Why Central Banks Can't Stop the Everything Bubble (w/ Etienne de Marsac)

Video Transcription:

  Why Central Banks Can't Stop the Everything Bubble (w/ Etienne de Marsac)

ROGER HIRST: Etienne, a very warm welcome to Real Vision. ETIENNE DE MARSAC: Hi, Roger. Thank you for inviting me. ROGER HIRST: Not at all. I think this is your first time. So maybe if you could just give us a little bit of background, because you've been in this business for over 20 years in hedge funds, investments, even in some of the European institutions. So maybe give us a little bit of color about this career that you had. ETIENNE DE MARSAC: Well, indeed, I started already 20 years ago. The financial environment was totally different. I spent so 20 years in the fixed income market as a global fixed income and currency trader, or investment manager. And indeed, I had the opportunity to move or to come across many various institutions, some of them quite small, some of them quite big. And as you said, my last two principal or serious experiences were in Luxembourg in a hedge firm before joining the EIB, the European Investment Bank, which is basically one of the biggest European banks in the European universe. People basically don't know in general, but the balance sheet of the bank is roughly 600 billion euros, and the role of this Development Bank is to provide credit to the whole Europe, but also the rest of the world. So it was these last two experiences were extremely interesting, extremely unusual. The hedge fund, because it was very technical-- a cross-asset hedge fund. So where we were trading equity, derivatives, commodities, fixed income, credits, globally all assets, with an overlay on the top of it. And then, the EIB, when I was in charge of investing the long-term liquidity buffers of the banks. So roughly 10 billion euros that needs to be invested for regulatory reasons. And before coming into this universe, this European universe, I had no idea about how regulation can distort prices. And I think this is pretty much the biggest thing that I've been taught and that I will remember. ROGER HIRST: And so bringing in all of that, I guess in some ways, the key thing here now as you're running money again is the state of the market. Because we have this incredible-- so to some people, it's an incredible world where the S&P has been marching higher, and although we're not at the lows in yields, it feels distorted. Valuation feels distorted. And yet, central banks are behind it. How do you perceive the state of the market right now? ETIENNE DE MARSAC: That's a key question. I'm a little bit suspicious right now. Either I've been participating to this very risk-on environment for many years, except to 2018, which was a little bit different, a different context, where or when the United States and, namely, the Fed tried to escape from the quantitative limiting but did not manage to do it. I've been participating to the risk-on environment for a long time. But right now, I have the feeling, indeed, that the valuations have been too far, are too much stretched. And even if you cannot short right away the market, which would be completely foolish, I am tempted to have a lower participation to this risk-on environment. So I qualify the environment as being greedy. I can feel some greed in the market. I can see some hubris within market participants. I can see a quite non-irrational exuberance, if I may say so. That is to say, a logical one that is explained by, mainly, three factors, three features-- first one being the American president very frequently referring to the levels of the stock markets as a key feature or as a key measure to qualify the efficiency of his policies. So this is very unusual. We had an example very recently last week when, during the conference following the signature of the phase one deal, Mr. Trump referred two times to the level of the S&P 500 and the Dow Jones as a key measure of the efficiency of his policies. And I think this is slowly and surely introducing a misperception of reality that price on the equity markets can go on upper and upper unless-- until Mr. Trump-- or, while Mr. Trump is still in power. So this is the first one. The second point, of course, has been induced by the omnipotence of central banks, or at least the perception that they will be here forever. I must admit that they have been extremely efficient, really good, at addressing liquidity issues as well as solvency issues, the latest example being the way the Fed addressed the repo issue in the repo market last year, beginning of last year, by injecting very precisely between $60 billion to $120 billion per day of liquidity exactly where the liquidity was required. I've been extremely surprised by this efficiency in the securities. So I must admit central banks, and particularly the Fed, has been quite efficient. The ECB is also part of the story. That the money supply impulse-- so that the year-over-year difference between the net asset purchases of the previous year relative to the new year-- the net impulse has increased by $3 trillion, not to mention the money supplied by China. So the central banks have been extremely successful in injecting liquidity. And so it would be absurd to not to participate to this party. But I have the feeling that we may be slowly but surely going into the end of these bubbles, on the end of this everything bubbles, that it is right now jeopardizing the equilibrium of