Why Central Banks Are The "Buyers of First Resort" (w/ Raoul Pal & James Aitken)
RAOUL PAL: Good to get you on. I really, really wanted to chat to you because you and I have known each other for quite a long time now and your understanding of the complexities of the juxtaposition between macro, politics and the plumbing is unparalleled. You're very well known as the insider's insider. I just thought with so much going on, you are the person who really wants to reach out to, just to get really an understanding of what is really going on, and where do we think this is all going and just to get your personal opinions on some of this. JAMES AITKEN: It was very good to see you all, boy, and thank you very much for having me on. I'm very grateful to you and your subscribers for their time. Before we get into markets, Raoul, I just like to give as our American friends would say, the most enormous shout out to anybody and everybody who's been affected by COVID-19. Our thoughts go out to families who may have loved ones in hospital or have lost loved ones, and thoughts of course, go out to all the heroes on the front line, medicine working in ICUs nonstop. Also, our thoughts, of course, go out to individuals who are trying to keep their family portfolios on an even keel, and of course, all those small businessmen and businesswomen who're imagining what the next six to nine months or 12 months looks like for their business. It's a very humbling time for us all, isn't it? I think that was a very generous introduction. I appreciate it, I'm just [indiscernible] who's deserved. RAOUL PAL: Give people a bit of background about yourself as well, just so they can catch up. JAMES AITKEN: No, I won't take the subscribers through a whole lamentable sell side career. I should be grateful for that. Things got pretty interesting for me in 2002, when I started working for a company called AIG, and I was in the trading arm of that and then it got taken over by Joe Cassano in AIG Financial Products. One might say that for the four years after that, I had a front row seat at the circus, and I thought I knew a tiny bit about economics and markets and then I became an employee of AIG Financial Products and I realized there was a whole financial universe out there about which I knew absolutely nothing. The irony, perhaps tragedy of AIG Financial Products is that while it was obviously opaque to the rest of the world, internally, it was transparent. I was able to walk 10 feet maybe 15 feet across the dealing room and Curzon Street in Mayfair, which you obviously know so well that building, and ask people what are you doing with this subprime CDO? What are you insuring? Talk to me about collateral balance sheets and everything else, and I managed to stay out of trouble there for a period of time, left to join UBS in August 2006, work with some fantastic people there, Raoul, and some of whom you know. UBS, I'll be ever grateful to them, let me loose on their client base and policymakers around the world. I was sitting on a foreign exchange sales pit, but basically doing everything and that was a very interesting time because from August 2006 onwards, I was trying to say to people, here's this thing called subprime. Here's what happens if house prices flatline, level and go down, here's structured credit, here's what's under the plumbing of the financial system. If A, B and C happen, we're in for a torrid time. Then through 2007 and 2008, I got to work with some fascinating people. I got to work with all sorts of institutional investors around the world. I was very, very lucky firstly, to have a job during that period when many of our friends were being laid off, and work with these people but also help people not lose money, which was critical, and help some people who you and I know well make a fortune. On the back of all of that, my client said in early 2009, you don't need a bank. Go work for yourself, we'll back you. As you may recall, back in '04, working for yourself is one of the most terrifying things you do, but happily 11 and a half years on with the backing of some fantastically loyal clients around the world, I'm still here, still plugging away and, Raoul, just to finish, I'm still trying to be less wrong. RAOUL PAL: Exactly. That's all we try and do. Talk me through the situation we're in now from your top down perspective, and just we'll dig in as we go just to see what comes out that's interesting. JAMES AITKEN: Yeah, let's think about the highest level, we have a double supply shock. We have the obvious disruption, which let's not forget has barely begun and COVID-19 combined with this oil dispute, which we'll get into our shim later, between food and Prince MBS. We also have on top of that, a nascent demand shock because everyone's going into hibernation and hunkering down and not spending or consuming. The last thing you want to throw on top of all of that is a financial crisis, hence the extraordinary actions that central banks are taking all around the world to prevent the financial system crumbling upon itself. Just to be clear, double supply shock. Obviously, the economic jolt from COVID-19 combined with the oil fight, throttle on the other side of that and nascent demand shock as we all hunker down. The number one priority of central bankers everywhere is to ensure that the financial system as best they can determine, remains on an even keel and does not crumble on itself. RAOUL PAL: Now, talking to the financial system, clearly a lot of what they're doing, there's an alphabet soup of stuff of which nobody understands. It feels like they're papering over a load of cracks. They're trying to get the system working. Because I've never seen the Treasury market really fail as much as it did. It got itself in quite a bit of a mess. What do you think the current problems are and how are they addressing them? JAMES AITKEN: It's like LTCM meets October in '97 inside 48 hours, that's what it looked like in the Treasury market. At the most basic level, you cannot hope to have a functioning financial system if there are no functioning risk free curves for people to price assets or hedge assets. That's why last September, if we go one step back, was so important. People went on and on about the repo conniption, and about Fed reserves and all these kinds of things, which was broadly correct, but not specifically correct. The events of last September were a tremendous wake-up call for anyone doing RV fixed income, because we almost lost the bond market. Let's think about a very simple example to help subscribers think about what actually happened in March in the Treasury market. Now, we won't go into the precise reasons but for most of the past five years, Raoul, there's been a very nice little basis trade available to RV fixed income managers. You'd go long Treasury cash bonds, and you sell the equivalent number of futures against them, it's a positive carry trade, or at least was, let's say, for simplicity around seven basis points. You would lever that to the hill and that requires obviously a lot of Treasury repo to be available to go long the bond, and it also requires a lot of liquidity in Treasury futures. Most of all, it assumes that your cost of financing is predictable and stable, which of course for about 48 hours last September, it was not, and we narrowly avoided last September, a very substantial nasty unwinding of all sorts of Treasury basis positions, and we live to fight another day. Fast forward to March, who would have imagined that the Fed cutting 50 basis points out of the blue, their first cut would have been the event that derailed all these relative value positions in the Treasury market because without getting too technical, if JC repo rates or let's just say repo rates are sticky, and the Fed cuts out of the blue by 50 basis points, then obviously, overnight index swaps and other short term measures of dollar borrowing come down a lot. That, ironically, is what blew up a lot of these RV fixed income trades that spilled over into the Treasury market just to finish the point, at a time when, let's just call him a principled man, was trying to unwind his risk imparity position, or risk disparity, and it all just fed on itself, throw a sprinkling of foreign reserves sellers of treasuries, and is it any wonder that constrained primary dealers and others found it very, very difficult to price and distribute liquidity around the world's ultimate risk free curve, which promulgated the most astonishing intervention from the Fed, which is ongoing? You recall many years ago, we all would have been blown away by the Fed buying 60 to 80 billion of treasuries a month. Well, they've been doing 50 billion to 80 billion a day, and it's barely keeping the bond market on an even keel. Look, what do we have? This basic, let's not forget, Raoul, this applies to so many things we've seen over the past two months. It's not just Treasury basis trades. It's not just credit, we went into this exogenous shock with everything priced for perfection. We'd had 10 years of leverage upon leverage, roll down carry, short volatility, illiquidity and duration all boxed up on itself, we came into 2020 and all of these heroes were saying cash is trash at precisely the wrong moment. Of course, you cannot vote to unwind 10 years of cumulative risk and leverage and everything else in about two months but suffice to say, we have removed an enormous layer of excess over the past couple of months and the very best