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.

We’re taking on our big questions for summer markets one-by-one. Last week, we covered tariffs and inflation with Michael Metcalfe. This week we focus on the question of currencies, especially the US dollar, its valuation, its fundamental drivers and after falling 8 to 10 percent so far this year, where it's going to head for the long term. But there's so much more because before we do that, we also take a deep dive on how to think around a currency process with Aaron Hurd, senior portfolio manager, focused on FX at State Street Investment Management.

As you're about to hear, Aaron thinks about currencies in a completely different way than what we're used to discussing in that he's focused on managing risk for his clients over a very long term horizon where considerations of value can supersede those of momentum, short term price dislocations and the day to day, back and forth of markets. Those are all still important factors, but nevertheless, this focus on long-term risk management is a fascinating and unique way of looking at the currency world.

Hey, Aaron.

Aaron Hurd (AH): Hey. How you doing?

TG: I'm all right and you?

AH: Doing well. Nice summer Friday?

TG: Yeah. In the office, sadly. It's the first chance we've had to really speak, so I wanted to start things off by just hearing a bit about you, how long you've been at State Street, how you got into FX… Actually, that's a, that's a good place to start.

AH: Yeah. Little bit of luck. It was a small hedge fund goal was to time global equity markets one day ahead. And so naturally the currency, it was all on an unhedged basis. So the currency figured into that and got me into it. And back in school, you know, an econ degree, you know, that was early 90s, China was introducing market reforms, free market reforms.

You had, you know, the fall of the Soviet Union, so free market reforms there. It was a very exciting time. So I was, you know, very much focused in my education on that kind of big picture, cross country socialism versus capitalism, you know, the kind of big theoretical questions. And so kind of just naturally, I saw a job posting for FX and I was like, this is kind of interesting. Then a little bit of luck took over.

Apparently, they had an offer letter written for somebody already. And I went into my interview, they said, oh, let's just check this one last guy. They absolutely did not hire me because they thought I'd be good at FX. They handed me a bunch of MATLAB code and VBA code and asked me to tell them what it was doing. And I read it and I got the job because they were transitioning, doing a big IT transition for the infrastructure for currency. And I was able to do that. So I won out and got kind of lucky. And that was 20 years ago. Turns out FX was every bit as fun as I thought it would be, and I just kind of stuck around.

TG: So learn to code. That's still the good advice.

AH: Learn to code. Yeah, yeah. And just, you know, understand that there'll be a certain amount of luck. Right? You just have to jump on it when it. When it happens, position yourself to kind of bump into as many lucky opportunities as possible, and it works out for sure.

TG: Can you talk a little bit about what you're doing today, then? What, you know, how has your career at State Street progressed? And, you know, working with FX for State Street Investment Management. What sort of things do you look at then?

AH: Yeah, so, I mean, obviously I started as a junior portfolio manager. So, you're really in the weeds, processing daily transactions now, rebalancing the accounts to whatever the targets were, whether it was a passive account or an active account. Making sure everything was in line with the desired positions, working on, after the first year, a little bit of research. They particularly threw me at momentum models because I just naturally do not like momentum models. So they said, oh, this would be funny. Let's put him in charge of that with the momentum research. And since then, it's kind of grown.

You get more accounts, you get a little bit more senior, you start to speak to clients. I love that. Right? Particularly the education component and teaching them about their FX risk and how they might manage it. And that's kind of taken over my job over the years. Right?

So I'm still a portfolio manager. I focus a little bit more on our active strategies and what we're doing there, but certainly for passive as well. If we have a thorny, highly bespoke account, I'll get involved with kind of brainstorming with the team on how to implement it and work out the mechanics of it. But mostly it's spent. My time is spent within the team kind of heading up the strategy effort. So market strategy, what are our views on currency Markets focused a bit more on G10 than EM these days leading up the research effort. So largely we have a quant base to everything that we do.

So, you know, what are those models? What are those models missing? I mean, my job day to day is to go around and talk about how bad our models are internally because you're just trying to make them better all the time. Right? But I'm actually quite happy and proud of our models. I guess my job is to criticize them constantly.

TG: You mentioned not liking momentum or not, not being a fan of it. What I feel like everybody has their sort of North Star. For me, it used to be like fair valuation and I kind of got away from that. Now actually I've embraced, raised momentum a little bit.