financial assets. And yes, I think we need to pay attention to various signals of excess leverage, excess liquidity, absence of notion of risk, greed, and, yeah, pretty much, that's all. ROGER HIRST: And do you think-- I think what a key area is here is that it feels like we deserve a pullback, but the pullback that you expect, is going to be a correction-- 5% to 10%-- which takes out the exuberance. Because in many ways, this is not a euphoric top that we are seeing, if it is a top at all. it's not a euphoria of mass participation by the man on the street, which is one of the reasons, in some ways, where this valuation story, which has been there for a few years now, has been ignored because it's a liquidity story. So do you think that the next chip phase, or the next downleg that we have, is a correction, or it's the beginning of a financial crisis? Or do you think that at financial crisis, potentially, is still quite a long way down the road because the liquidity, it might come out a little bit, but every time we've seen initial return, the liquidity comes back even faster. ETIENNE DE MARSAC: An easy question. If I'm honest I must admit that I don't really know the answer the party can goes on again and again and quite longer so that there has been a tremendous effort done by the regulations and the regulators around the world to avoid the same type of financial crisis. So basically, these acronyms like BRRD-- so bank resolution-- BRR, so bank resolution regime, LCR ratios, these type of acronyms, they all provide support to the idea that the next financial crisis won't happen within the banking sector that had been extremely recapitalized these last years. If we step back a little bit and we focus on the European sector, the recapitalization effort is of about 6 trillion euros in 20 years. That's huge. That's even bigger than the impact of the balance sheets of the ECB. So the solvency issue has been addressed within the banking sector, either in the US or in Europe, but it is also having an amplificating effect on these euphoria that we were discussing. The liquidity buffers, they need to be invested. As an example within the EIB, one of my last missions were to invest between 5 and 10 billion euros or dollars on sovereign bonds. Care less the level of the prices, of the level of risk, of the level of rates, because the cost of being non-compliant to regulation is even bigger than the cost of being of having a negative carry on your holdings. So the banking sector is in a better shape, but you can still see some fragilities in some areas. And the socalled doom loop, which is a way the banking sector is being forced to buy sovereign debt at ridiculous levels because they are AAA and because they consume very low level of risk-weighted assets could be a factor or a trigger of a bigger meltdown. We had the example quite recently in Italy with-- when the blowup of the Italian sovereign bonds is having a direct effect on the sovereign spreads. To answer a little bit more specifically to your question, I think we are not-- we are living in a big bubble that is made of small bubbles, and these bubbles will deflate-- either naturally, when suddenly people come back to reason, or either because the regulator or the central banks will start to be-- or will start to focus on them. And last week, Robert Kaplan, for instance, made a speech about the financial instability that needs to be tackled. And I have the feeling that probably, if a crisis emerges, it will be internal. It will come from the central bank themselves. They were the ones who inflated the bubbles, and they could be the ones who will try to deflate it. Not a very long time ago, one year, one year ago, Mr. Powell, through the quantitative tightening, was exactly trying to get out of this mess and trying to exit the balance sheet of the Fed, assuming it would create some bout of volatility. He went a little bit too far-- much too far-- with a very clumsy communication that the financial market could not really understand. But this is how I see the world. Either it will correct because of a doom loop within the banking sector-- either it will be directly due to a change of focus of central bankers trying to address the global imbalances that they have created for all the reasons that we know-- inflation targeting, et cetera. ROGER HIRST: Well, how do you think we move from this? Because we currently have is almost a virtuous circle. How does the virtuous circle turn into the doom loop? Because if anything, the central bankers themselves, I think, have learned a few things. One is in the 2000s, they cut rates, and the equity market fell in 2000 to 2003 and 2008. So now, gone, it's not the price of capital. It's the availability of capital. Hence QE, and hence, during last quarter's repo issues, the capital went in. It was-- that was more important than the cost of capital. So the central banks, haven't they-- in some ways, they're now saying, OK we will put-- rather than a put under the equity market or the bond market, we're going to put a cap on volatility until we stabilize everything. We continue to provide that liquidity. In some ways it's not that we've got asset bubbles everywhere. We've got extremes but no euphoria. But we might have a bubble in central banks. But why don't we just keep on doing this? Because at the moment, there's no inflation. At the moment, there's no-- at the moment, as we saw with Powell's misstep with