news for the financial system is thanks to these extraordinary central bank actions, we once again have a basically functioning financial system and we have basically functioning risk free curves and the Treasury curve, but I very much doubt any central bank's going to be able to step out of this for a long time to come. RAOUL PAL: Part of the issue here is that the free market regulation of the Treasury market switched from banks to private counterparties, who don't get direct access to Fed liquidity, and therefore, there's a link in the chain which is what blew up essentially was their access to the same price capital as the banks would get. JAMES AITKEN: Yes, that's one way of thinking about it for sure. There were a number of smaller broker dealers that emerged over the past several years who did nothing but repo. Obviously, it's been a difficult time for those fellows, and I feel sorry for them. I would say at best, those folks were marginal players and marginal providers of liquidity. A lot of the repo provision was still via the primary dealers, and we've all looked at the data or examined the data on JP Morgan and to a lesser degree, Wells Fargo and we can see who had the biggest reserve deposits at the New York Fed so we can imagine who the top players were. I just say, Raoul, that it was still pretty much the banks we know, the famous household names that were providing repo liquidity, but I suspect your question is thinking through the chain or following the money trail. It's one thing for JP Morgan's broker dealer to finance Treasury positions and provide financing to their hedge fund customers and others. It's another thing altogether to downstream dollar repo liquidity around the world or through Japanese banks, and I'm taking a couple of steps ahead here but bear with me. When I think about dollar liquidity choke points in the system and where things get stuck, and where repos sometimes doesn't work or gets congested, I think first and foremost of the Japanese banks. I think if I remember correctly, you've written a bit or talked a bit about Japanese banks, and how important dollar liquidity is to both sides of their balance sheets. If I think about the past month, critical thing was ensuring that the Japanese financial system more so than any other financial system had an adequate stock of dollar financing, whether it be secured or unsecured to tie their financial system over. To me, I'm spending a lot of time looking at Japanese banks and thinking about their ability to upstream and downstream dollars around the world. RAOUL PAL: We've talked a bit about the Fed here, what about-- and again, we'll get into that fiscal stuff in due course, but talk me through what the other central banks, the BOJ, the ECB, the PBOC, who's doing what here, and what effects is that having? Then I want to come back and talk to you a little bit about why bond yields aren't lower yet. JAMES AITKEN: Good points. Let's start with the relatively easy one, the PBOC compared to their global peers has done nothing. It's remarkable. Here's this event that is going to be disruptive for some time to come, which you'd think in the context of the shock to the Chinese economy, the People's Bank of China would be doing something like they did in '08 or '16, and related to which you'd expect that the CCP would be stimulating as, on the extent, same extent that they did in '08 and '16. It hasn't had. It's odd, and maybe there's some constraints there and to be clear, I don't mean the balance sheet constraints. I don't mean dollar borrowings by Chinese corporations, although we can get into that. I'm thinking more of the political narrative that Xi Jinping has created since 2017, which is this obsession, this persistent obsession with a deleveraging campaign to try to make the Chinese financial system fit for purpose, that still seems to be the dominant theme, which is remarkable. The PBOC is a bit of a mystery to me. I don't think they're boxed in by the renminbi or the dollar borrowing by Chinese corporates, but I am surprised they're not doing a heck of a lot more. We know they're going to stimulate, but it seems quite limited and very gradual. Moving across the Sea of Japan, the Bank of Japan's all in every which way, because they have to be. They have to be. RAOUL PAL: They just keep going. JAMES AITKEN: Yeah, they have to, and I think my rule of thumb is that they will be buying every Japanese ETF at least until the Nikkei has regained 20,000, and that could require an awful lot of effort. The JGB market-- I think we've had this chat before. It's to call JGB's a market to give markets everywhere a bad name, the JGB market is just two numbers on screen but they're completely meaningless. They're fair play to the Bank of Japan because they are very savvy when it comes to monitoring the liquidity of their banks. You may recall in 2016 that there was some pretty nasty spill overs of the QQE, as they call it, the Bank of Japan was doing, and you got some pretty nasty tightness in the dollar funding markets which caused some strains for Japanese banks. A former Deputy Governor of the Bank of Japan called Micaso, created a unique facility that enabled the Japanese banks not to tap the Fed of course, because that's always been there but, Raoul, to use their JGBs to pledge against dollar funding from the Bank of Japan. The reason I flagged that, I know it sounds a bit complicated is the Japanese authorities have ample ability to liquefy their financial system in dollars and yen, but they would be hopeful that the problem goes away. The executive summary of Bank of Japan is muddle through, more of the same and things seem to be improving for them. RAOUL PAL: Why does the TOPIX bank index looks like shit then? It basically looks like the European banks. I get what you're saying, but I just look at the chart, it says something's not right still. JAMES AITKEN: Here's an example of what's not right. Over the past several years, the People's Bank of China and other lenders of dollars have taken advantage of the dislocation in the infamous yen/dollar cross currency basis. As we know, for most of the past several years, there has been a premium for dollars and if I have surplus dollars, I lend them via the yen/dollar cross currency basis. I lend them to, for example to Mizuho. I convert it into yen. I buy a Japanese T-bill, which gives me a synthetic US T-bill with a yield pickup. That trade's been going on for years. The People's Bank of China and others supply the dollars to the Japanese banks. Let's stick with Mizuho. Mizuho turns around and re-lends those dollars or reinvest them in guess what? US credit. Five or six years ago, the Treasury teams of Japanese banks would re-lend those dollars into investment grade credit, or hang on, let's take more risk. Let's extend duration. Let's end up in high yield. Let's add some currency overlay on top of that, say Brazilian real just to spice things out. Job's done. What happens if the People's Bank of China withdraws the dollars that they've lent Mizuho. Well, that whole daisy chain unwinds and for the past couple of years, if you look at the chart of Mizuho and overlay US high yield spreads at an index level, it's the same thing. It's the same thing, and I think that makes perfect sense. I ponder, Raoul, if the Japanese banks would appear to be adequately funded, I'm not worried about that. Unfortunately, they have taken a lot of their dollars, it would seem and invested in some very risky stuff at the wrong point of the cycle, and they have been punished for that. RAOUL PAL: Particularly, if we start to see some downgrades of these BBBs, and if they're in the junk bond sector, there is-- I think we could say, a trillion dollars of BBBs get downgraded and the junk bond sector's a trillion dollars, even if my numbers are wrong by 50%, it's still impossible for the junk bond market to trade that. JAMES AITKEN: There will be patches of indigestion I would imagine. RAOUL PAL: The ECB, so we've already seen obviously Australia and New Zealand now QE. ECB, that's the big unknown because there seems to be this is where we start to move into the world of juxtaposition between politics, fiscal, monetary. Talk me through what you're thinking about that and then I want to come back to bond yields again, as we said. JAMES AITKEN: Sure, sure. Raoul, the ECB, if we thought July 2012 was whatever it takes, this is whatever it takes hued, and to think that Madame Lagarde with one loose sentence undid nine years of Draghi when she said, unforgivably, my job is to not control spreads. That was quite courageous over, she realized within five minutes how foolish that was. Ever since, the ECB has been in repair mode. If we thought the summer of 2012 was whatever it takes, one would imagine, Raoul, that to avoid fragmentation risk, which is the great terror of European policymakers as we know, to avoid fragmentation risk, the ECB is going to have to be the buyer of first resort of all its sovereign bonds and Italy, in particular. There's a bit of a discussion around that I'm sure you've seen, and your subscribers would have seen, a lot of headlines and again, last night, all the duction the Germans did against euro bonds and joint and several liability and all this stuff, okay, that's unfortunate. You would have thought there's be a little bit of more political solidarity right now across and within Economic and Monetary Union. It's not happening, but you know what, I don't