1st Year Macro HF Analyst: My Macro Framework

I did a Q&A a couple weeks ago (Q&A: First year macro hedge fund analyst | Wall Street Oasis) where I promised some people I would go more deeply into my macro view and provide some resources that I've found helpful. This is that thread.My Framework:I focus pretty heavily on how the monetary/banking/financial system functions from a high-level, what are the goals, incentives, and motivations of the major players, and how that drives capital flows across geographies and asset classes. This means understanding the activities and motivations of the largest banks (GSIBs) and Primary Dealers and how their behavior changes in response to financial/economic conditions and also how their behavior reflexively causes changes in financial conditions.I spend a lot of time on this because leverage and credit cycles drive peaks and troughs in the real economy, especially since the financialization of the US during the 1970s and 80s.It's also important to have a good understanding of how the financial system connects to and interacts with the real economy and where it does not. Equities, for example, are only very loosely (if at all) tethered to the real economy, whereas the rates, credit, and commodity markets are much more directly connected to real economic activity. Within each asset class you have some assets which are more idiosyncratic and some which respond more strongly to macro factors. Copper tends to be significantly influenced by global economic growth/inflation conditions while uranium tends to be more idiosyncratic. Corporate credit can be both idiosyncratic (i.e. individual company solvency issues) or can be systemic (wave of corporate defaults due to the inability to roll financing). Rates tend to be the most closely tied to actual economic/financial conditions of any asset class because they're the foundation of the risk-free rate/opportunity cost of capital and influenced by economic growth, inflation, central bank policy, money creation/destruction, you name it. It's Difficult Trying to Be a Jack-of-All-TradesI tend to stay away from the nitty-gritty details of any singular asset or asset class, aside from US Treasuries for the reasons I discussed above. It's too difficult trying to be a jack-of-all trades (i.e. trying to get a handle on copper, oil, uranium, cyclical equities, that one junk bond issuance, the AUD/JPY exchange rate, etc.) and USTs sit pretty much in the middle of the global financial system. By understanding UST rates and a few related markets really well (Eurodollar futures, repo, FX swaps, etc.) I find tends to give you a pretty good handle on what is generally going on regarding financial flows and economic conditions. You can then make inferences based on what these markets are telling you.For example, declining UST yields combined with a rising USD against EM currencies is a deflationary signal because it implies that global banks are stepping back from USD intermediation in the riskiest economies first (i.e. the supply of USD is falling while demand remains roughly constant). This will tend to lead poor economic conditions in developed economies by several months. Furthermore, it's often a negative signal for risk assets in financial markets because it often means that collateral terms are being re-negotiated (high-quality collateral is catching a bid and leveraged structures are being threatened). If you were pledging Italian bonds in May 2018, they're getting rejected and now you gotta scramble to find collateral that won't be rejected (i.e. German bunds or USTs). That cascades into dealers re-evaluating risk positions across the globe which leads to a reflexive tightening of financial conditions. As dealers tighten risk management, financial conditions become more inelastic, which makes financial conditions look more bleak, which triggers more risk management, so on and so forth. What does this look like in practice?More specifically, I pay a lot of attention to the collateral system, meaning the repo market and related activities including securities lending, collateral transformation, OTC derivatives trends, etc. This includes both domestic repo like tri-party repo/FICC cleared GCF/sponsored repo as well as the larger global uncleared bilateral repo and securities lending market. What type of and how much collateral dealers are willing to accept (and repledge) and at what haircuts basically determines the amount of leverage that can be sustained in the financial system.I try to figure out based on the activities of large banks/dealers (as well as various market indicators) if we are in a reflationary or deflationary regime. Basically, as a result of permanent changes in financial market participant behavior (primarily banks and dealers) after the GFC as well as due to Dodd-Frank/Basel III regulations, our economy hasn't really been able to recover since 08 – meaning the trend in growth of the labor market, economic growth, you name it (even more esoteric datasets like labor force dynamism, business establishment turnover, payments through the correspondent banking system) has been broken. It's still growing, but just far more slowly than before. This is far too nuanced and complex to get into here, but its not primarily due to demographics issues, global debt levels or any of the other commonly used explanations. In fact I think that tight financial conditions are driving poor economic performance and causing our demographics and debt issues. Demographics drive long-term economic potential, no question, but people don't realize how reflexive demographics are. People stop having as many kids (in developed markets where children are not a source of labor) during poor economic environments. Economists and policymakers were equally as concerned about the negative or flat rate of population growth in the 1930s