreciated, they were saying, okay, this is transitory. They didn't know we were going to get four different COVID shocks, right? Four waves of COVID. They just say, okay, we have the shock, textbook says it's transitory, let's hang on for as long as we can and hope that they come down on their own.

If however, inflation expectations start to get unanchored, then we have to go and go hard. And that's what happened. In late 2021, inflation expectations started to get unmoored and they had to go hard. So now we're at a place where consumers, it would take less to get to that place where inflation expectations started to move. I don't think they get there, but theoretically, it's a lower bar to clear. So the Fed has to be a little bit careful. Even if they believe strongly, I think, in their heart of hearts, that the tariff effects are going to be transitory.

Now, what's changed since April is we're not going to get a big, massive hit from tariffs. It's going to be smaller and stretched out over a longer period of time, right? Because for a lot of reasons, one, the way the tariffs are being applied and things are getting negotiated, but also a lot of businesses pre-hedged, right? They bought in advance. Some of the businesses are trying their best to stave off price increases for as long as possible. That's going to wear out at some point, and the prices will creep up.

So my central expectation, again, I'm just guessing at this, right? But just from a conceptual point of view, I expect over the next 18 months to see inflation more elevated, not dramatic, three-handle, low three-handle, maybe a high three-handle if things are a little bit worse, because we have other things working in the background that we'll talk about in a second. But I expect it to get there and stay there for a longer period of time and then slowly will absorb them. And then the disinflationary forces of productivity gains and all the good stuff that we tend to have in the economy will take hold.

But part of the reason I think inflation can even go up to those levels is we have a couple of other backdrop items. One is the labor market, right? The labor market is going to be tighter than otherwise would be. Even if unemployment is increasing, it's going to be tighter than it otherwise would be because of the labor supply problems. Second, we have electricity costs that are going up and other costs that are going up, right? I mean, look at a chart of electricity. It's not good. And there are other elements in the economy disturbed a little bit by the erratic policy making and the uncertainty that are just going to stay a little stickier. So I expect sticky inflation for the next 18 to 24 months at a minimum, but not at nasty levels. Still, with a three-handle, it makes it difficult for the Fed, even a low three-handle makes it difficult for the Fed to go much further than they have so far.

TG: The electricity angle is a really interesting one. Yeah, I've only just really started to focus on that one. But the first one, the labor supply element, I always ask people when they bring this up, and I'm curious to get your thoughts. You know, tighter labor supply, yes, but potentially lower aggregate demand through lower hours worked and a smaller working age population.

Do you think those two kind of counterbalance each other through time or is it still kind of?

MD: The new Fed governor is trying to make that argument, but I don't think it washes because we know that when the supply of labor increases, it increases growth in net terms, right? But it doesn't really have any meaningful price effect. So I would expect the reverse. It will have an effect on growth, but it's not really going to be disinflationary, right? So I just expect the reverse basically what we saw when, you know, the normal labor force growth or even accelerated labor force growth that we had for a little bit in the Biden administration. I think it's offset, at least offset, by the competing for the scarcer, the smaller labor pool.

TG: Going back to this question of independence, that was not seeing that in price, particularly long dated inflation swaps really, really surprised me. And so I was curious to get your take on whether markets are actually pricing for a potential loss of Fed independence or a degradation of Fed independence.

And if not, what would you look at to kind of gauge that?

MD: Well, it's being priced in a little bit. And I think that's factored in. I mean, there's a lot of reasons that drive the gold market, right? Because I always say the perfect bubble asset has no fundamentals, because you can create any narrative you want. And gold is almost the best at that. Bitcoin is the best at that. But gold is almost as good.

Just to recap really quickly, and I think most people know this by now, but I've been arguing this for quite some time, probably last time I was on with you. And I don't like, traditionally not like gold as an asset. I don't think it's a great hedge. However, what I did know and do know is that historically, the main driver of gold in terms of correlations was real interest rates and nominal interest rates. Real interest rates are a little bit more than nominal interest rates, but interest rates. That started to break down about six months before Russia invaded Ukraine. I didn't totally realize that at the time. I noticed the breakdown in the correlation. And I said, okay, I'm not shorting gold, right? Because it's not behaving the way I would expect. And I didn't want to buy it, but I didn't want to sell it. That happened.