think it matters because the ECB has an open-ended balance sheet here. I think they're going to need a lot of it, so they are buying and buying and buying. Their priority is to prevent a fragmentation premium in Italy in particular, for obvious reasons. I suspect they're going to be on the hook as the sovereign buyer of first resort for a long time to come because there is no alternative. I would recommend we all keep a very keen eye on BTPs obviously. I am somewhat concerned to say the least, that despite extraordinary and persistent ECB buying, Raoul, these BTP spreads keep leaking. That's not a great sign, not a great sign at all. The ECB, I assume, is a constant presence in all those sovereign curves for a long time to come. I shouldn't overlook the fact that they've given tremendous regulatory relief to Eurozone banks. To be clear, that does not mean a catalyst for any sustainable rewriting of European banks, but it does mean that they are free from balance sheet restrictions and via the ECB is financing facilities, they are getting enormously cheap funding at a cost of minus 75 to put into eligible collateral of all sorts, which creates a positive carry trade for European banks. Again, that doesn't mean you own them, but the idea would be that that positive carry trade enables the best European banks to muddle through. The final point, as much this also applies in the United States, the regulatory relief that we've seen in the United States, such as at long last, a one-year raincheck or relief on the leverage ratio, it's not as some people have said to allow primary dealers in the United States to go hog wild on Treasury repo or anything like that, it's to ensure that there's enough balance sheet capacity to lend to the real economy, which is obviously the critical thing here. It's about the real economy and ensuring that there's ample credit flow into households and small businesses and that's critical in the US as much as it is in Europe. RAOUL PAL: I just want to get back to the Treasury market right now, just because it's been interesting to me that you imagined that the Fed wants to have yields as low as possible, it's a bit sticky still that the market hasn't woken up to the game or there's something else going on. Why is that? Why have bonds been stagnant for the time being? Why is the whole curve not trading at zero? JAMES AITKEN: There's a lot of bonds to be sold, Raoul. That's the short answer. RAOUL PAL: Who's selling them, the sovereigns? JAMES AITKEN: Well, there's some of that and we can see it in the Fed's custody data. There's definitely been some liquidation of Treasury securities by-- it's called the North Asian reserve managers. That's no surprise that the holdings would go down. When I say there's a lot of bonds to be sold, I should have been more precise. There's a lot of bonds to be issued, a colossal amount of bonds to be issued more than anyone can perhaps tally up yet, because we've got the CARES act that went through Congress the other day, and that's going to require a lot of issuance. Now, they're talking about oh, well, the cost of borrowing's free, let's tag on another 2 trillion of infrastructure or whatever. There's no barrier to issuance. I think quite a few people, Raoul, are starting to or trying to tally up the amounts of treasuries that will need to be issued or even bunds or BTPs or gilts or Australian government bonds to finance this bridge that all these governments are trying to provide through COVID-19. I wonder if that is in the back of investors' minds in terms of, you know what, now we're going through an economic emergency, perhaps an economic catastrophe. All in all, if the world's going into a sudden stop, Treasury yields ought to be perhaps a lot lower given the disinflationary undertow. However, when I imagine the future supply, perhaps that ensures that yields don't fall too much yet. Now, of course, the flip side of that is that for macro financial reasons, it would be a disaster as we work our way through or perhaps we've arrived at this very tenuous equilibrium, if we dare call it that in financial markets where realized and implied volatility is coming down a bit in equities, which is no bad thing. Somewhat similar in the better parts of the credit markets, giving everyone a time to take a deep breath and reflect on what their right exposures ought to be. The worst thing that could happen in this mini-timeout here is that long term nominal and real bond yields start to go up a lot. RAOUL PAL: Yeah, I'm worried about the real bond yields. JAMES AITKEN: Exactly right. The good news for the Fed and by golly, that's taken a lot of buying is that they have arrested what was a very nasty selloff in TIPS, or should I say yields backing up a lot. These days, Raoul, even positive 10-year TIPS yields in the United States would probably be orthogonal to any hopes of a rapid rebound out of this mess. RAOUL PAL: How can you possibly-- look, I don't know how big the deflation number's going to be in CPI and core CPI which lags it. I have no idea how big it is. Is it 5%, 10%? I don't know, but it's going to be monstrous, even if it's 3%. The problem is with bond yields that close to zero, you only get a tightening of financial conditions. JAMES AITKEN: Temporarily, you would think so. At the highest level, that's not a bad way of thinking about it. Then I also have to calibrate this extraordinary support that the Fed and other central banks are providing and then I need to calibrate it another step further, because I think we're all aware that this is going to be a very, very difficult couple of quarters, if we're lucky. This current quarter, every piece of data is going to look a little bit like the Great Depression, and I very much doubt anybody incorporated that in a vamoose, except Renaissance Technologies. Anyway, that's another conversation. We all know it's going to be hideous. If we're lucky, we get one quarter of data that feels like the Great Depression. Then if we dare to imagine the third quarter, we get some serious crappy, tentative recovery, although it won't actually be a recovery for a lot of people, it'll feel like a really bad recession that comes after the Great Depression. Now, the reason I flagged that is because there's no doubt we have this extraordinary disinflationary undertone to the current quarter, but as realized and implied volatility comes down, markets will start or data start looking through and saying to themselves, okay, near term disinflationary risks are given versus, dare I say, medium term inflationary risks as we attempt to restart the world in a heterogeneous fashion with bottlenecks everywhere. What's the unemployment rate? We'll probably be ending up quite high for the foreseeable future. We may have an extraordinary situation in the third quarter, I don't know yet. This is just a theory or thesis. We may have an external situation in the third quarter where the unemployment rate remains high, and firms are having to bid back for labor to get people into the labor force again to help them expand capacity and deal with the global economy spluttering back into life. I hear what you're saying. I don't doubt that we're going to get some extraordinarily bizarre CPI prints through the middle of this. I'm trying to imagine the second half of this year when the world starts to come back online. Temporary disinflation, a given. Structural reflation or more inflationary, I think that's what we need to keep our eye on. Again, it comes back to the Fed, what's their trade off? Well, they told us going into this ironically, they were going to consider the yield curve control and revising their inflation target and everything else. By the way, what they're doing now looks awfully like yield curve control without actually targeting a particular rate, because they're in the market every day. They are going to be so cautious dialing back any of this liquidity provision as we move through the rest of '20 and into 2021. They are only might be that the inflation that they've long desired might arrive in a meaningful way later this year, but they will remain on hold. That's, indeed, the answer to your question about between inflation and real yields and everything else. RAOUL PAL: Going back a bit to the comments about the issuance of bonds. We know there's probably more to come from fiscal stimulus around the world, probably quite a lot. Particularly when you go into let's say, Q3, things have dragged on a bit, the economy's not there. We expect to start to see stuff and certainly around the election, we're going to start to hear a lot of noise. Now, I presume the central bank will be the buyer of every bond issued, and we start moving to the MMT style environment where basically, the government balance sheet as they're trying to repair everybody's balance sheet, the households, the small businesses to everybody else, the central bank has to step behind it. That's globally, the same central bank did everywhere to try and allow governments to run massive deficits to do this. How is your thinking of that evolving? JAMES AITKEN: The implicit in your question is central banks everywhere, which to me means competition for global savings. If we assume that any central bank anywhere is not going to be a backstop buyer of all those bonds to be issued, we assume that one or more private sector actors will find them decent value and consider the case of the United States. Yields are still positive, a bit. They're