because everybody stopped having kids because they were just focused on trying to survive. The fear about negative population growth in the 1930s seems quaint now. We also had a similarly stifling debt burden after WWII. What happened? We grew our way out of it. "Balance Sheet Expansion" in Order to Facilitate Economic GrowthThe problem today is that we went from having a very elastic/liberalized monetary system to one which is extremely inelastic and repressed. This in and of itself isn't necessarily a bad thing, but the problem is that the financial system we've developed since the 1950s relies on continued bank "balance sheet expansion" in order to facilitate economic growth. If you take those things away without fundamentally restructuring the system, you're just left with a neutered banking system which drags on economic performance. The analogy would be something like: 1950s-2007 financial system was like a Ferrari that ran on high-octane fuel. Fast, efficient, but ultimately unstable. Post-crisis behavioral changes and regulations have taken away the high-octane fuel and replaced it with low-grade fuel because it's safer, but now we're just trying to drive a Ferrari with shit fuel and no one is willing to try to switch out the Ferrari because it's too much work, so we're stuck trying (unsuccessfully) to switch to a low-risk financial system without fundamentally restructuring and reshaping the framework of the monetary system itself to deal with the problem of overreliance on central intermediaries (GSIBs, Primary Dealers, etc.). The Fed's trying some stuff now on the margin – standing repo facility, possibility of UST central clearing, etc. – that is attempting to regain control over the system and disintermediate primary dealers, but I'm not terribly optimistic. I think the whole system probably needs to be redesigned from the ground up.The "Secular Stagnation" TheoryThis is the cause of the "secular stagnation" theory that was popularized by Larry Summers in 2014. It's not a coincidence that Japan has had zero growth since their banking crisis in 1989, Europe has been screwed since 07-08, but especially since the European sovereign debt crisis in 2011-12, China has been falling off growth trend since 2015 (CCP is struggling to hit their 6% GDP growth target even with massive state-driven fixed asset investment) when the EM US dollar shortage hit, and the US economy has struggled in fits and starts since 07-08. A functioning money and banking system is absolutely essential for economic growth. A broken monetary system plunges economies into depressions, just like in the 1930s. The only difference is that this one is a "silent depression" because we don't have 25% unemployment – it just shows up in statistics like labor force participation instead.Understanding the Banking System - The Hierarchy of MoneyI borrow and extend a concept from Perry Mehrling and Zoltan Pozsar called "The Hierarchy of Money" to understand how all these different payment systems link up. Basically, reserve balances are liabilities of the Fed and money for banks. Bank deposits are liabilities of banks and money for individuals and businesses. Physical currency is the only final settlement mechanism that can be held by anybody (banks/businesses/individuals). If you buy something using bank deposits, reserves will be transferred via Fedwire/CHIPS to the person's bank that you bought the goods/services from. Banks facilitate the net payments of everything in the real economy and financial system. Now, there's basically no distinction between deposits and physical currency – but it is very important to understand that bank deposits are only an intermediate settlement mechanism, not a final one. This is why bank reserves matter. The Great Depression can be summarized as banks having issues in the intermediate layer of the money hierarchy (deposits were not easily convertible to physical currency).However, financial market participants (banks, dealers, MMFs, HFs, asset managers, FX reserve managers, sovereign wealth funds, other supranational entities) have large cash portfolios which they tend to not like to hold in bank deposits, because insurance limits only cover so much (in the US the FDIC covers $250k, for other countries its similar). So, for the financial system, collateral (generally high-quality collateral i.e. highly rated sovereign bonds like USTs, UK gilts, German bunds, JGBS, etc.) takes on a role analogous to bank reserves. Agency-MBS are also generally considered high-quality as they have the explicit backing of the US government, but are not as liquid or reliable as USTs. During reflationary periods when dealers are feeling bold, other types of collateral becomes acceptable (albeit a higher haircut) including IG corporates, HY corp, private-label ABS, etc. The Importance of CollateralSince the GFC, basically nobody is willing to lend unsecured anymore (just look at the actual transactions that comprise LIBOR or the LIBOR-OIS spread since Lehman). If you don't lend unsecured, that means you're lending secured and collateral is paramount.Repo facilitates credit creation in the financial system and is a derivative claim on collateral analogous to how deposits are a derivative claim on the monetary base (i.e. bank reserves and physical currency). The conversion of repo collateral into further money/credit creation in the financial system (through repledging) is constantly in flux depending on the perceived quality and liquidity characteristics of the underlying collateral and general market conditions, giving rise to a "collateral multiplier" which is analogous to the deposit multiplier. Just like in the Great Depression where there were issues with conversion of the convertibility of deposits into the monetary base due to a lack of effective government backstop, today there are intermittent issues