And then when Russia invaded Ukraine, it kind of became clear to me, Russia had been trying to diversify away from the dollar. Now you can't diversify away from the dollar very much because there are no big alternatives, right? And that's why the gold market is very small. And the dollar market is massive. And so a little bit of diversification goes a long way, out of dollars, goes a long way in the gold market.

So that's how that started. And then after the invasion, other state and non-state actors, they kind of said, well, maybe I could be in that position one day and the US could weaponize the dollar against me. They also started to buy gold more aggressively. And then you start attracting narratives and you start attracting more people into the asset class. And that's what's happened, right? And now people talk about a lot of other factors that are driving gold. Whenever gold goes up, they always say, look, it's the debt and the deficit. They've been saying this since before I knew what the stock market was. I do think it's taken on a little bit more vigor, or meaningfully more vigor, since the Fed's independence got threatened. Because it brings in another group of people, apart from the state and non-state actors that think that the dollar could be weaponized against them.

You bring in other people that say, I probably need a little bit of gold, because who knows what happens if Trump controls the Federal Reserve. I think that's happening. You see that at the margin and it also affects the steepness of the yield curve. Interestingly, Bitcoin hasn't benefited from that the way gold has. But I think it's there in the narrative a little bit. But on balance, if you had to say yes or no, is the market pricing in it? Pricing in the Fed's loss of independence? It's closer to no than yes. It's like a lot of things with Trump. Financial observers say, when I see it, I'll believe it. Who knows because he says all kinds of things. A lot of people think, it's not going to happen. No, it's not going to happen. A lot of things.

So I think a lot of people are saying, still in that mode, they say, well, let's see if he can really take over the Fed. I think he's going to be successful in doing it, de facto, but it remains to be seen. So I think until we kind of see it, not going to react to it. A lot like in the stock market, when people say, well, why isn't the stock market pricing in this bad news or that bad news? Typically geopolitical shocks is where you see this. And I always come back to, is it going to affect earnings? And when you see a conflict between Russia and Ukraine, not going to affect earnings, except for a few companies, right?

TG: Yeah, locally, yes, but globally, no.

MD: Or pick whatever, Argentina, or pick whatever global issue there may be, geopolitical issue there may be, unless you can draw a clear map to earnings, it's not going to matter. And even if it does, even if you can in your mind and draw a clear map back to earnings, until people start to see it, there are going to be a lot of people who don't believe it.

TG: Would you then – not to jump ahead too much to trading views because we are going to get to those – would you stay long gold at these levels for that risk to continue?

MD: Yes, it depends on your time horizon. But I think gold's a little bit overdone now and has to consolidate. If we get a sell off, actually gold's kind of an interesting asset to watch because it will probably be the, if we got a meaningful sell off in equities, 5 percent, 10 percent or something like that, gold would probably be the one, the last one to sell off. So that would be a good indication of we're getting close to the end of the sell off. And that's a good thing to remember.

But I think it's trading well, all things considered, and it's overbought and people are over enthusiastic about it. But longer term, I still think you want to be there because the gold market is tiny. The fear of weaponization of the dollar and uncertainty about the Fed, that's not going to go away. It's likely only going to get worse.

TG: Before we get to the market views, there's a few things I wanted to ask you about. And you mentioned deficit levels earlier. You talked about curve steepness and that was also thrown around, I think, potentially as a kind of Fed independence measure, people looking at things like 5s/30s.

And it wasn't just the US market, though. You were seeing this in a lot of markets. And so I'm wondering, especially those markets like Germany, France, the UK, and the US to a degree, Japan, and Japan actually, yeah, that's the best case of it. We have this focus on debt and deficit levels. And I know historically, and I think we talked the last time about, there's always deficit hawks who have been, they've been bringing this up for the last 40 years, especially with respect to the US, usually wrong.

Do they have a point in some cases right now?

MD: Well, not usually wrong, every time wrong. They've been wrong every time.