certainly not zero, but there are no incentives for example, for the fully hedged Japanese investor to buy any treasuries account prices, level and structured credit, they're just odd. Unless, unless you get the dollar down a lot, so in yen terms, to use Japan as a proxy for global power savings, the only way you entice private capital back into the Treasury curve in a meaningful way that would enable the Fed for example, to step back, I think is via a very substantial dollar depreciation, which we'll talk about later on. RAOUL PAL: Just the other thing is why not the US pension system, which is massively underweight treasuries and has a need for it because of the aging population? JAMES AITKEN: Well, that's what I thought. One of the most extraordinary things of the past month is that you look at holdings of Treasury securities and holdings of STRIPS have actually declined in March. Now, if I read the data correctly, it was $15 billion. Who cares, but obviously, the STRIP treasuries have been very, very popular so US pension funds, in particular are managing their long term liabilities. I'm like, why on earth would US pension funds, assuming they're the biggest holders of these STRIP treasuries, why on earth would they be net sellers? What other exposures do they have that they got called away from, because I think there's much redemption risk? The broad answer to your question is, yes, of course, at a price, the US pension system will be a buyer, but then I need to calibrate that for capacity in terms of the amount of bonds to be sold. Of course, there are banks as well who would be happy to own Treasury securities in their HQA buffers, so of course there are buyers of Treasury securities around, but I still come out to myself and say, I very much doubt that the Fed's going to be backing away much from support in the Treasury market because they cannot afford to have any sustained rise in nominal, and especially real yields. I think they're stuck that there's this broader question about competition for global capital. Australian superannuation funds, are they going to be buying huge amounts of Ozzy government bonds? Well, I guess so. How about Japanese investors? What's the cost of hedging your FX risk into Ozzy and stuff? Then you go around the world and you're saying who's been the keenest buyer of Treasury securities or certainly one of the biggest constituencies of Treasury ownership over the past several years? Unsurprisingly, it's the sovereign wealth guys or more accurately, the reserve guys. If for reasons of downstream liquidity to their own financial systems, they're no longer a net buyer, they're the net seller. You keep coming back to the Fed, I'm afraid they're the only game in town. We have a lot of unfinished business in government bond markets. I would be surprised if central banks have stepped back much, if at all, by the end of this summer. You may have seen yesterday the Reserve Bank of Australia articulated that they were intending to step back a tiny bit from the rate of bond purchases they've been conducting while still targeting three years of yields of 25 basis points. Perhaps it was another misunderstanding by markets, but even the merest hint that the Reserve Bank of Australia was stepping back from their current run rate of bond purchases, sure, a pretty nasty selloff in Australian government bonds and the 10-year in particular. I think, Raoul, that's not a bad metaphor into thinking about how difficult it will be for the Fed to step back and to finish this point, how impossible it is for the ECB to step back. RAOUL PAL: Then I think that the fiscal stimulus side is going to be huge, and I'm interested in what you're picking up within Europe, because that's what interests me, because we talked about the dollar deval and we'll come into that, but I also see the risk of Europe having to do certain things which may put pressure on the euro for a period of time as well. I think there's, in my mind, a phasing that comes from global weakness in currencies, with the dollar going higher, and then everybody having to do something about the dollar. Talk me through a bit about that and the relative, what Europe's going to have to do here, and maybe why Lagarde was actually brought in, in the first place. JAMES AITKEN: Let's deal with Madame Lagarde. There's this theory going around that Madame Lagarde was brought in there to take Economic and Monetary Union to the brink and make euro bonds and more fiscal union inevitable to save it all. I doubt that. I think she recently learned the hard way that it's a big step up from the IMF to being a central bank president when the markets are hanging on your every word, she won't make that mistake again. That's the first point. I wouldn't overinterpret the fact that Madame Lagarde is the president of the ECB. I'll just add quickly that she is ably served by some extraordinary staff running their balance sheet as good as any people in the world, and they've been the ones who have rescued Economic and Monetary Union for itself. You're asking about fiscal, look, I think the initial response in the Eurozone was loans as opposed to spending, credit guarantees for creating industries, in Germany using KfW to provide a wrapper if you will, for companies that couldn't borrow, all sorts of things like that. I think, look, there's a lot being announced and done already and it's all moving in the right direction. I don't know quite how to answer the question other than to say that the extraordinary change in fiscal attitude in Germany in particular is to be welcomed and encouraged. Look, a year ago, if Germany had said, you know what, debt to GDP, the debt like everything else, we're letting it go, it doesn't matter anymore. Gosh, we would have all been betting on a very reflationary world, which is part of the irony here. It's like oh my gosh, the Germans have discovered fiscal policy, hallelujah. Well, the fiscal policy that they're now deploying is barely offsetting the economic disruption from COVID-19, not just within Germany, but around the world because obviously Germany is a leading manufacturer. The way I think about fiscal policy, if I've understood your question correctly, is that it's going to be with us for a long time to come. All these so-called debt breaks and everything else in the Eurozone are obviously no longer relevant because they've been superseded. I hope, I hope that Germany in particular, is not tempted to step back from this extraordinary response too soon. I hope they keep it going as I do hope that every fiscal authority around the world overdoes it rather than underdoes it as we seek to navigate this economic disruption. Really, I come back to the ECB, the ECB is the fiscal backstop in the Eurozone. Just with the Fed, I suspect, Raoul, that many European politicians are quietly very pleased that the ECB is the getaway car, just as the Fed is expected to be the getaway car and the backstop of everything under the CARES act. Really-- go ahead. RAOUL PAL: Do you think there could be a massive agreement amongst the European finance ministers to also, right, we're all going to be allowed our own fiscal stimulus of x so we can all breach our agreements with Europe itself, we will do this, and ECB will backstop it. That's where I'm come from that that coordinated or semi-coordinated mass fiscal stimulus is something that Europe needs. There's no way Italy can get around it without it or Spain, or even France now, it's so difficult, unless they got that backstop explicitly. JAMES AITKEN: I think they're well on the way towards that. As we know, from looking at the history of Economic and Monetary Union, it has advanced over the decades one crisis at a time. This is a big one, because the whole project's at stake, their citizens welfare is at stake, and as you would have seen in the headlines, there are any number of sneaky plans afoot to spring Germany and the Netherlands into agreeing joint and several liability by euro bonds, but to focus on one specific idea that subscribers might like to dwell on, the European Stability Mechanism or ESM, there are proposals afoot which haven't been agreed upon but they're proposals to use the ESM and ramp up massively its borrowing and then to downstream that cheap borrowing because it has a AAA rating to all sorts of European sovereigns at the same spread. Now, that's very cheeky, isn't it? Because that is a backdoor euro bond without actually calling it as much. They're very cheeky these people in Brussels, and they will never give up. I would focus on this emerging story, that the European Stability Mechanism, ESM, I think I've got the name label correct. Let's just call it the ESM in case I'm wrong, that could be fired up in a large way to issue AAA paper in size at a spread compatible to Germany or maybe even inside it, and then to downstream that as a central Treasury to other sovereign states. It's very crafty, I take my hat off to them, but I'd recommend we keep an eye on that as a backdoor towards fiscal solidarity. RAOUL PAL: I want to talk through the currency markets now. Then we'll move on to different scenarios in how this could play out, because it's a very uncertain world. Talk me through your phasing of the currency markets, how you see this play out. We all understand that the dollar is a problem. How do you think this plays out? JAMES AITKEN: Well, we've seemed to have inverted that famous anecdote from Secretary Connolly in the 1970s. Remember