with the conversion of repo liabilities into the collateral base.The fluctuations in the expansion/contraction of this collateral system drive reflationary/deflationary conditions in the broader financial system and global economy by facilitating or hindering the extension of credit by changing funding availability to financial intermediates throughout the globe. If funding is more expensive or less plentiful to financial intermediaries (banks, dealers), this trickles down to all other entities in the economy, because all other entities (businesses, hedge funds, individuals, etc.) depend on financial intermediaries for the extension of credit.Just Because Credit is Cheap Doesn't Mean That It's Widely AvailableIn this respect, low interest rates can actually be indicative of monetary tightness in the real economy (Milton Friedman's interest rate fallacy) because everyone conflates the price of credit with the volume of credit. Just because credit is cheap doesn't mean that it's widely available – banks may only be lending to low-risk counterparties and prioritizing liquidity above everything else.That's a super quick, very high-level overview of how I generally think about markets. There's far more than I could ever fit into a post here, but I tried to hit on the main points as concisely as I could. If anyone has further questions, I can try to clarify. Here are some resources that I have found extremely helpful in formulating my views:Zoltan Pozsar "How the Financial System Works: A Map of Money Flows in the Global Financial Ecosystem" 2014.If you only read one thing, this should be it. It's a powerpoint appendix to a paper he wrote for the US Treasury Office of Financial Research called "Shadow Banking: The Money View" (which is also worth reading in its own right), but this is the most comprehensive walkthrough of how the financial system works that I've seen ever seen. You might have to go through this 10 times before it finally starts to make sense, but if you can start to understand this, you're 50% of the way there. He also came out with a more updated version when he moved to Credit Suisse called "Money Markets after QE and Basel III" but that one is more specific to STIR (I definitely recommend going through if you're interested).Since moving to Credit Suisse, Zoltan has done a long series called "Global Money Notes" (I think there's 31 issues in total) and a shorter series called "Global Money Dispatches." I highly recommend both, but they're a bit more advanced, so make sure you have some of the basics down first.Manmohan Singh, Collateral Markets and Financial Plumbing 3rd edition. This is a book that's a compilation by various papers from Manmohan Singh, who's one of the experts on global collateral markets. It's a bit dry, technical, and long, but I have yet to see another academic or market participant with such a deep understanding of the nature of collateral use in financial markets. If you're too cheap to buy the book you can get many of his individual papers online for free from the IMF:"The (sizable) Role of Rehypothecation in the Shadow Banking System" 2010"Velocity of Pledged Collateral" 2011"Money and Collateral" 2012"The (other) Deleveraging" 2012"The Economics of Collateral Chains" 2012"The Changing Collateral Space" 2013"Pledged Collateral Market's Role in Transmission to Short-Term Market Rates" 2019Joeseph Wang Central Banking 101This is a new book that just recently came out written by a former trader on the FRBNY's open markets desk. I don't agree with everything that he says regarding the all-pervasive strength of the Fed (central bankers gonna central bank), but he's able to distill a lot of very complicated topics into simple and understandable language in a way that I haven't seen elsewhere. Probably one of the easiest reads on this list but doesn't sacrifice any rigor or accuracy.James Sweeney at Credit Suisse did a series on shadow banking/collateral from 2009-2013.You can get these for free:"Long Shadows: Collateral Money, Asset Bubbles, and Inflation" 2009"Long Shadows: The Sequel""When Collateral is King" 2012"Liquidity Required: Reshaping the Financial System" 2013Sweeney's papers are great – Zoltan now works on this guy's team.Most of the stuff written by Hyun Song Shin and Claudio Borio at the BIS is fantastic. Some of my favorites include: "FX Swaps and forwards: Missing global debt?" "The dollar, bank leverage, and real economic activity""The dollar exchange rate as a global risk factor""The failure of covered interest parity: fx hedging demand and costly balance sheets"In terms of a high-level overview, it's a bit outdated, but you can't do better than Stigum's Money Market. It's a 1,000-page epic that covers basically all of the important players and instruments in the money markets and much more. Essential for understanding the "behavioral" element of finance since it extensively uses interviews with practitioners (kind of like the Market Wizards series but exclusively focused on money markets). I've read all versions because I focus very heavily on economic/financial history so I like to see how the monetary/banking system has evolved, but the most recent one was published in 2007. If anyone is interested in economic or financial history, my personal favorite book is Financial Innovation and the Money Supply by T.M. Podolski. It was published in 1986 and is out of print now, but it perfectly captures the significance of the financial innovations happening in during the 1950s-1980s. Another great paper on economic/financial history is "The Eurodollar Revolution in Financial Technology. Deregulation, Innovation, and Structural Change in Western Banking in the 1960s-70s" by Stefano Battilossi at the University of Madrid.  Those are all the great sources I can think of for now, and it should be a good 6 months to work through all of this.