What for you is kind of the North Star in thinking about currencies?

AH: I think I'm back in that valuation camp. Certain valuations just don't make sense. They're not sustainable. Shorter term, I can see momentum working however I test it, I just can't get it to consistently work across currencies and across time. So there's obviously the big dollar yen move from 120 to 160, right? Those, you want some momentum in there to capture those sort of things. But most of the time you're just getting chopped up, right? Even the pandemic, you got this huge dollar move. All the momentum signals flipped dollar's way up and then the dollar into 21 tank, right? So you got whipsawed, then you got a little bit of momentum working. Then you got whipsawed again as a dollar took off, right. And then you had a nice 18-month run on momentum. But even there it got a bit choppy. Like every January we'd get this big correction and then you'd get wiped out or knocked out of your momentum trades and whipsawed.

And so it's just kind of unsatisfying. But valuation, although it's longer term, but even short term, yeah, I'm cautious. I don't like to think about short-term fair value in the same sense as long-term fair value. Long-term fair value. I'm really talking about equilibrium. And you know this. If the currency stays where it is, then other things are going to happen that make that unsustainable and force the currency back. Right now that could take a decade. And that's very frustrating. But that's also why long-term valuation alpha exists, because it can take a decade and so people can't stomach it. And so if everyone could stomach it, they jump in and arbitrage the opportunity away. But it exists because people can't stomach waiting that long, right? Or only a very few people can. And so I believe in that short-term fair value. It's more in my contrarian nature, right? You see a big move and you're like, this is crazy. Like, yeah, it's a three day move, nothing's really happened.

On the active side, we have some models that try to capture that, right? What are the common day to day drivers, what's going on in equity markets, commodity markets, interest rates, that sort of thing. And you get a move and there's no apparent reason for that move, right? Economic data hasn't really changed in a meaningful way and those other market variables haven't really changed. And so that's likely just some sort of liquidity driven overshoot and it will revert, right? But if it doesn't revert, there aren't those powerful underlying forces that will eventually bring down the European exchange rate mechanism that can break the peg on the RG dollar back in the day, right? Make Soros a billionaire in a day. You know, those sort of equilibrating forces really aren't at play in the short term value models. So my North Star is really that longer term value. But of course short term matters, right? I can't just be like, hey, don't worry, just wait a decade. We got to, you know, we have to pay attention to short term. And I have a lot of fun with that.

TG: And then long term, this is where I'm really curious because there's any variety whether it's fear or beer or just simple PPP.

Like what, what types of things do you use to assess long term valuation for currencies?

AH: I don't want to say this is a settled decision because we're always reviewing, but you know, we really have kind of settled on PPP as the workhorse, right? All the ear models, right? Fear models, beer models, cheer models, peer models, they all have various problems. You take a fear model, right? So fear model is trying to find that exchange rate which creates internal and external balance, right? So you want to balance that external capital account and you want that to happen at a balanced. You're at full employment with inflation at target, right? Well, we know just from the last few years, right? I mean, R Star is a huge issue. And where are we in that? In NAIRU, right? What is NAIRU? What is that? Equilibrium unemployment rate. Really hard to measure. What is an equilibrium capital account? How indebted can a country be? Well, that depends on many, many things, right? So having to estimate all that stuff and then from there estimate the exchange rate that's consistent with that is just too much of a heavy lift for me.

A beer model will take behavioral factors, what's going on with terms of trade, Some things that would go into a fear model, right? Or conceptually productivity balances, those sorts of changes in productivity, some people with changes in interest rates, that sort of thing. There's many different kinds of beer models, right? But behavioral equilibrium model.

So you think what are those things that drive it? In a way we kind of do that, right? We have that short term value model that has some of those things.

We certainly have productivity adjustments in our PPP. But what I find is people tend to throw a lot of stuff at that and then the fair value becomes too volatile. So what we need is, right? So I say, oh well, yen's cheap, yen's too low, yen's really cheap. I'm going to go long yen because I expect it to go back to fair value where two things can go wrong. One is it doesn't go back to fair value, it just keeps getting cheaper. Value trap. That's the big issue we think a lot about every day with PPP models too.