I remember, I don't know if it was in the context of our discussion, but there's a Time magazine cover from 1973, saying, is the US bankrupt? I think Uncle Sam is on the cover with his pockets turned inside out or something like that. So this debate has been with us for a long time. In theory, there's a level at which people would lose confidence in treasuries, you would think, right?

I mean, Japan obviously has a lot more debt than we do, but it's really, really hard to get there for two reasons. Well, three reasons. One of the reasons is fading a little bit, and that's because the US has the most policy credibility around the world. The other is that we live in a world where finance has gone from, let's say it's evolved into a world where lending is collateral based. It's not the bank kind of lending out money so much as everyone is liquefying all kinds of assets. They're taking assets and they're pledging it against something and they're getting money from it.

So the world is collateral based and the number one, most pristine form of collateral in the world is US treasuries. So it's so deeply embedded in the system, in a way no other country in Japan or anybody else. That utility makes it much harder for people to lose confidence. And it's a little bit like being mad at your computer or an app or something like that. It sucks, but you have no alternative. That's legitimately there.

And then there's a third element that people don't think of. And that is a little bit more complicated. And it's when think about it takes up an understanding of the mechanics, just like pawning in the treasury market. And that is when the treasury issues a bond, what happens? Okay, so they sell a bond to you, you give them your money, and then they turn around and they spend that money.

So what's happened? The amount of money in the system is unchanged. But you have an asset now. In the aggregate, the private sector has more assets. And I know people don't like to think in these terms because there's a lot of anti-government bias, but it's increasing the wealth of the private sector at the expense of the public sector, but it's increasing the wealth of the private sector. Well, what happens when the private sector has more wealth? They invest part of that wealth. And what's the number one asset that people want to buy or need to buy? Treasuries. So paradoxically, issuing treasuries has a recursive effect. Obviously, the coefficient is less than one, right? But there's a recursive effect there, a kind of a multiplier thing where it increases the demand for treasuries itself. So for those three reasons, the bar is extremely, extremely high. I worry much more about the quality of our government expenditure, expenditure than the level of debt or level of deficit.

TG: Would you extend that to some of these other countries though?

And we'll leave Japan aside because I think, you know, a country with such high levels of national savings probably isn't a problem. And there are others, you know, where just the simple R versus G type of analysis, that your growth rate is at least higher than your rate of interest and you don't necessarily have a growing debt pile as a consequence. But I'm thinking particularly of the UK and France of the two right now, because you don't have the nominal growth necessarily at levels that would make you comfortable with the level of interest rate that's paid on the debt. And you might have worries of a debt burden growing to...

MD: And they don't have these benefits that the treasuries have. Yes. It's not the pristine collateral around the world. And people aren't forced to buy it when their wealth increases. Someone in the UK could, it is likely to buy treasuries. Yes, they are. Yeah, they're more vulnerable.

But if you take the monetary paradigm a little bit further, kind of think about it, they're just government liabilities, right? Let's say that they couldn't issue debt. If they just printed money, those are also liabilities. And they can do that up and to the point where it causes inflation. And as we've seen from the past 15 years, it's really hard, if not impossible, in most cases to cause inflation from printing money, right? It just doesn't happen. The money sits there. There's a liquidity trap. No one uses it, right? The way you can create inflation, apart from the external shocks like COVID that we saw and the tariffs, we're seeing in a small way now, is through fiscal.

TG: Yep.

MD: Because you're injecting wealth into the system. By printing money and taking out bonds, you're not changing the wealth of the private sector. So in theory, they could get around it, and effectively it would happen from the ECB, not in the case of the UK, but in the case of France, the ECB could buy those bonds and replace it with money.

And as long as it wasn't inflationary, which it would unlikely be, they would actually be okay. Conceptually, people are just so wired, getting back to the intuition issues, that printing money means inflation. Milton Friedman's quote does a lot of people a disservice about inflation everywhere and always being a monetary phenomenon, and they didn't read the rest of the quote either, where he kind of caveats it. But they could do that. So I think Japan could do that, France could do that, and in some sense, the UK could do that with its own central bank. But it's still going to be a little tougher for them because people aren't obliged to buy and they don't have that recursive wealth effect as much as the Treasury does.