the rate hike in 2018 at the end and the final move down, they know what will cause things to blow up, so they know what they can do. So why don't they just keep it going? ETIENNE DE MARSAC: Just because at some stage, the targeting financial stability and targeting price stability is becoming two different goals, two orthogonal goals, that will hurt, themselves, each other. The world of the central bank, they have chosen to privilege the inflation targeting, despite the bubbles that they may have created all around. They perfectly know this. They are perfectly aware of the bubble created within the fixed income market, within the corporate market, or within the equity market. But it will only require a change of focus. And I think this is where we are slowly coming right now. The ongoing valuation of the tools that the Federal Reserve is using and also the ECB is using is an ongoing valuation that will last some months. But maybe-- and I will discuss this after at the end of your interview-- but there are probably some surprises to expect from the review of the tools, the review of the CPI figures, the review of the methodologies, and globally, the review of this inflation targeting and the level of inflation. Is the level of inflation of 2% still relevant in an environment of pressurized prices, in an environment where the quality effort is pushing the prices to the downside? Have a look at your iPhone, for instance. Your iPhone, the price of your iPhone is the same than what it was five years ago, basically, but there is much more technology inside it. So how is this technological aspect being taken into this inflation reflection or this inflation target that the central bank are having? Is the CPI computed 50 years ago still relevant in this new environment? Our grandmothers, they were not buying phones, or they could not use so many services that are free from the moment. On your telephone, you have a WhatsApp application that is totally free. It used to be-- it used to eat used to consume a lot of wealth before, so you used to pay for it before. So how do you account for this new environment? And this ongoing debate within the central bank, I'm sure, is going to lead to some surprises that we will face next year. Still, the amount of risk in the financial market is much too high. Coming back to the 1999 years, the global level of debt was of $80 billion. Right now, it is of roughly $270 billion. So it multiplied by three. Meanwhile, I don't need to say that the growth of the earnings did not follow the same train. So we have a big issue of loss of efficiency in the allocation of capital. More and more debt is explaining or is leading to less and less growth. So the capital efficiency is a big issue. So globally, what I'm discussing here is the liquidity trap, so the Keynesian, the very basic Keynesian liquidity trap, when providing liquidity, even providing debt and more and more debt, you favor zombie bonds or zombie corporates that are less and less efficient and that, at some stage, are going to blow up. So either you let them blow up themselves-- and WeWork is a perfect example, for instance-- or either you raise interest rates in order to increase the debt servicing so that these zombie corporate dodge themselves. What is a zombie corporate, if I may open a parentheses? It's a company that is not able to pay its debt or more than one year of debt servicing, or more than two years of debt servicing. So its revenues are less than two year of debt servicing. If you have a look at the environment, you will see-- you see that in Canada, the number of zombie corporates is increasing to 30%. So 30% of the corporate world is made of zombie corporates. In the United States, it's 20%. In China, it's 25%, and so on. And these figures have doubled in 10 years. And I think it's not healthy. They shouldn't be kept above the level of the water, and they are posing, probably, crippling effects, or they could have cripple effects on the rest of the financial world-- namely, insurance companies, pension funds who were made to invest in these extremely risky corporates to increase their revenues, but at the end, you can fear some domino effects. ROGER HIRST: But in many ways, isn't this just a rinse and repeat of what we've already had? 2000 was, in some ways, the beginning. We got a verifiable bubble. It deflated, and they used the same tools to inflate, reflate the bubble. Deflate-- they used pretty much the same tools with a bit of a turbocharge on to reflate the bubble again. It would seem very strange that, having done this for the third time, here we are with everything near the tops of the range. As the price is riding high, the central banks will go, now is the time to change, and bring the whole system crashing down? Aren't they just going to keep trying and trying to move this forward? And the question really comes from this line-- and I know we're going to talk about the US-- is that outside of the central banks maybe doing something, which we'll come to at the end, what are the potential catalysts? Because we always look at the US as a potential catalyst. Is there an issue there? Or is it going to be the European debt crisis? What is the thing which is beyond the control of central banks printing yet more money to stop this thing becoming worse than 2008? ETIENNE DE MARSAC: So indeed, the increasing amount of debt is not a purely US phenomenon, of course. Obviously, it is also a