Comments (62)

San-Chan, what's your opinion? Comment below:

Ur the best, gonna look through all the authors, books and articles

powerforward1, what's your opinion? Comment below:
  1. How much do you look at bank stocks/earnings/balance sheets? with GSIB/HQLA/SLR, what's the line between rates analyst and bank analyst?
  2. Since this is your first year in the industry and rates/macro suffered a lot before having a renaissance during COVID, how do you think macro has changed?
  3. How much do you pay attention to vaccines/mobility/lockdowns/COVID stuff?
  4. What about geopolitics?
  • 1
Most Helpful
MacroJunkie, what's your opinion? Comment below:
  1. Bank balance sheets, GSIB/LCR/SLR

I actually pay a decent amount of attention to bank annual filings (both US and foreign) and even occasionally listen to/read earnings calls/ transcripts to get some color on how management is thinking. Obviously with management you have to take what they're saying with a grain of salt b/c most of these guys are pretty far removed from making actual market decisions, but sometimes it can be helpful.

I don't know many FIG/bank analysts so this may be off-base, but I'd imagine what I look at is very different. I don't look at earnings, cash flow, how the SLR and their CET1 capital affects their ability to do buybacks - just balance sheet, some footnotes, and their regulatory stuff (LCR calculations, etc.). I also don't really care about how any single bank's investment portfolio is changing over time or their net interest margin - I'm just trying to see if I can pick up general trends among the whole sector. A lot of the data is pretty aggregated in official filings so the information I can get from there is limited - but sometimes there's just enough to get a feel for when risk perceptions might be changing on the margin.