The other I think more common problem is the fair value itself is so volatile that you go long yen, but the fair value actually does the correction. So the fair value goes down and meets it and then you don't make any profit, maybe even lose a little bit. But you're right, the equilibrium held. Ultimately it was misvalued and now it's fairly valued. But the fair value move did all the work. In a way that's saying that the currency predicted those determinants of fair value better than those determinants of fair value predicted the currency. And so when I use beer models cheer models that capital enhanced. So a lot of interest rate type factors, fair values tend to become too volatile and make it difficult to trade PPP very long term.

I like that again because it makes it less likely that people arbitrage it away. But there are also structural issues, right? Particularly in EM, you know, the fair value changes as the economy changes. Structurally, it's a 15-to-20-year cycle, seven to 10 years up, seven to 10 years down.

Since 1974, we've had like maybe two and a half cycles. So from a statistical standpoint, you have to take it with a grain of salt. You know, I'm not saying it's the panacea, but it's a nice stable, it's intuitive in that, you know, a cheap currency does in fact eventually tend to lead to competitive advantages. Capital inflows because, you know, land, labor, capital is cheap.

Some of the problems that plagued PPP in the past, right. It was very much a trade-based theory, but I think it works well in this current world, right, with heavy capital flows because you can see companies saying, oh well, this current, this country's chronically cheap currency. I'm going to open a factory there. Right, because you're in fact used to be a big thing. You know, PPP only holds for tradable prices and not non tradable, but with, you know, more integrated global capital market, you can kind of trade non tradables.

When you hire somebody, you hire somebody, you pay the prevailing wage, which is the prevailing price of haircuts and housing and all the things that are non-tradable across borders. But it's embodied in that labor, which is in fact tradable because you can decide to open your company there. So I think it just kind of makes more sense to me and empirically it has better results over the, I would say 50 years. But in the context that is in fact a short sample period.

TG: Yeah, yeah, yeah. And incorporating this into the work you do for clients. I'm curious to hear about the various functions because of course there's alpha generation which you've talked about, especially with respect to short term. And I want to hear about that. But also kind of the currency hedging or currency overlay type strategies which do you.

Is that the sort of work you then advise on for clients to set up these kind of long term hedging programs? And how does that work?

AH: It starts with convincing people they should pay attention to their currency risk. And this has gotten increasingly difficult because the dollar is such a huge portion of most major global indices. So if you're a beta investor, you have a huge dollar US dollar asset exposure. We're over 70 percent of the MSCI in the US so you have these large exposures, but the dollar's been kind of a free lunch for a long time. It's been going up for 12 years. Obviously cracks recently that we think will become a bear market, but you were making money and it was highly negatively correlated to risk assets. So it's reducing your portfolio risk and increasing your return for the last, you know, 10 or 15 years. A lot of people just like, I don't have to worry about that. That's great, right? So you're just not paying attention. In the US kind of chronically foreign exposures, aside from a brief period, you know, around the GFC and in the early teens, foreign exposures have been fairly low. So it's popular to ignore the currency effect, but in fact it's pretty meaningful. Right? So it starts with just educating people that currency's a risk, you should pay attention to it. Then you start with passive hedging. That's the simplest thing to do. Right?

So we do a lot of work with, you know, quantifying the currency risk and then showing, okay, if you passively hedge it, here's how it changes. And then there's some nuance there. Most of our investors are long term. You're planning for retirement 20, 30 years from now, or you're a pension fund or an endowment that really has a perpetual horizon. In that case, you know, it's what correlation to a matrix do I use? Do I use monthly returns and calculate correlations so. Most people do, but is that right if you're a long-term investor? Because if you take three year returns and you get a series of those and you calculate correlations dramatically different than if you use monthly returns and you get a wildly different optimal hedge ratio or risk minimizing hedge ratio, and then we get to talk about return. And that leads us a little bit more into alpha. Okay?