European one. It is also a Chinese issue where the money supply has increased by-- I think it's 33 US trillion in 10 years. So obviously, there is a money supply bubble in China as well as a global debt bubble in the US, but also in Europe. The thing is, while the amount of debt is increasing, the sensitivity of stock markets and of the financial community to even a very tiny move in the interest rates or in the dispersion of interest rates or in the past of interest rates, the sensitivity is also increasing. It did not require a lot of misguided communication from Mr. Powell last year or at the end of the 2018-- during the Q4 quarter-- to prop up a fantastic meltdown of, say, minus 30% on the US equities. ROGER HIRST: So I think it's 20, 20% from-- ETIENNE DE MARSAC: 20, 20%. ROGER HIRST: Average, 25% average. ETIENNE DE MARSAC: So here, we have a big, big issue-- how to address such a sensitivity to a very tiny level of a really tiny movement in interest rates? And the key issue is how the central banks are going to communicate to the market when tackling or addressing the stability issue. There is a paradox. Right now, the central banks are injecting liquidity, injecting money, purchasing directly assets in the primary and the secondary market in the name of the financial stability. But at the end, the paradox is also that in the name of this financial stability, they are provoking what they want to avoid-- that is to say, financial instability everywhere-- excess of capital, misallocation of capital, zombie corporates, zombie banks. So how do you reconciliate these, the same objective? Then how do you reconciliate this paradox? So I think there's no way out, apart from extremely precisely addressing some parts of the bubble. So by communicating very softly, which is probably what Mr. Kaplan has started last week, by changing the expectations into the passive rates so that many companies understand that the party is over. I can feel that the message has been pretty well received, because back to the first week of this year, there has been a record in issuance in the European corporate market. 100 billion of issuances have been launched. By the way, they were oversubscribed three times. And this represents 20% of 2019 issuance. So 20% of the 2019 issuances have been launched in one week at the beginning of this year. So isn't it because the financial community is aware that the party is not going to last that long, or will not last for a year, and that they should try to refinance at these very low levels their debt in order to survive as long as possible? But it's also a sign that maybe I'm not going to talk about a hybrid because I think it's much too premature, it. But by changing the inflation target, for instance, this will send a huge message to the financial community. If the inflation target of the ECB is revised-- ROGER HIRST: And what will they-- what are they going to do there? Because at the moment, it's, what, 2% on HICP, so-- ETIENNE DE MARSAC: Yeah. ROGER HIRST: And they can't get anywhere near it. So what are they going to do? Because they can change a target, but isn't it irrelevant if they could never get to whatever target they set? ETIENNE DE MARSAC: Well, if you admit that the new environment where the output gap is being filled with a 1.5 percent of inflation, then shouldn't it be logical that the target is 1.5% instead of 2%. So there is a debate inside the ECB, right? There are some people advocating for, OK, let's push up the target to 5% so that the people really get aware that we are going to wait a large amount of time before raising rates. So enjoy the party, and let's reflate the whole economy. But there is also the opposite argument, where some other people, in Banque de France, for instance, they advocate for a lower inflation targeting so that it would recon that they stole too much accommodation, that the right level of inflation has been achieved, paradoxically speaking, and that maybe the last bout of quantitative easing is no longer warranted. ROGER HIRST: Doesn't that mean that-- we saw it in the US in some ways at the end of 2018, where we got I think it was 3.25% on the 10-year, which rang the bell for the equity market. And every time we get a move in yields in Europe from negative to positive, we all get excited because we've got growth. But then, everyone scratched their beards and goes, well, hang on a minute. That whole pile of debt that every bank owns is just about to fall in value. Everyone's now bankrupt. So you have a choice. And isn't this-- for the ECB, in particular, you've got the rock and a hard place. You either have no growth, negative rates, you kill savers, you have a flat yield curve, or you try and raise rates, and you kill the very banks you were trying to say by doing QE in the first place. So you either collapse the system, or you have the death by 1,000 cuts. How do you get that for Europe, between what we currently have, and saying we want growth, but then the balance sheets get distorted? How? What do you think they're going to do there? ETIENNE DE MARSAC: The direct link between high rates and the destruction of value inside the banking sector is questionable. If the yield curve's steeper than the way the banking sector is making money through the transformation, the so-called transformation operations. So that's basically lending at a higher rate that- - your funding rate, than you you're making money. And