when Connolly was negotiating the end of Bretton Woods and he famously said, add dollar, your problem. Well, right now, it seems that the United States say add dollar, our problem. We will be the world's central bank. We will downstream dollars at a fair price wherever they're needed in unlimited quantities to prevent the financial system tipping over on itself. Now, if you consider that, if you consider what the Fed's doing, and if you consider what we discussed earlier about the amount of Treasury issuance to come, you'd say yourself, my gosh, that's creating the conditions for a very weak dollar. Now, to be clear, I'm not overlooking all the dollar indigestion that we've seen over the past couple of months, and which, broadly speaking, has calmed down a lot so that the plumbing is starting to work much better. It's not perfect, but it's much better. The Fed is shoving money, shoving dollars out the door. That seems to be working, but the dollar is not weakening. Here's where we need to get a little bit technical and down into the plumbing. Let's think about this scenario. The Fed is offering dollar liquidity to other central banks at a price of three-month OAS plus about 25 basis points, which let's say for simplicity, 35, or 40 basis points all in. Now, that's very cheap dollars, and unsurprisingly, that has had a tremendous impact on a lot of dollar funding spreads around the world. The cross currency basis swaps, which have developed quite some fame over the past several years, there's now a discount for dollars as opposed to a premium. It's spectacular. Then the next step back, we have the Fed's commercial paper funding facility, which doesn't get up and running until April 14th. The initial cost of this commercial paper funding facility, which need I remind subscribers, is a short term unsecured loan, commercial paper, in original cost, I think advised by Mnuchin which was a ridiculous three-month OIS plus 220, which is stupid. They kept the cost to three-month OIS plus 110, which I still argue is stupid, especially-- sorry, to be clear, it's not stupid, it's unnecessarily high to be fair to them. You have dollar liquidity going out the door via central banks at 35 or 40 basis points via the dollar swap lines, and you have a commercial paper funding facility at three-month OIS plus 110, 120 basis points when you factor in the thing. That's very, very high. The problem here to think about exchange rates is that the cost of this commercial paper funding facility is acting as a floor to Dollar LIBOR. The one price of dollar funding, if we want to think about it this way, that looks completely out of line on my screen is three-month Dollar LIBOR, which continues to set let's say simplistically, around 130, 135 basis points. That's because I'd argue that the commercial paper funding facility hasn't started yet. The cost of it is too high, and we'll have a clearer picture on dollar funding conditions from April 14th onwards, and you can tell where I'm going with this. Up until April 14th, if Dollar LIBOR is still fixed in, three-month Dollar LIBOR still fixed in at 130, 135 basis points, it's going to be very hard for the dollar to come down. Even though there's dollars going out the door and we're re-liquefying the plumbing, 135 basis points compared to negative numbers in some other jurisdictions, the dollar's going to remain sticky. I think after April 14th, Dollar LIBOR is going to ease off, maybe through May and June. On balance, my suspicion is that may tend to undermine the dollar. I don't know yet but I'm watching carefully. RAOUL PAL: Because one of the things that still goes through my head, I'm still very much in the camp that the dollar goes much higher. My fear within this is that the swap lines are just an alleviation of a symptom. It's taking a headache tablet for the flu. That's all it's doing. The actual problem is Chinese, South Korean, Indian, Brazilian and a bunch of corporates have a lot of dollar debts. Now, the problem is in this world, as you know it, flows from the central bank to the banking system. BOJ gets a bunch of these or whichever central bank it is, they give it to the banking system. The banking system, utilizes what it can, and obviously, in a world like this, you only give the dollars to the best credit. It feels like game of musical chairs, where the worst creditors are trying to get their dollars, trying to get the chair and so I worry that there's a negative convexity in this market that if the dollar goes up, it goes up a lot. JAMES AITKEN: Well, we certainly saw a hint of that in the past month, didn't we? RAOUL PAL: Yes, that was scary for a minute. I've not seen that for a while. JAMES AITKEN: It was brutal. It was just this mad scramble for dollars because there was this absolute preference for cash, dollar cash. You know the world's in a bit of a bad spot when you can't even sell a Tbill, or the bid offer spread on a T-bill is like 10 basis points wide, which it was. That's just insane. That added to the panic when corporate treasuries around the world said, oh, I'm just going to just move out of my T-bills into dollar cash. It's like, you mean it's 10 basis point wide, and I'm actually hitting a negative. It was bizarre. Let's use a real anecdote here to help illustrate the point. Yes, there's been a tremendous amount of dollar borrowing around the world over the past several years. No surprise, because large scale asset purchases in the United States in particular, reduce the flow of dollar securities. We know that. I was in Beijing and Shanghai in February 2017. It was extraordinary, very humbling experience, by the way, because you realize you just know nothing about China at all. You can read everything you like, but it's just unknowable, almost, almost. I met some of the treasurers of the big Chinese policy banks. It was a fascinating discussion about how they manage liquidity. There's the onshore Renminbi liquidity, which within reason, within political reason, can be managed to increase yield. Then there's the gigantic dollar liquidity buffers that the biggest Chinese banks have offshore. That's when I suddenly realized wait a minute, who owns all the dollar paper issued by Chinese corporations? Where is the bulk of it? The answer is tucked away in the Treasury books of the biggest Chinese banks. Now, of course, there's a smattering of other dollar paper that falls into the hands of sophisticated mutual funds, the Evergrande, probably a dreadful example but Evergrande paper and other paper, there's some mutual fund holds, or mutual funds plural hold, but again, the key point here is that a lot of this dollar paper issued by wobbly Chinese corporates is tucked away in the dollar balance sheets of the big Chinese banks. I would suggest that they're very interested in continuing to support the home team. I imagine it's extremely unlikely that they're a forced seller. If things got immensely grim in China, I would imagine that the People's Bank would happily lend against dollar paper issued by the most critical Chinese borrowers. Why have I shared all that with you? Look, I've been as worried as the next person for a long time about the minimum amount of dollars, if one thinks about it that way, that the Chinese financial system may require on any given day to remain on an even keel. There's one little magic trick that I think people may have overlooked after August 2015, yes, there was a lot of styles of Renminbi for dollars from August 2015 onwards, but the magic trick is that those dollars did not leave the Chinese financial system. They were redeposited with the Chinese banks. That's one of the ironies of that episode. The point I'm making here is like yes, am I watching the price and the yield on Evergrande bonds in particular? Absolutely. Absolutely. Am I watching the cost of dollar high yield bond spreads from-- Asia high yield dollar bond spreads? Absolutely. If you asked me to rank the issues that worry me now, I put that it might be in the top 10 maybe, but it's not there yet. I think the broad answer to your question about how hard is it to downstream dollars to the people that need them in emerging markets, I would say it's improving. It was remarkable to see yesterday that the Bank of Indonesia announced they too have created a dedicated $60 billion repo facility with the New York Fed. That's remarkable. Now, I can't tell you with any certainty what difference that makes to the Indonesian financial system and Indonesian dollar borrowers, but the fact that Indonesia has that backstop, I would suspect it does a lot of confidence across the Indonesian corporate sector. Really, I don't think we've answered, ultimately answered your question about how do we ensure there's always adequate dollars flowing around but there are a few things being worked on particularly in the IMF to create backstops, which might give everyone time to think and reflect. RAOUL PAL: Because we've seen-- two questions. One quick question is there's been no dollar swaps with the PBOC. JAMES AITKEN: And there never will be. RAOUL PAL: Okay. Talk to me about that. JAMES AITKEN: It's just not going to happen. Let's talk about this Fed's new repo facility that went into place last week, this FIMA repo facility, I'm sure subscribers have seen the announcement of that. One report that's come back to me, and I need to be careful here, but I think it's true. SAFE, the State Administration of Foreign Exchange in Beijing who managed China's reserves, there