  1. How has macro changed

Like you mentioned, I'm fairly new in the industry so I'm not sure how qualified I am to answer this, but our LPs/potential investors have definitely been very interested in a more flexible macro "quantamental" approach given all the craziness the past year. We're on the smaller side so I don't know if this applies to the broader swath of allocators, but I'd imagine 12-18 months of COVID lockdowns, mass protests, election problems, geopolitical conflict, etc. might make some people rethink their allocations.

For as long as equities continue to go up 10-15% per year and the PE ponzi bubble keeps going, this might not seem like a big deal, but with negative real rates I think a lot of people are going to seriously start to question their portfolio construction for the next decade.

  1. Vaccines, covid

I pay attention to it, but honestly a lot of it is just noise IMO. I'm more interested in looking at how different governments are reacting (Australia/New Zealand vs. Denmark) and how people in those countries are reacting to restrictions (protest vs. compliance).

  1. Geopolitics

I pay a lot of attention to geopolitics (as mentioned above) but it's difficult to explain how it informs our investments. This is really where the art of investing comes in vs. the science.

One of the things we're constantly monitoring is US/China domestic politics and international relations since this tends to have a pretty outsized effect on the rest of the world. For example, the recent crackdown on billionaires, tech companies, education sector companies, Huarong/Evergrande problems, etc. in China. A lot of these things you could have seen coming if you were paying attention.

The SEC head wanting Chinese-listed companies to provide more information is another interesting development.

There's a power struggle going on amongst the upper ranks of the CCP that has been playing out over the past few years that might start getting more heated.

We also look at regulatory attitude towards crypto-related tech, and do some game theory on future fiscal packages and Fed policy choices.

powerforward1, what's your opinion? Comment below:

good stuff

  1. TBH, I always felt European macro guys have an edge, especially trading EGB spreads against Bunds as a macro trade. Your thoughts on comparing yourself to a European Macro analyst?
  2. What are your thoughts on inflation?
    1. Lot of fiscal help during COVID and FAIT/transitory seems flimsy. (yellen's inflation model running hot). What's your view?
    2. How do you look at commodities in an inflation framework? Do you look at energy/ags/metals?
  3. Say for some reason, 10 yr goes to 50 bps. Do you think macro is essentially dead at that point?
  • 3
  • Analyst 3+ in HF - EquityHedge

This was a great read, really appreciate the content and the way you broke things down so that they were relatively easy to understand from my equity L/S perspective. I have a bunch of questions, but curious on your thoughts on Evergrande and potential knock on effects to both the Chinese and global banking systems. Is this something you think investors in the US should be more worried about?

macrotrends, what's your opinion? Comment below:

Amazing, great advice

MrBarelyComprehensible, what's your opinion? Comment below:

Extremely, extremely informing and entertaining to read, thank you

Legion42, what's your opinion? Comment below:

Do you think Gold is still a hedge against inflation? 

Do you think China Tech Regulation will continue if China expects to be the number one economy in a decade or two? 

What do you think of MMT Theory? 

Would you say Bridge Dalio is the Warren Buffet of Macro? 

MacroJunkie, what's your opinion? Comment below:

1. Gold is a hedge against inflation, but it's not the only one and possibly not even the best one depending on the circumstances. In some inflationary regimes equities or other real assets have outperformed gold. That being said, I think if you're expecting inflation, a moderate gold position is never a bad idea.

2. China is a whole other can of worms that's too complicated to cover in any reasonable period of time, but I'm going to try. 

More than anything the CCP needs control over its economy/government/tech etc. I think if they had to choose between being the #1 economy and control, they would probably choose control. This is also why I think it is extremely unlikely that we will ever see the RMB/CNY as a reserve currency. In order to have the reserve currency, you need to be comfortable with offshore lending/borrowing/financial activities (basically you deep a deep, liquid, institutional market), which I think is fundamentally against the governing philosophy of the CCP. The digital Yuan/RMB I think is driven more by desire to control the domestic economy/banking system than it is by a desire to usurp the USD.