then, basically, the banking system remains stable. Clearly, from one way or another, the deflating the bubble will have a cost. So the question is, who is going to take these costs? Indeed, there is some social costs. Probably, it's not right now a big-- the good moment in France, for instance, to start this process. And that's particularly why the last round's run of quantitative easing was lost. It was a social QE, right? It was particularly a QE addressed to the Italian people and to the Italian banking sector so that they could present, at the end of the year, some key ratios, such as the liquidity stable rates, the net stable funding ratios, and liquidity coverage ratios at the end of the year. So the quantitative easing at end of last year has been addressed, particularly for social reasons, and also for geographical imbalances. So back to your question. Hi, how do you reasonably deflate the bubble? Well, you just leave the bonds that you've been purchasing within the balance sheet of the ECB or of the central bank you leave them slowly but surely. Decrees are being reimbursed and paying their coupon. And if they have some default, you'll absorb the default inside the balance sheet, which will create a debasement, basically, of the currency, which is exactly what all these central banks are looking for. QE's aim is-- these they will never say, but it is targeting explicitly, implicitly, debasement-- so lower currencies. So in case you have defaults within the balance sheets of these central banks, then, it will achieve exactly the same target, which is lowering the cost of capital, lowering the currencies, gaining in competitivity relative to the other partners, et cetera. ROGER HIRST: With that, because one of the fantastic things about currencies in a way and also the demand for inflation is that Japan debases its currency-- so the yen falls. So Europe does it, so the euro falls. And then the US does a bit more QE, and so the dollar falls. So if everything falls, nothing has fallen. They're all on the same level. And so in some ways, let's say Europe does that. And if Swan said, oh, you're going to debase the currency in Europe, I would run a mile. I would sell everything in Europe, because the euro's going down. So that they get penalized for doing that. And this has been this bizarre world where each central bank has been trying and nobody's actually succeeded because everybody's done it together. So all that's happened is that capital has gone in with a lot of capital going in with a low cost, and no one's currency has really moved that much. Obviously, the dollar has strengthened a bit. ETIENNE DE MARSAC: Yes. ROGER HIRST: How do we break out of that? And how does one break it without being a manipulator? ETIENNE DE MARSAC: Well, as you said, except versus the dollar. 10 years ago, I think the value of the euro was something like 1.45. We are at 1.10 or 1.11. So the euro has deteriorated with quite a high level of efficiency versus, at least, the US dollar. So the US dollar is the loser in this equation, and Europe is quite a winner. So I tend to disagree with the idea that it is a zero-sum game, because from time to time, you have big devaluation effects before your other partner starts a devaluation process. ROGER HIRST: And do you think that the US-- because you talked about the dollar's strong. But the US has lots of debt-- lots of corporate debt, lots of buybacks. If there's any equity bubble out there, you'd probably say it was the S&P and bits of the NASDAQ. So in some ways, that, the most exaggerated part of the market, is also where some of the most aggressive junk and triple B volume is as well. Do you see that as a risk that actually-- when I say "risk," it sounds like it might be a positive risk for the US. The US might be the one that comes unstuck but which, therefore, may be able to rebalance first? Just how do you see the US versus Europe? Because everyone's looking for, which region is going to blow first? And how does that come into the framework? ETIENNE DE MARSAC: Well I think right now, the US are the hottest emerging market for 2020. I think- - ROGER HIRST: And can you explain what you mean by that? Because that, to me, is like-- ETIENNE DE MARSAC: Yes, it's a little bit controversial. I apologize for your American audience. I agree, it's pretty much controversial. But when you apply an emerging country risk matrix to the US, well, you have the feeling that it takes-- the years are ticking a lot of boxes for a potential downgrade. And we're not discussing about something that is seen as super or not natural. The US had been downgraded already in the past by S&P. I think it was in 2011. And it could pretty much happen again. So for many reasons, so the way I look at the US right now is by applying exactly the same metrics that I apply to a country analysis in South America, for instance. I see challenged institutions. And everybody would agree with this, that probably-- most Americans will agree with this, too, that we are in a very precise moment in history where the institution the various institutions of the United States are being challenged by the White House, typically. So the Mueller report, the Hungarian affair, or the two procedures of impeachment that have been submitted to the Senate, very recently, they all accounts for this fragility that I see in this political landscape. So I think ultimately, the institutions will remain strong and robust enough