are a few more price sensitive clients in the world. I will haggle over every basis point whether it's an FX hold, a swap, spot execution, let alone a Treasury purchase or sale or bund or BTP, whatever. There are reports coming back the during March, SAFE was an indiscriminate seller of treasuries, and I'll just say all the government bond markets around the world, highly unusual behavior for such a price sensitive market participants. Were they desperately short of dollars, or were they trying to create mischief? I think we should all reflect on that deeply. I was struck by the way this New York Fed repo facility last week was announced. It's designed to help people liquefy their Treasury securities, an overnight financing transaction to get dollars to the real economy, but it makes absolutely no sense at all, Raoul. Let's imagine you and I, the People's Bank of China are safe and for whatever reason, we need more dollar cash in the system, so we pick up the phone, the New York Fed say, hey, look, we want to lend you 20 billion treasuries overnight. Well, hang on a second, I'm going to have to roll that every 24 hours. Do I get the dollars back again every 24 hours? It doesn't make any sense even if you assume it's a term repo facility. I think this repo facility that the Fed has artfully created, is to send a message to Beijing, don't you dare do that again. Don't you dare, if you want to go and hit a bid in the open market in treasuries and create mischief, we're on to you. Meanwhile, here's the facility that can actually act as an off market purchase facility in a sense for your holdings of treasuries. Thanks very much for coming. I think there's a lot more to it, and I would be surprised if the People's Bank of China were to receive a specific facility. This might be as good as it gets. The last quick point on that is if I read the term sheet correctly, this FIMA repo facility, or foreign reserve managers, I imagine who, comes at a cost of interest rate on excess reserves plus 25 basis points, something like that. It's not cheap. It's not cheap. I'm not holding out for China to get much love here. RAOUL PAL: Do you think the Saudis and the Middle East have to liquidate stuff as well? I feel like it might help them a bit because, obviously, if the oil revenue is imploding, they're going to need a bit of cash to maintain their system. JAMES AITKEN: If one reads the term sheet, there's nothing to stop Riyadh using that facility as well to generate a few extra dollars. I did think it was a tell, I don't know if you saw this, was it last week or the week before, where Aramco says, oh, we're thinking of selling a $10 billion pipeline. Well, hello. I think this morning, I caught the fact that the Saudis are doing a $10 billion bond issue, also a known here. Strange times in the Kingdom, as always. RAOUL PAL: I want to look forward a bit because the market's going to have to grapple with a number of outcomes. One is, is the liquidation event finished? None of us really know yet, but it's-- then there's probably, I think we both think there's probably a respite phase, whatever that is, whether that's a real recovery, which is what you said, then we get inflation issues, maybe things change, we've got an enormous amount of stimulus coming through eventually, et cetera, particularly after the election in the US as well. What happens if growth remains negative year on year and ongoing for a while? Because if I look at the psychological impact of what's happening, if I look at what's happening in Hong Kong, which is now seeing a rise in cases again, if I see what Singapore has just done, the Singapore Prime Minister had a fabulous speech where he just said, listen, it's basically broken for a year or two, whether you like it or not, we're going to keep-- we're never going to open our borders and we're going to be closing down the population from time to time. All that says, to me, all of this stuff and the scarring of people's behaviors means that the trend rate of growth goes down significantly for a period of time. The question is, how long that period of time is? I am focused on I think if we go to three quarters of negative year on year growth, though Q2 growth is going to be impossible now because of this last quarter. Let's say so we're in it, we go from depression quarter to bad recession few quarters, which would be normal. Normally in recession, you got 18 months of this stuff. I fear an insolvency event. That's my biggest fear, it's my highest probability that we have the largest insolvency event in history. That's what I'm looking at. I know, again, neither was know, we don't have a clue. We're just trying to look at what the probabilities are out there. Talk to me about that. JAMES AITKEN: Thanks for such an easy question. Let's try and knock that out of it in an effort to be less wrong. Let's face it, if we get any of this half right, we're doing very well so let's try and think about less wrong, and what we know. We know that we have a very tightly bound complex system called the global economy that for decades has been optimized to fault. Just in time inventory, just in time liquidity, just in time borrowings, just in time leverage, supply chains going every which way. It's a very complex system. Therefore, the notion-- not held by you, of course, but the notion that we can flick a switch and turn this complex system off, and then reflate it in a quarter or two, I think is wishful thinking. Because think about incentives, pending the arrival of the small business loan or the PPP loan, or the unemployment check in my account, which in the United States might in some unfortunate circumstances, still take another month, what am I doing? I'm knuckling down, I'm hunkering down every which way. My consumption other than a Netflix is going to zero. I'm not buying anything. I'm not spending, and economy wide and globally, that is a very bad outlook, and businesses everywhere are incentivized to fire employees first, ask questions, apply for loans late, and then imagine to extrapolate this example, the dilemma for small business owners around the world, and we were talking about it a bit earlier, it's not terribly social for you. I do agree to go to a bar in which we have to stand 20 feet apart. No bar owner's going to open that way, we're not going to turn up for a drink. Then the restaurant, do we all have to have sit three tables apart? Why would any small businessman reopen if their revenues are going to be at best 50% of peak revenues, which is your point? The answer is, they may not do that. No matter how grand the government largess, no matter how long the PPP loans go for, and everything else, look, in the United States right now-- I'm not sure about other jurisdictions, but in the United States in particular, we are not yet arresting the rise jobless claims. We are not yet arresting the rise in unemployment, we are chasing it. That's most unfortunate, but knowing that and observing that, if we're daring to sketch any economic recovery in the world's most important economy, bearing in mind that the US consumer has been the world's consumer of first resort for decades, and we have penciling in not only a very patchy recovery for the United States, but are very patchy recovery to the global economy, because as we seek to move through this, the global economy will only be as strong as its weakest link. Where I come out-- and we could go into more details, but for the sake of time, if we can muddle through this with some L-shaped recovery for two or three quarters, I would take that because I think that would be a phenomenal outcome, phenomenal outcome. I actually hope it's an L-shaped recovery. It's certainly the intent of fiscal authorities and monetary authorities around the world that we don't have an exact rerun of the Great Depression. It's remarkable, it's breathtaking, Raoul, that we have turned off the global economy. We've turned it off. Some estimates I've read who said there's a billion people at home right now, just waiting for an employment check, or waiting for the bailout. The idea that you flick a switch, and we all go back to work, or we all take the Lexington Avenue Express, the four or five train or we all rush back to get on the-- RAOUL PAL: Here's something interesting. A couple of things. Obviously, China asked people to go back to work, to go to factories-- JAMES AITKEN: Well, because they can. That's another important point. We have command and control in China, because that's-- RAOUL PAL: What happens is, if you look at the TomTom data, the Shanghai, weekend traffic is still down 80%. People go to work, but on the weekend, they don't go out because they don't want to. Also, they've now got factories building stuff to sell to who exactly? JAMES AITKEN: Well, that's it, that's it. RAOUL PAL: This is what I worried about, solvency, because you've got this rolling issue of subdued demand. It's either catastrophic demand as it is right now, but on and off if you're not Brazil out the global economy for a few months, you're not India out for a few, you've got this rolling destruction of demand. That whole situation just really concerns me. Just to see that people-- there is no normality, people don't go back to normal does not happen quickly. Obviously in due course, but supply chains, everybody's going to change. The trade tariffs already started it. Now, every boardroom's act are going to have to say, can we allow for this weakness? JAMES