Baseline for setting a currency hedging program is minimizing risk. Implicitly you assume the return is zero. Currencies wash out. Believer in PPP. PPP doesn't change a ton. So yeah, I agree it largely washes out. But there is a country risk premium, right? And people recognize this. They still say it washes out, but they recognize it in EM because it's a large country risk premium, G10, it's smaller. But if a country's riskier and it tends to show up in the form of higher interest rates that you have to pay when you hedge, you know that return matters. And then if you think about PPP type reversions or longer run that 10-year cycle, that's a big deal. So if you're 20 percent overvalued and that reverts halfway over the next decade, that's a percent a year. So fine, if I'm doing a 50-year or a 100-year optimization, I can assume currency return is basically zero and I can minimize the risk. But if I'm doing a standard asset liability study, I do every five to 10 years. I can't assume the return is zero.

So what do you do? Right, you can either build it directly into your optimization engine by coming up with expected returns and correlations. Just like you treat any asset class.

You get your capital market assumptions, expected return and correlation involved and you throw them all in some sort of optimizer scenario. You do that, that's fine. Most people don't do that. They come to us with a benchmark, it's already set, they've done their ALM study well, they have some idea and then they want us to help. Well, the way you do it is that long term value, say okay, what is that 10-year horizon expected return? Well, add in some carry a little bit, look at the potential for a reversion to the mean over that 10-year period and incorporate that. So what you can do then is you can say, okay, well here's a basic passive hedge, that 50-year view. Let's layer in a value-based adjustment to that. So hedged expensive currencies at a higher hedge ratio. Why? Because one, you just made a bunch of money on them, you think they're going to revert because currencies wash out.

So hedge those a little bit more and the currencies that are washed out, hedge those a little bit less because they've already lost.

So that's kind of start. And then we go to our, you know, the other layer of our strategy set, which is more tactical, which is okay, take care of those long-term considerations. But now you do care that you just blew up in March of 2020, like that matters. And maybe you want a little bit of alpha more consistently. So let's look at what's going on with economies and interest rates and that short term value model I spoke about earlier, relative equity markets, a little bit longer term, those sort of drivers and make more tactical adjustments.

Also look at risk regime, right? Are we blowing up? Is there a volume? Is there more likely to be evolving in the near future? That's interesting.

TG: And do you have a vehicle just for that alpha component? Is there sort of a currency portfolio that you open to clients just to get that kind of short-term dislocation that you're looking to correct?

AH: No, pretty much everything's done in the overlay context. Sometimes comes to us when someone comes up with a portfolio, it may be just look, I have this one portfolio, it's a billion out of my plan, which is 300 billion or it's 100 million or whatever it is. And I just want you to manage this sleeve. And so it's managed by State Street or its investment management, or it's managed by somebody else.

And we overlay that and adjust their currency so we get the report saying here's what that underlying portfolio owns. And then we implement a hedge or some sort of active adjustment to generate alpha or improve the return, the risk profile, but nothing kind of standalone where you just go in and get that pure alpha. On the currency side, there were some huge players in that space back in the day, but most of them kind of closed up. There's a lot of small hedge funds out there that do it. A lot of people just get their currency through their global macro managers if they want that rather than a dedicated currency alpha.

TG: Yeah, yeah. No, that's why I was asking, because I know it used to be a thing. Yes.

Well, let's start to think about views here. And there are a couple things that I grabbed my notebook and wrote down just so I wouldn't forget them. But you talked about making hedging recommendations based upon value dislocations. And you also mentioned 50-year views, which I always love. I have 50-year charts in my presentation on the dollar in particular. And the real effective exchange rate of the dollar was flagging for a little while, just overvaluation.

And so let's start with the dollar and get your thinking on whether this is something you're recommending clients hedge risk away from a little bit more. And does the valuation component play into that?

AH: The valuation component does play into that. And I am a big dollar bear and my dollar bearishness is based on my great skepticism of US exceptionalism.
I'm just not a buyer. I'm a buyer of some components.

Nvidia is a fantastic company. Google's doing some amazing things. The next $4 trillion company that no one's ever heard of probably comes out of the US we have very flexible labor markets and we can reallocate capital and be more dynamic over time.

There's a social cost to that, but there are certain key features of the US economy and the US capital markets that give the US a true advantage. What I think has happened is far too much of US asset outperformance and US dollar outperformance has been attributed to those true good qualities or good qualities in terms of generating earnings and GDP growth. Anyway, as I said, it comes with a little bit of social upheaval and a bunch of inequality, but still from an investing standpoint, that all makes sense. But we have to pay attention to These other things, like if you look at just Bloomberg expected deficits or CBO expected deficits, 10 years ended 2027, we'll have spent 70 percent of GDP in fiscal stimulus.