to absorb these ongoing shocks that they are facing. But yes, globally, there is a feeling of, maybe, slight corruption that we are also facing in Europe- - that is slowly spreading like a disease within the US institution. I totally trust the institutions to resist, but still, they are much more fragile under this administration than the independence of the monetary institutions such as the Fed is being questioned. So many times in recent years, last year on and on year before, did we hear Mr. Trump voicing against Powell-- he doesn't have a clue. They don't have a clue. They should lower rates. I could fire him if I want. They don't understand a single thing. They don't know what they are doing. These are what we've been used to hear from Mr. Trump, and it's very-- and even if the Fed resisted to the White House pressure, it's very possible that by resisting, it may have altered the reaction function of the Fed. If Mr. Powell had delayed his reaction in order to show his independence vis-a-vis the White House, isn't it a loss of independence per se? So this is a question. I think there is a decent loss of skills within the Fed, the Federal Reserves, and within the triggering. The fantastic team made of former MIT guys-- so Bernanke, Yellen, Dudley, Fisher-- they are all gone. And they were-- they all had an extremely high economic mindset, much more able to tackle these difficulties than Mr. Powell has right now. ROGER HIRST: But aren't they the architects of the doom loop? Aren't they collectively the ones who created the very framework that, in some ways, Powell, with his pragmatic hat, tried to address? The markets told him, though, stop in 2018. Yet in some ways, it's that whole fragility that we've got was created by the Chicago School and the MIT School, and all those guys who have spread their wings across the whole world? Is that maybe, we actually need a practical mind? We need a Volcker type mentality to accept the reverse, Volcker, obviously in, inflation. Now this world, we need somebody who attacks the system and creates pain. But I don't think Trump will allow that. And then, just finally on that, we did have a downgrade in the US, and you said to fail early 2010, '10, '11, it they didn't have much of an, impact. And in fact, as an investor, if US yields moved up 10, 15, 20 basis points relative to everybody else, I'd actually go more get more excited about US bonds, and I'd put money in. So wouldn't it be self-correcting for the US? Because Europe doesn't look great. Japan doesn't-- has never looked great. China doesn't look great. So in this relative game, It will take a lot to destroy or undermine the US, won't it? ETIENNE DE MARSAC: Three questions in your "Big Questions." I disagree. I think there's I thing that you are softly inverting causes and consequences. I don't think that what we are-- the world in which we are living right now, which is the liquidity trap, the Canadian liquidity trap, is the product of this MIT team. On the contrary, I think that Ben Bernanke, for instance in his helicopter money speech in 2002 was extremely accurate, and was able to foresee the deflation coming , and was able to design exactly what should be the reaction of a central bank in case we reach a lower burn. And probably, the failure that, if the Fed was exposed to this situation, would have to lower even lower. So decisively, enter into a period of negative interest policies. So this has been extremely well written and foreseen by Ben Bernanke, 20 years ago. I would argue that the way Mr. Powell implemented the reverse of this policies is extremely questionable. If QE is an empirical experience, it's not something that is automatic. So you can't say in front of the world that the balance sheet of the Fed is on automatic pilot it's a misunderstanding of, what is QE? It's typically an experience made of faces. Exactly the same apply for the European QE-- that started with lower rates. Then you stop. You see what happened. Negative rates. You stopped to see what will happen. Direct asset purchases-- you increase if it's not significant enough. Direct loans to the private sector through TLTROs, et cetera, you need to be pragmatic. And I think by using this very unusual wording like "automatic pilot," or by using concepts that Mr. Powell does not fully understand, such as natural rate, natural rate of inflation, or "far away from natural rate," if I make quote him, was a mistake-- extremely messy-- and directly accounts for the equity meltdown of Q4 to 2018. Is a downgrade going to have an impact? So first of all, I am saying that the US are going to be downgraded in the coming weeks or in the coming months. But it will probably-- what will probably happen is first of all, a downgrade of the outlook. And if you have a look at what Moody's is actually saying and reporting, it's in his annual report published in December 2019, it's exactly this. On a long-term basis, the strengths of the US are weakening, and the weaknesses are strengthening, or are rising. So I fear not a downgrade, per se, but a downgrade of the outlook that would be the start of a long series, maybe, of various downgrades. And so it all depends on, if we have a downgrade, is it associated with, still, a negative outlook. So if the US were to be downgraded plus a negative outlook it could have ripple effects in the banking system, since the sovereign debt is owned by the banking sector itself, and if you have the