TG: What then, as someone who is ex-IMF, what does it take for a government to go to the IMF? What are the conditions you usually would have seen back in your time there?

This is an appropriate week to ask it as well with what's going on in Argentina.

MD: Yeah. So the IMF exists to provide balance of payments support, even though the adjustment almost always has to be fiscal. So the classic story is that a country pegs its currency or is manipulating it to keep it artificially strong because it's unpopular and inflationary to let your currency go. The currency doesn't matter for us in inflation terms very much because we're a large closed economy, share of exports and imports of GDP. But for these other countries, it matters a lot more.

So they don't want to see it go and people don't want to see the purchasing power deteriorate. And in countries like Argentina that had serial problems, and a lot of these countries around the world have had serial problems managing their economies, there's a kind of a psychological thing too when the exchange rate goes up. It just loses, you lose confidence in the economy rather quickly.

So the country keeps this exchange rate artificially strong for those reasons, but continues to run a hot fiscal policy. That means you're buying a lot of imports and not exporting very much because your currency is too strong. It can be accompanied by capital outflows, it depends on what the situation is. But basically you get into a disequilibrium where you're not generating enough foreign exchange to service your external obligations or even to continue importing at the rates you have been.

And so the fiscal disequilibrium creates a balance of payments crisis. They go to the IMF at some point and they say, “We need your help.” And the IMF goes, “Okay, I'll help you. You've got to cut up your credit cards and promise not to go out on Friday night anymore and we'll give you bridge financing at a very cheap rate in dollars so you can continue to import and you continue to do these things. Service your debt, ideally, but you're going to have to let your exchange rate go so that you can start generating foreign exchange from your real economy, you know, exports of goods and services greater than imports of goods and services.” So that's the typical scenario and that's exactly what's happening in Argentina right now.

TG: Let's talk about that a little bit. Milei has been, it looks at least successful in trying to cut spending or at least he'd had that push towards that.

They've kind of managed the currency weaker, partially at least, maybe not enough, but where has it gone wrong for them particularly?

MD: This is what's happened. So he's been, the type of leader you need, whether it be a company or a country, can change depending on the circumstances. So I remember Boris Yeltsin in Russia, he stood on the tank in front of the Duma and face down the insurrection. He had that kind of courage. He was a terrible administrator.

Well, Millet is the kind of guy that has that crazy, insane courage to actually cut the budget deficit in a way that Argentina needs. And he's doing it, right? And he's done it, he's done a good job of that. However, his libertarian ideology leads him to believe that get the government out of the private sector, deregulate, and you're going to get so much growth that you're going to get into a virtuous cycle. So he cut fiscal spending dramatically and inflation started to come down. He kept the exchange rate too strong because it helps bring inflation down faster.

In Argentina in particular, but this is common to most countries, but Argentina is a particularly cute case of this. They're more willing to believe that a stronger exchange rate than is appropriate is actually not too strong. I saw this in 2001, seen this in many, many times. It's the old story. So they kind of convinced themselves that, oh, this exchange rate is not too strong, but it is. And you can see it. So, he spent reserves, the dollar, scarce dollar reserves that he needs to generate, right? Because we talk about the balance of payments problem. He spent those in keeping the exchange rate from depreciating further. The IMF lent US$14 billion and he burned through 10 of them, just defending the exchange rate, and that wasn't in the program. So that's one problem. Now they're stuck with an overvalued exchange rate. It got midterm elections coming up, and they know if they let this exchange rate go, they're going to have another burst of inflation. It's not going to be like the inflation they had before, if they maintain the fiscal anchor, right? And it would be politically damaging, because you talked to your average Argentine, the only economic number that they know is at all times is the exchange rate. They all know this.

So it's extremely sensitive politically, and there's a strong incentive to believe these other theories that allow you to keep the exchange rate strong, and somehow you're going to get some productivity gains that will get you out of it. And I just think it's extremely unlikely. So that was the first mistake. The second mistake was believing that it would unleash growth when fiscal contractions are massively contractionary for the overall economy. That's just, again, this is a lesson everyone should have learned over the past 20 years. But if you remember, if you just roll back the tape, 10, 15 years, even when Obama was president, everyone's saying, oh, well, you know, fiscal spending makes it worse. Because you're taking resources away, you're crowding out the private sector. Turned out not to be true.