AITKEN: That's it. At a minimum, there will be a much increased preference for cash as opposed to just in time leverage refinancing and everything else, who much increased preference for cash. As I think a lot of corporations are finding out even in a low yield world, and we need to be very mindful, Raoul, that does not become self-fulfilling, because then, every corporation around the world, and every household around the world says I prefer cash over every other asset. To be clear, we are not there. We're not there yet. We may never get there, but that is your classic liquidity trap, which the authorities are doing their best to avoid. In a liquidity trap, by definition, you have some very serious solvency problems because not many people can refinance at any price, and that's not good. To be clear, look, we can guess various letters for an economic recovery, and we can speculate endlessly on how difficult it is to restart this complex financial system, complex system called the global economy, but that doesn't mean we should not be looking to invest. We have to keep an eye on some of the extraordinary attractive assets that have been coughed up over the past month and may yet be coughed up. To talk specifically about insolvencies, and you mentioned it earlier about high yield. I think it's very interesting and important that the Fed has made no effort to backstop the riskier parts of the US credit markets. It's not an accident. If we think about the politics of what we're sketching out here, which is I hate to say it, human misery and human tragedy, which hopefully we can work our way through. The optics, the political optics of the Fed, or frankly, any other central bank, bailing out the financial system yet again, before money has arrived in the bank accounts of consumers and households and small businesses around the world, it's not a good look, and yet everyone tells me, oh, don't worry, the Fed's going to be on the hook for all the credit. They're going to buy high yield. They're going to do this, they're going to buy CLOs, you go down the credit food chain, they're going to be the bar. I'm not holding my breath. They have been consistent-- I know it's hard to divulge from what the Fed's been saying for several years, but if you read between the lines, they have been laying down a marker on commercial real estate, CMBS, leveraged loans, they have in conjunction with their peers around the world, been warning for five or six years about something you and I have chatted about which is secondary market illiquidity in corporate bond markets, and to then do a handbrake turn and support every part of the credit market, some investment grade, will be setting them up as a political punching bag, especially if this unfortunate crisis drags out for more than one or two quarters. RAOUL PAL: Why did they not do it via the municipal pension system? Why don't they just inject money into the pension? That's my theory, because like you, I think it's impossible politically to go and buy the high yield market, but to say, well, the pension system, we need to make sure that they're solvent. You inject money into them, because they're basically funded by tax receipts at the moment. There's no tax receipts. The Fed can essentially or the Treasury-- the Treasury or the Fed can-- or government, whichever mechanism, inject money into those with the, you can support the credit markets for us. JAMES AITKEN: I think you're asking me what's the probability of a state bailout and then what's the probability of a local bailout across the United States? RAOUL PAL: Yeah. JAMES AITKEN: You are seeing some minor improvement in the municipal bond market, which is no surprise because like so many risk assets over the past month, the enormity of the Fed and other central bank responses has injected this enormous amount of liquidity, which has reflated pretty much everything. Just to give people time to regroup and think about what they own and municipal market has benefited to some extent. Rather than getting too involved in a direct bailout of state and local pension authorities, perhaps part of the idea of the CARES act, potentially, is to create some special purpose vehicle for state borrowers, I don't know yet. Again, I come back to the point I'm sure they thought about it, and yet, isn't it interesting that they haven't done it? I don't have a great answer for you other than pointing out they haven't done it and there must be a reason for that. Maybe they are hoping that the liquidity eventually trickles down from some of their other programs and that there's an element of balance sheet capacity and arbitrage which brings pass of the muni market back into line, but Raoul, if you're asking me about a bailout for state pension funds, I'm not holding my breath. RAOUL PAL: Well, that's going to be a problem at some point. I guess it's not today's problem. Today, we've had a liquidity event, not a broader-- but if this drags on, then we got a pension crisis front and center. I just want to-- because we've been chatting for a lot, and there's a lot we've covered, which is fantastic. What I'd love to get you talk about some opportunities, where are you seeing the opportunities here because it's very difficult for most people to get their heads around what's shit and what is gold within this. You're getting through this, so we have to know what you're doing. JAMES AITKEN: One way of thinking about it, for sure, but I think there are-- yeah, there are plenty of opportunities for patient capital. To provide a metaphor, one consistent observation across all the largest pools of global capital, who I advise, is that they've all been nibbling in this selloff. No one's trying to pick a bottom, no one's trying to predict the bottom. They're deploying capital into very specific assets and sectors based entirely on valuation. I think that's important for all of us, because we can read every COVID model we like. I don't think that's going to give us much insight into how to deploy capital. It might make us informed, but it's not going to tell us how to value a security that might be on sale at an enormous discount. I think that metaphor, nibbling and to be very precise, there is capital being deployed at the top of the US credit markets, so AAA CLOs. Just an anecdote, and I keep saying just an anecdote, but I'm trying to make it tangible for your subscribers. There was a strange Bloomberg story last week, and I think it was ill advised if true, that Citigroup had made 100 million dollars by buying a AAA CLO trash from potential investments. Now, that's a very strange transaction, because first, why would [indiscernible] of all people given they're fully funded need to sell a bulletproof and they are bulletproof AAA CLO tranche in the low 90 range? It doesn't make any sense, and yet Citigroup had the balance sheet to take the other side. The reason I share that is because I think it reminds us how different this is to 2008 because in 2008, it would have been Citigroup spraying stuff everywhere to the buy side. Now, Citigroup that has the liquidity to allow the buyer side to sell, and it tells you where a lot of this risk is held, hopefully in a sensible way. There is capital being deployed, very specifically senior secured credit for those who have read their prospectus, AAA CLOs. Obviously, this money that's dribbling into US credit up in the bulletproof tranches is not nearly enough to offset the potential supply and destruction to come, level out and offset anything people might need to distribute in high yield. Now, this is a very important technical point when we think about opportunity and solvency. On March 24th , ICE BAML indices said that they were going to take a raincheck on rebalancing their credit and fixed income indices at the end of last month. Now, that's very interesting. Then the other index providers, including Bloomberg to a degree, followed on and that actually gave the credit markets a lot of breathing room because if the rebalancings had gone ahead as planned, Raoul, there would have been a tremendous amount of liquidation in all sorts of credit, which the market would not have absorbed. It would have been particularly problematic for the Vanguards of this world and all the passive quant funds. They've postponed that to April 30th . The point I'm flagging here is there will be plenty more opportunities in credit for the professional credit investor, and the long only credit investor because they're able to name their price and they're able to hold on rather than picking a bottom in all this other stuff. We could talk about credit, more data afterwards, but I want to come back to equities as well. I think we all need to be very careful here, especially now, given the uncertainty to try to stay within our circle of competence. To be very frank with your subscribers, some of my friends would argue-- I'd even argue whether energy more at the broadest level is within my circle of competence. Although you and I know many very, very smart energy investors who have done phenomenally well in all sorts of market conditions. Now, let's think about numbers. Potentially over the next week, there may be some agreement between major energy producers that takes 10 million barrels a day of supply off market, perhaps by May. On the other hand, if you look at what traffic Buru and other leading oil firms are saying, demand action right now, as a result of the things we've been discussing in the energy markets, is