feeling that in some months or some years, the US are going to lost their AAA or lost or even lost their AA or could be single A. Then, at some stage, it will require, for the banking sector, a recapitalization and much more riskweighted assets than what is computed right now on the basis of a single AAA. So this is where the doom loop can start-- force, force sailors from the US banking sector, and also the European one, of bones that you expect are going to be downgraded, until it reaches a level of return that is more compatible or more in line with the risk that you take right now the baby the levels of rates and as I'm fixed income terms extremely cautious about valuations. You're not totally-- you're not rewarded for the risk that is slowly, that is slowly rising, particularly if the US are losing their statutes of buyer of last resort, of funder, your cheap US funder of last resort, which is basically the contract that was contracted after the World War II where the US agreed to found cheap dollar versus, OK, the rest of the world, you agreed to fund, to use your savings glut, and you'd fund our deficits. But if the contract is stirred, then the US should lose their very particular status within the way the agencies are rating the US. And so I think the two play could be in danger. ROGER HIRST: Sounds like that's a very, very deflationary environment where basically you're saying here is there's going to be an almighty re-balancing which means that any asset allocation is done en masse is actually a capital destruction before you actually have an allocation. So it's never a nice, simple transaction. So that sounds like the-- it sounds like a very risky type of environment. Which, again, in some ways goes back to showing that's the last thing the central banks and policymakers want, who spent the last 10 years effectively putting a cap on volatility as their means of putting a put on their asset prices. Are they going to avoid-- yeah, no one want to be the wall who in history is the one that burst the bubble, so why not just keep it going, and going, and going. ETIENNE DE MARSAC: Well, the time when the Fed was trying to exit wasn't very far, isn't very far away from us. It was in 2018. The time when the ECB was also thinking about exiting and was not at all engaging to a new series of quantitative easing-- this is only 12 months away from here. So have they forgotten this objective? Have they put it-- had they put it aside I don't think so. I think that it's still pretty much present in their mind and just waiting for the occasion to softly try-- if they can-- Softly try to deflate these bubbles. I agree that an excess cannot be corrected without another excess, all right? This is how it works. This is based on emotions. This is based on perceptions and a misguided perception of reality conducts to another misperception. And there is no -- it's extremely difficult to find an average pass between these two extremes and this is why the central banks community is in advance thinking about it in case we are much too excessive in the way we fight these bubbles, in case it leads to a new financial, crisis how what will be the new instruments that will increase the sensitivity of markets to interest rates? Right now, as you know in this, liquidity trap, the money velocity is extremely low. So are there new instruments that they will use or be able to use in trying times when the bubble will have exploded? This is what they are, in anticipation, working on right now. So with that, really-- ROGER HIRST: So with that, we can move from what we saw, I think, in the US when Powell made his misstep. The markets spoke and said, no, and then, he reversed. ETIENNE DE MARSAC: Exactly. ROGER HIRST: And then-- and then, in Europe, you had-- in Europe, we saw bond yields back at minus 75 basis points the. Markets spoke. And Draghi went, OK, well we'll go back to it? So we got Lagarde, And everybody is saying, the last thing Draghi said was, we'll buy everything. And people say well, they've run out of stuff to buy. But Draghi basically said, no spend loads of money, print loads of bonds, we'll buy them. What is it that you're seeking in the ECB? ETIENNE DE MARSAC: Yes. ROGER HIRST: You just mentioned, you've just touched on it, but one of the very clear signs over the next 12 months we've seen from the ECB that will be changes and maybe that could impact things like inflation. ETIENNE DE MARSAC: Yes. ROGER HIRST: Which might ultimately be the thing that brings it all down, what is that, if you can just give us that ECB view? ETIENNE DE MARSAC: So having worked for the Us-- port for European institutions, namely the EIB, and quite closely, with the ECB and, also, the European Commissions, I try to stay quite tuned with that universe, And I try to maintain my network within these institutions. The first, first point, we need to, if we come back to September and October, 2018, the new set of QE has been extremely powerful from a certain block standpoint. Think about it. They lower rates by 10 basis point. They were able to surprise the market. They lower rates by 10 basis point. They lengthen the forward guidance by saying what you just quoted-- that is to say, we're not going to raise rates until inflation definitely rises to a sustainable levels. They relaunched direct loans to the banking sector-- namely TLTROs so long-term loans-- at a very low price at a very low level of rate. They made the case