We're running debt to GDP over 100 percent. It's just not sustainable.

And if you go back and say, well, look at the way we've run up the deficit, that goes straight to corporate earnings. That really flatters growth and corporate earnings. They sent a check for US$4,000 to my son during the pandemic. He never lost his job. He was doing great. He's a up and coming actuarial assistant, very proud of him. But he gives us four grand and I'm like, good for you, this is great. And he saved a quarter of it. Good, taught you well.

The other three grand, within two weeks it was in some corporate income statement, right? He bought a, got a new Play Station and he took a trip here. And as soon as the restrictions were lifted. So it flatters corporate earnings. And the way we do it, by reducing corporate taxes, we took 36 to 21 on corporate tax. We can't go from 21 down to 6.

It's just not going to going to work. And so we're going to lose that big tailwind to US earnings growth and US GDP growth. Also we have fixed rates, everybody refinanced, right? Corporates out there issuing debt. I have two mortgages, 3 percent fixed, 30 years, you go to 5 percent interest rates. We don't take the pain. No. Corporate net interest expense fell off a cliff because they pre-funded. They haven't had a roll much of that over yet. They have these extra cash balances which are now earning 5 percent or today, you know, a little over 4 percent. So net interest expense goes way down. Same for me. My cash reserve is now making money, but my mortgage payment hasn't changed.

So we pay less of a price for monetary tightening than the rest of the world. And that's something that we can't really repeat. So and in fact it's going to roll off. Even if The Fed cuts 200 on average, people are going to be refinancing corporate debt at a higher rate than they did back in the pandemic. So that's a tailwind. Globalization. For the past 15 to 20 years, I think the US was better than most people, most countries at taking advantage of offshore to boost up profit margins. That's going in reverse now.

I would argue that, you know, it's not that the debt is unsustainable, it's actually going to have to go in reverse. We're going to need to do something lower rates, higher inflation, more austerity, something that's bad for the dollar. In the end, the only way to cure a debt problem is tighter fiscal and looser monetary in some way. That's a terrible combination for a currency. So again a big force over the last 10 or 15 years. That's not repeatable over the next 10 or 15. But if you look at valuations of US equities, look at valuations of the US dollar, it seems like the world's pricing it as though it's going to continue. US exceptionalism will continue as strong as it has been.

And so even a 10 or 15 percent rebalancing through increased hedge ratios, just some actual rotation out of US assets, it just gives you a slightly more balanced but still US centric portfolio. But that's trillions of US dollars. Three to five trillion probably.

TG: We track this a lot. We have hedge ratio estimates against the huge particularly equity exposure that foreign investors now have. In the US the balance of capital shifted about five years ago where the US used to be a net exporter of equity capital and now it's a net importer of equity capital. And that's, that's a mountain both through mark to market effects as well as inflows. And that has not been hedged to the extent it could be hedged to that point though the US is still a high yielding currency.

How do you advise clients in getting around the negative carry effects? Given that, you know, they're mostly probably looking at rolling three-month hedges until the Fed cuts. How do they get around that? How do you advise them to do that?

AH: There is no way around it.

TG: You're right.

AH: I've had people come to me and we don't do options. I'd like to play around with them a bit, particularly like writing options on Long Horizon contrarian Strategies as a way to get into the positions and generate a yield. But people have proposed that, oh, can I use options to get around this? Well no, the interest rate differential is priced in there, right?

You can't escape it. You can hide it, pretend it doesn't exist. You can change your hedging behavior and just say, well, I'm not going to hedge many US dollars yet going to wait for that carry.

But as we saw earlier this year, when the dollar corrects it can be very episodic and very fast and so you risk missing it. So I saved myself a hundred basis points in carry by waiting until the Fed cut A few more times, but the dollar's down another 6 percent. So you've lost 4 percent relative to acting now. But I do think that it matters.

And particularly if I think of dollar, yen, and yen is one of my favorite currencies over the next year or two. It's a little rough right now. I mean, I really want to see that. Japanese lifers have taken their hedge ratios way down from historical averages. They probably will wait until rates actually come down. Still think it's worth getting long now on yen in anticipation of that. But it could be a bit painful.