But a lot of people believe that, and that's consistent with kind of the libertarian ideology that Milei has. So overestimating growth, and now people are feeling the pain of the economic contraction. The non-tradable sectors are getting crushed. So he's losing popularity, which threatens his fiscal anchor. So he's got an overvalued exchange rate, a fiscal anchor that's being threatened politically, and an economy that's slowing very rapidly. And he didn't anticipate the exchange rate problems and the growth problems the way I would have, or most more, I don't want to say orthodox, but normal economists would. However, if you hadn't had a guy as crazy as Milei, as intense as Milei, as determined as Milei, as ideological as Milei, you would not have gotten the fiscal anchor in the first place, I would argue, in a place like Argentina.

I mean, it's a little easier coming out of hyperinflation to get the kind of support for a while, but it was always, and if you go back through my tweets over the past couple of years about Milei, I was always there, wait for the growth, wait for the growth. It's just going to be a hit to growth. He's got to survive that in order to continue on his plan. So he needs to survive to shock the growth politically, and he needs to have a come to Jesus moment with the exchange rate, which I think some of his advisors understand at some level, but it's just so difficult politically that it's going to be hard to do. So I think that's where it is. People were just way too quick to say, there's anti-government bias in everything. So people were, oh, look, the ideology I would like to be true is winning. Because everyone would like to believe that more freedom means better results. But that's not always the case.

TG: The trading thoughts are really where I wanted to close this.

I'm really looking forward to hearing, first of all, the answer to the first question, you always talk about this on your Twitter feed. How are you seeing the ball these days?

MD: Okay, I'm seeing the ball pretty well, I think. Can change tomorrow, right? That's how these things, I think I'm seeing the ball reasonably well. I'm cautious a little bit about risk, not for, just I think things need to cool down just a little bit. And we're probably going to be seeing marginally slow.

I know we got a hot print this morning out of Atlanta, but that number changes a lot. I think we're going to have a growth in the high ones is what I expect to have as a run rate. And that means we're going to see some prints that probably aren't great. Not terrible, but not great. And we're priced for great. So right now, I don't think it's not much to do really in the markets from a trading perspective. You've got a longer term time horizon, you want to stay invested because things will probably work out and everything's good and no, I don't see a tragedy on the horizon.

But I think it's a good time just to chill a little bit. And even on the positions where I have been aggressive lately, long euros and long gold, it's just maybe a moment there to step back and let things cool down because that positioning is a little bit stretched and things are running a little bit, particularly in gold, not so much in the euro.

But the euro has a pattern that I think is likely to break out of sooner or later. And this background effect of diversifying out of the dollar, again, it's a drip, drip, drip, not a flood. It's not enough to drive things in and of itself, but it's just constantly in the background and ultimately weighs on the level of the exchange rate in the case of the euro. So I wish I had some home run trade or some compelling setup. I just don't see much to do right now.

TG: Yeah, I mean, one of the things, to the extent I actually changed the charts that I look at on my Bloomberg setup the last time we talked is that I took away from that conversation was especially your approach to trading was focusing on things that had kind of volatility or an emotional component, I think you called them. So you say that set of assets or currencies is smaller.

Does the dollar factor into that though over time? Does it, has it took on that component earlier in the year, say Q1, Q2? Do you think you will get opportunities, I guess, to short dollars in the future? Or is it just too slow of a move now?

MD: I think so. I think so. But it's just right now, it's one of those things where I think that's the fundamental, the direction of travel fundamentally, as people say. But I don't think the positioning is conducive to that being an easy trade. So I would like to see positioning a little bit more cleaned up, ideally leaning a little bit the other way for whatever reason, and then maybe step into a more aggressive trade again.

You want that emotional component to line up with what you think the fundamentals are. And right now, they're kind of at odds with each other.

TG: Yeah. I mean, our own positioning metrics would say exactly that. Like institutions have gone from massive overweight to massive underweight. One of the things that we're looking for on that is we can also track hedging patterns. And particularly, foreign owners of US equities have not really... They're hedging kind of the flow. The flow is going into hedged product, but they've not hedged the stock.