running somewhere around 30 to 35 million barrels a day, a day. Let's take 10 million barrels of capacity off market, the frank answer is so what? Why should we care? If I go down another layer, and I turn on the Bloomberg and I look at all those products and spread products and all down the energy food chain, it roughly comes out with a market clearing price of oil, let's just call it broadly oil, somewhere in the low teens. You think to yourself, uh-oh, there's a lot more reckoning to come. It is however striking then in the context of that which every oil professional knows that some of the better shale, the large cap energy stocks have stopped going down, because eventually they discount the worst case scenario. We need to sharpen our pencils here, but we're in the process of what you might call the shale reckoning, or the shale restructuring that was postponed in 2016. On the front edge of that, there will be consolidation, people will need to tie their balance sheets to the ground, but there will be winners, and at some point that despite this supply dispute, despite the demand destruction today, we will need the oil and we will need these companies no matter as a sidebar, whatever people tell us about ESG. If we're going to restart the global economy, we need these companies and we need the shale companies in particular. If I dare to think about what's not in the price, I look at what, again, to use that metaphor. Our friends down in Texas, the really sharp guys are doing, and I say, okay, I'm watching what they're doing. I'm doing my own homework about the liquidity on the balance sheet, and the funding and the hedging, of course, and the breakevens of some of these companies that I imagined might last, so it might be the Devon Energies, the EOGs, the WPX, those sorts of things, passive energy, and then of course, I'm thinking about Chevron, Exxon and Hess. Then I might be thinking about what side of Australia. It really depends, but the point is, I am very carefully-- I don't trade, but I'm very carefully deploying some of my liquidity buffer which I've had for a long time into some of these companies. RAOUL PAL: Equity or bond? JAMES AITKEN: Equity. I'm doing so knowing that the demand destruction is staring at me in the face. I do so knowing that I'm very likely to be punched in the face again if I missed the market, but I'm prepared to absorb that because I think to myself there's long term value in these particular companies. RAOUL PAL: Do you think that the shale credit market has priced much of this in as well? Look, it's not going to be completely correctly priced, but everyone knows it's all going bankrupt and somewhere within that, you're going to find some real gems as exactly as you say. Do you think it's all priced in, or do you think there's bit more ugliness still to come? JAMES AITKEN: Put it this way, if I'm a sharp reducer, and I couldn't refinance at the end of 2019, which was the greatest credit liquidity bubble of all time, I'm dead. I think it's CUSIP by CUSIP. Mr. Market is identifying it company by company. There's a long way to go yet. You saw Whiting petroleum, I think it was last week, basically tapped out, there will be others. The ones that are left behind are the ones we need to keep an eye on. A similar argument could be made for certain infrastructure companies if one's taking a long term view. Now, I know what I'm describing so far is a little bit boring and conservative perhaps, but everyone goes on and on about Warren Buffett, especially now, everyone's trotting out Warren Buffett clichés and finding out the hard way, but it's all very well to talk like Warren Buffett, it's a very different matter to actually act liking when things go 50% off, but I would have thought, Raoul, that the ideal time to buy the metaphorical monopoly toll bridge is when there's no traffic. I'm looking at things like Sydney Airport, which has never had this few-- well, certainly for six decades has never had this few flights looking at their balance sheet. I'm looking at Ferrovial in Spain, which is a company with which you'd be familiar, they evaluate their market capitalization versus their 25% stake in Heathrow, the LBJ tollway in Dallas, and also the 407 around Ontario and they've got a look on those assets until 2061 and 2076. I'm pretty confident they're going to have future cashflow. I'm just trying to think about, as best I can tell, the survivors, the money good assets, but on only dribbling money in because every analog for bear markets like this tells you in no uncertain terms that you revisit the low. Everyone has it. RAOUL PAL: I wrote about this in GMI, I was like, look, all the smartest people I know are doing exactly what you're doing. I say one thing I do know is everybody will get stopped out once or have a gut check once, and then it usually works because it's always the people doing their homework who figure out, okay, these things have now ridiculous pricing. For whatever phase that is, whether that's ongoing or it's the next three months, whatever it is. It's always interesting. I think you're right. JAMES AITKEN: Yeah. It's very careful, very selective. No doubt subscribers have different things on their radar that they understand. It's not trying to be fancy. You and I have used airports, or at least we used to. Still think to yourself, they've got a minimum amount of liquidity, their net debts are-- RAOUL PAL: That's a great idea. JAMES AITKEN: Just very gently and-- RAOUL PAL: That's right. The toll roads have no tolls is a really bright idea. JAMES AITKEN: Monopoly toll bridge with no tolls, and you can use that metaphor for a range of industries and sectors. Mr. Market is giving an opportunity for patient capital to have a look-- RAOUL PAL: They always adopt. Those businesses are not reliant on growth. They're just-- because they're not like-- not oil services company, oil services company to get back to the highs, needs building tons more pipelines, whatever it is. The toll roads just expect some return to normality, and before you know it, it's cash play. JAMES AITKEN: Look, but believe me, it's not nearly as exciting as Bitcoin or anything like that. Then again, nothing might be. For someone like me just trying to be sensible, trying to lay out some capital, trying to imagine a year or more out what a healed world might look like, it's not sketching in growth. It's not trying to forecast growth. It's not trying to predict anything. It's just trying to say, okay, I am reasonably confident that we will need X, Y and Z. We will need energy. We will need logistics and infrastructure. We will need-- I could go down the list and if Mr. Market is allowing me in, allowing me to have a small ownership stake in these assets at a discount to their replacement cost in what-- and this is the cherry on top, might be for a while a more inflationary world, I have to think carefully and deeply about those assets and the opportunity, not because any of us have the ability to predict the bottom. In fact, if we wait for the bottom, it's too late. We have to think about it now. We have to think about how we feel if they all go another 10% or 20% off, which actually affords you would hope a larger margin of safety. We're not a seller at that point. We actually have to say, okay, I need more of it. I'm just trying to imagine the world one or two years out that's looking a little better, and what might be quite valuable. RAOUL PAL: James, listen, I can't thank you enough. It's been an epic conversation. We've covered an enormous number of crowns, and enormous other things and you're exactly the right person for this because your, as I said, your breadth and depth is very unique and rare, and I think to come out with some opportunities out of it as well. It's not just gloom and doom or listen, we don't know where it's going, but here's some concrete things people can think about. I think it's incredibly useful. As ever, I'm ultra-grateful. JAMES AITKEN: I'm grateful to you as well, mate, and well done for the success at Real Vision. I'm glad to finally at long last, be a tiny, tiny sliver of it, here I am. RAOUL PAL: You were with Jim Grant before me, that was outrageous. JAMES AITKEN: I do apologize. Now, I was actually tempted to wear that revolting sky blue jacket that I wore for that interview, but I thought your subscribers have seen enough of that. Look, just to send a message to you, your family and your subscribers, it's a very difficult time. There's no precedent, no easy precedent, no easy analog, I had greatest sympathy to all the families that have been directly impacted, and indirectly impacted by COVID-19. The most monumental shoutout to the first responders and everyone in ICU and to the small business owner, husband, the wife, the person sitting at home trying to keep their portfolio on an even keel, as an antidote to all the troubles immediately in front of us, and there's any number of them, try this. Draw up a list of the assets you've always wanted to own with a margin of safety and dare to dream that you might actually get a piece of them in the period immediately ahead, which will help you protect your capital for a long, long time to come. RAOUL PAL: James, great, thank you. Appreciate it. JAMES AITKEN: Thanks for your time. JUSTINE: If you're ready to go beyond the interview, make sure you visit realvision.com where you can try real vision plus for 30 days for just $1. We'll see you next time right here on real vision.