for negative rates exemptions towards the banking sector. So that excess reserves are no longer being taxed, so that the cheering system and the relaunch started as a direct asset purchases at a resume of $20 billion per month. So the package has been extremely powerful. So since it just started, even if there were so many voices inside the ECB against the package, expect the end of the ongoing review to come to the end before the ECB comebacks or comes out with a surprise. So right now, indeed, Mrs. Lagarde launched an assessment of the instruments that are being used. What are the main instruments? What are their efficiencies? Are they still relevant in the environment or not? Should we suppress some of them? Should we increase some of the others? During the next six months, and Christine Lagarde has been extremely strong with, some reporting against any information being displayed in newspapers. I think we will not hear, on many conclusions, about this rear view, But we still have some flavor about it. So as I said the inflation targeting is, obviously, a point of interest. They will come with something else. Is it a different level? Is it, by stressing the fact that the target is a symmetrical, that as the Fed is doing, they will be happy with living a much higher degree of inflation if ever it happens? Is it by level targeting? That is to say, suppose that you should be at a level of 150 in terms of prices. Because inflation was so low, you were only at 110 because there is a gap of 30 of prices that you need to bridge before being at the target. So it's not just a target it's also about the accumulated deflation that you are, on an historical basis, wearing upon yourself. Expect also the new music that we're starting to hear about digital currency to gain traction. And digital currency is-- I'm just back from Frankfurt, where we were discussing about that in a year in an ECB symposium. And digital currencies will probably be the way that helicopter money-- money, so back to the Ben Bernanke speech-- helicopter money will be implemented using the blockchain for security reasons. For money velocity reasons, because it will be extremely efficient, and this subject, I think, is clearly gaining traction in the US, in Europe, in Canada, et cetera, and deserves all our attention. ROGER HIRST: And so just to finish off, if you could just-- because it must be-- what is in your portfolio? What are, maybe, the two trades that you think is the best? Way to play this environment because you say that there's so much uncertainty, but it sounds like it's a structural change that could be coming. So how do you play that? Do you have any long-term trades on, or are you waiting? ETIENNE DE MARSAC: No, no, no, no, being at awaited is not an option, because your cash is being taxed. So you're losing money when you are not Invested. So we like selective, high-yield names within the European sector or the European sector, or the American one. So the idea here is to build a book full of carry, but a quite short-term carry with quite a high level of visibility. So if you have visibility of cash flows on a very specific corporate bond, or a specific culprit, then you can gain some carry. I like the idea of the reflation narrative, even if I am perfectly aware that it's still a narrative that deserves to gain traction. But using-- so through some high return currencies such as Aussie, for instance, allows you to catch up a little bit of this narrative. Now, the risk aspect that we've been discussing is of the hedges against these quite risky environment. They are quite, indeed, concentrated in my fund. So basically I'm buying gold for debasement reasons, for low real rates reasons, for this pursuit of debasement. I think the environment is extremely favorable for gold and for precious metals globally. Then, I have [indiscernible] against inflation, even if I don't really believe it-- believe about it. But, who knows? Maybe it's just a genie that is going to be to get out of the bottle, even if it's for a very long period of time. So steep news on the UK, US yield curve, the European yield curve, too. 530, for instance, and that's pretty much my book right now. ROGER HIRST: Volatility, long or short? ETIENNE DE MARSAC: Volatility, well, it has a negative carry impact, right? So I'd prefer you need to be extremely good in timing when it comes to vol options. So as a hedge trying to build up some-- it's counter-intuitive, but I do believe that in case-- and we've been discussing about that-- in case a proper liquidity meltdown happens, then the Fed will have no choice than lowering the Fed rates. So I'm wearing, or holding Eurodollar options, so Eurodollar call options. ROGER HIRST: What strike? 100? 99.75? What level are you? ETIENNE DE MARSAC: 98.50. Right, two years. ROGER HIRST: So if take calls, and I'm selling at out-of-the-money calls. So 75 and 99. Or so basically, 87-- no. Basically, 85, 87, 90 are profiling you now in December. ETIENNE DE MARSAC: Excellent, good. ROGER HIRST: Well, thanks for those trades. Thanks very much for the views on the market and the world, and the inside ideas on the ECB. It sounds like it's going to be-- second half of the year could be very interesting. ETIENNE DE MARSAC: Yes, exactly. ROGER HIRST: Good. Thank you very much for your time. ETIENNE DE MARSAC: Thank you so much. ROGER HIRST: Good to see that, and thank you very much. ETIENNE DE MARSAC: Thank you very much.