Is that a big component of your long-term thesis, or what are the other factors you really look at in having a dollar view?

MD: Well, I just think this dynamic of wanting to diversify away from the dollar, but not being able to do so easily, that creates this drip, this drip, drip, drip. But definitely, I'm hearing this too, that people are hedging their fresh flows. I think the number was like 80 percent of new flows into US equities is hedged, or something along those lines. That intuitively makes sense to me. So yeah, I think that's where we are.

And I don't think it's changing if you have a Fed that you think is going to be more politically driven, pushing rates lower, perhaps aggressively depending on the setup. And you have this background of the weaponization of the dollar and the other things that you fear. I mean, if you're 80 percent dollars in your holdings, you wake up and you go, well, maybe. Because think about it, how many portfolios around the world, irrespective of whether they're domiciled, are dollar denominated?

I mean, Singapore, people think in dollars a lot more than anything else. And they've invested that way because we have the deepest, most liquid. And up until now, at least, the best regulated markets, right? The one that you could trust the most in the economy with the most policy credibility. So people kind of got out over their skis.

And we also had a period where, when we were raising rates, people got really long dollars. If you look at a 20-year chart of the dollar against the euro or some dollar index, we're not at particularly weak levels. In fact, we're still in the upper half of things. There's a lot of room for it to grind lower from all this positioning that we're talking about. The stock that you're referring to.

TG: Exactly, exactly. Yeah, I mean, that is not just tens of billions of dollars that could be sold, but literally hundreds. For small adjustments in the hedge ratio of these investors.

So with a low realized volatility environment and maybe a smaller set of views that you're really passionate about and have high conviction in, what are some of the favorite things you have, maybe long-term, that you really like?

I mean, last time we spoke, it was home builders that worked out, depending on how you invested, worked like it worked out pretty well.

But what is the Mark Dow long-term outlook favorite trade now?

MD: Well, there's nothing compelling as a sector. I mean, even home builders, they've run a lot and there's a risk that if the labor market weakens more than people expect, people aren't pricing in a lot of labor weakness into the home builder market. They're thinking, okay, there's a shortage of homes and interest rates are coming down. But if the economy slows to a lower run rate, and maybe it's not so good. So I don't know.

I just don't see anything compelling. I kind of stay close to home, you know, stay invested, you know, in your passively or whatever you're doing, and then just wait for an opportunity. It's just, I might be seeing the ball well, but I'm not seeing any strikes. And seeing the ball changes all the time, as could be the opportunities. It could be a week from now, two weeks from now, some opportunities catalyzed, but I just don't see anything super compelling. I mean, there may be some foreign equities, foreign markets that you could chase, but again, there's nothing where I want to bang the table.

TG: It's actually a really interesting point to close on, I think, because we are in this low volatility environment. Things do look pretty good. Mark, I don't want to take up any more of your time. It has been so great to catch up. I always learn from following you, chatting to you, and I think maybe we give it another 18 months and see if what we talked about today turns out as well as it did 18 months ago.

MD: We'll see. You never know. It's easy to be wrong. The important thing is to be wrong quickly.

TG: Exactly.

MD: Just so you can stop out and then move on. I was saying this yesterday, the key to being a good trader is good health and a bad memory. Like a lot of sports, really, you just have to, when you're wrong and you're wrong a lot, just forget it, move on. So hopefully, in 18 months, if I was wrong, I will have moved on.

TG: Very good. Well, we are going to move on for now, but I can only say to people, give Mark a follow on Twitter. It's @mark_dow. And for his premium platinum service, it's @BehavioralMacro. Mark, as ever, thank you so much.

MD: Thanks, Tim. Thanks for having me.

TG: Thanks for listening to Street Signals. Clients can find this podcast and all of our research at our web portal, Insights. There, you'll be able to find all of our latest thinking on markets where we leverage our deep experience in research on investor behavior, inflation, media sentiment, and risk, all of which goes into building an award-winning strategy product. And again, if you like what you've heard, please subscribe wherever you get your podcasts and leave us a review. We'll see you next time.