And then you have obviously the political upheaval with the LDP losing the upper house and maybe Ishiba having to resign. So that could create some volatility going into the fall. But you know, I say we're, we're kind of close enough to that turning point. I think the dollar turning point's already happened and we're close enough to where we get another leg lower. It's worth paying a little bit of the negative carry.

TG: You mentioned the, the correction we've had. And on a, a real effective basis, I think it's been about 8 percent on a trade weighted basis. Similar, probably 8, maybe 10 percent.

What for, for people listening who maybe aren't as familiar with FX.

What do you think was the dominant reason for that? We've kind of danced around a few of them, I think. But what do you think really drove that dollar sell off from kind of, I guess it started maybe January, February this year up until just very recently?

AH: Yep. I think it was two parts. I think the initial sell off in February was really driven by that fiscal news out of Europe. And then it became, obviously that was Europe centric news, but it just became a general. Oh, wait a minute. Positive things can happen outside the US, the US dollars, you know, particularly after the run in Q4 and into January, it was really stretched on a short-, medium- and long-term basis.

And so that just kind of triggered some profit taking and you got that first leg up. You know, at the same time you started to see the tariff threats against Canada and Mexico. I took a red inauguration. So I think that explained like a quarter of it.

A little bit of risk premium. Like, oh no, what if in April, I think it was, you know, it shifted. So it really wasn't the relative growth story. It was just pure risk premium. Because you saw the Liberation Day announcement. The dollar sold off through April 21st along with equities. And I think that at the same time you saw steepening of the yield curve.

It was all real yield led as growth expectations fell. So it was all term premium, all country risk premium. I think that's drove that second leg lower in the dollar and I think that still has a long way to go in terms of pricing. So as I said, the US growth does converge back to the rest of the world over the next several years.

And the dollar just generally isn't as reliable as safe haven with debt levels. And some of the other things I mentioned as part of the dollar bear case, higher inflation risk premium, higher term premium, generally higher country risk premium. Those risk premiums and the pricing of those risks more specifically are correlated to where you price all risky assets. And so on average that should decrease the negative correlation. Does it go back positive?

I mean, on average the dollar was positively correlated to equities through the 90s into the early 2000s. Does it go back there? I don't want to make that call yet. But is it a strong diversifier that it has been or the strong diversifier it has been over the last 10 or 15 years? I don't think so. Only case that will happen is a true liquidity crisis. You know, big banking failure, need for US dollar funding is tremendous.

And so if you're in a position where you're not sure you can roll over your US dollar funding, you're a Japanese bank lending in the US you have to hedge that back basically because all your deposits are in yen, then you need that dollar funding. You just can't accept it. So you're going to scramble and do everything you can to get more dollars to make sure you don't lose your ability to roll over your dollar funding.

So in that type of pure liquidity crisis, I think dollars still is by far the best safe haven. But any economic crisis or any of the other sort of crises that we see, or volume shocks, I think the dollar's much less reliable as a safe haven, which argues for higher hedge ratios just on that basis, which argues for a lower dollar.

TG: You talked earlier about the European story and the fiscal expansion and the growth differential narrowing.

What about thinking about the euro as a safe haven? Are you starting to think about it that way?

AH: I definitely do, yeah. And in fact, our model, so we have a safe haven model. Okay, got to a macro regime model. Euro isn't competing with the dollar, but it is one of the favorite currencies and has been for a little while, actually for, you know, over a year, has been one of the more favored currencies in there.

And so the correlations, you know, hold up. It's a huge creditor region, right? So European investors have a massive amount of businesses have a massive amount of capital overseas. And so if there's some sort of shock and they get a little bit of home bias, they pull some of that home. It kind of makes sense. People are underweight, European assets more generally. Based on this, productivity is just going to be anemic forever.

I don't have a great story to tell about any particular country in G10 outside the US my US dollar bear call is more US doing poorly or the other countries doing slightly better than abysmal. Oh, things are a little bit better. And US policies like trade and tariffs, we already see the big spike up in Canadian exports, Chinese exports to countries other than the US as exports have dived to the US so pushes the rest of the world together, helps them to cooperate. Maybe you can actually get some of those intra EU trade barriers to come down, kind of harmonize banking policy and other trade policies and it brings people together and encourages some level of deregulation outside the US I mean it's a very long-term story. But that just on the margin makes things, the productivity growth outlook a little bit better.

TG: How do you view the yen in that context? Because the yen of course classically was the safe haven of choice. But then we went through Abenomics and then we have, you know, the changing of hedging patterns that really broke that correlation.

Do you think about it in the same way as you might have done say 10 or 12 years ago as that potentially returning back? Especially if you believe currency hedging of dollar risk picks up or is that relationship broken?

AH: Well, I think it comes back. I think over the near term, the next 12 to 24 months, yen is likely to be the best safe haven. It'll vie with the franc which has been very popular, but nobody's short the franc.

You know, it's unbelievably expensive. Yields are already at zero. Probably have to go to NERC and or currency intervention to slow the appreciation. So that leaves yen really as my favorite and then euro and then Swiss actually as the third best safe haven on the day of a shock. Don't be surprised if Swiss is top of the league tables on that day. But if you look at that kind of whole volume event over a week or two, I think yen and euro will give Swiss a run for its money.

TG: That actually brings up, I think a good closing question because you and I have both done this for a long, long time and thinking about how we deal with volatility events.

I wanted to see if you could talk a little bit, just as a closing question, how your process has changed with respect to volatility events and maybe compare and contrast this April with maybe not the GFC that was pretty special, but other big China Deval back in 2015 or Volmageddon in 2018.

You know, how has your process evolved to cope with volatility events?

AH: Some of this isn't really FX specific, but it's my evolution as an investor. It's regardless of asset class. You know, particularly kind of growing up super junior, right?

During the Asia crisis, I was sitting on an EM local debt desk. Then I switched to equities just before the Internet bubble blew up. So seen a lot of downside. Then of course the GFC and it was all about avoiding that downside and reacting to it.

Now I think I'm much more focused on proactively managing it to some extent, but really not getting stopped. I found that that's kind of the worst thing. I want to be a buyer when people are forced sellers. I don't want to be one of the crowd that's forced out. So in terms of sizing positions, Swiss yen is a, is a fate. You know, my favorite short, right. 

Long term, I don't know, it's going to take maybe six months or three years to work out.

TG: But it's, it was always too. And it was pretty painful, right?

AH: People getting, everyone's getting stopped and I'm like, no, this could get really painful. It could be a graveyard trait. So we get a size this small and we sized it small and we're just able to ride through this and maybe add to it.

We're getting close to that point, right? So you know, trying to get ahead of it a little bit more and really thinking about these risk events more as an opportunity as well just to find, you know, what has been forced lower, you know, the baby's thrown out with a bathwater, that sort of thing. So I think I'm more focused on that. Gotten burned by stops too many times.

You just lock in your loss and then. But again, if you size your positions, assuming you know a three or four standard deviation event, you're never going to take any risk. So you know, there's some balancing that has to happen there. Also in our regime model, right? We're not just looking, are we in a crisis? Half the regime model is that half of it. We've looked around and we've said are there conditions right for a crisis, so I've started to think about volume, particularly over the last 10 or 12 years, like post 2015, in terms of potential versus kinetic energy. Everyone's measuring and reacting to the kinetic energy when it's actually happening. Really got to look at that potential energy, how it positions. Is everyone one way?

You know, are there kind of signs that everyone's all bulled up. But they really don't want. They're avoiding certain things because they don't really have high conviction in that. So maybe there's some cracks under the surface. So something that predicts that a smaller and smaller catalyst event could trigger a big move.

As position gets stretched and everything gets overvalued one way or the other. So try to get ahead of it. And sometimes you take risk off the table a year too early when you're looking at that sort of thing. But I think it pays off because then you're in a position to add back risk when everyone's forced to sell.

TG: Very good, Aaron. It's been really, really interesting. It's been great to get your thought process. I really. That's what I was kind of hoping for and I think we got there. It's been a lot of fun. I know you're about to go on vacation, so I'm not going to keep you from that. Hopefully this is the last thing you get to do before that. So thank you so much for doing the podcast.

AH: Oh, thank you for inviting me. It's fantastic.

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