The entire philosophy of their tech sector is also driven by this. Innovation - but only as fast as the government wants. They would prefer to sit back and watch the US experiment with tech and work out the kinks of something before they implement and integrate something into their economy. You have to understand that to a significant degree, the large Chinese tech companies basically represent "China Inc" and most of the major decisions that these people make is on behalf of or with the consent of the government. 

Right now there's a struggle between the Xi Jinping faction and the Li Keqiang faction (China's #2 and the former top Chinese leader Hu Jintao's apprentice). Xi is more or less "anti-business" and Li is more or less "pro-business," but its nowhere near as simple as that. I think Xi is really misunderstood by the Western media, but that's too complicated to go further into. Long story short, I think the government crackdowns will continue as they're just an extension of the anti-corruption purges that Xi has been doing since he rose to power.

3. I think the whole framework behind MMT is worth looking at, if nothing else than because it's another interesting mental model, but many of their core assumptions are deeply flawed. They fundamentally misunderstand the reason why the US has been able to run endless deficits (insatiable demand for pristine collateral to fill the void left by the absence of high-quality private collateral post-GFC) and assume that Congress is more competent at controlling inflation than the Fed. I don't have a terribly high opinion of many Fed officials (there are a few exceptions) but I think the Fed is marginally more competent and capable actually making decisions, unlike Congress most of the time. Also, you can't just use fiscal spending to force your way to economic prosperity, that's how you end up with a lot of waste and underproductive structures.

That being said, I listened to an interview of Stephanie Kelton one time (because I try to keep an open mind about everything) and something she said about inflation actually really made something click for me. She mentioned how inflation isn't some monolithic thing, that sometimes it can be idiosyncratic and can be significantly influenced policy/legislation. I think she's 100% right about that. We haven't had skyrocketing college tuition and medical prices because we've had lots of money printing, but because student loans have been guaranteed by the Federal govt. (it's the same problem as with mortgages pre-GFC, the banks have no incentives to use risk management if they'll be reimbursed by Uncle Sam regardless) and medical expenses have risen because of the structure of the health insurance industry and, IMO the faulty incentive structure of the Affordable Care Act. 

4. I think a lot of people would probably call Ray Dalio/Bridgewater the macro equivalent of Buffett/Berkshire Hathaway. His macro framework-type pieces "How the Economic Machine Works" and "Principles for Navigating Big Debt Crises" are ok if you're interested. If I'm not wrong, I think one of his fundamental innovations was really a "business" innovation in the sense that I think he was one of the first people to really separate alpha vs. beta for allocators (so allocators could cheaply lever their beta exposure to their liking and layer alpha exposure on top of that). His macro view is too mechanical for my liking - he literally calls it the "economic machine." I think of the economy of more of a complex-adaptive system, like a constantly evolving organic entity. But I get the point that he's trying to convey. Obviously he's far more successful than me so far, so take what I'm saying with a grain of salt.

Texas Tea, what's your opinion? Comment below:

Great post.  I wish WSO had more of stuff like this.  This took a lot time and a lot of effort, well done.

  • 1
paperkat, what's your opinion? Comment below:

Thank you for the insights -- I deeply appreciate it. 

Regarding US's ability to monetize debt via fed RRP, do you think there is a level that will erode US's funding franchise (2/10/100 trillion?). Also how would you rank the greatest threats to the US's ability to monetize debt (central bank divergence, fiscal policy, trade imbalances, total credit vs GDP etc.).

MacroJunkie, what's your opinion? Comment below:

Ok a few things:

1. The RRP isn't monetizing debt, it's actually kind of the opposite.

The RRP (reverse repurchase facility) is where authorized counterparties (overwhelmingly MMFs) lend o/n to the Fed in exchange for a UST as collateral. It is designed to set a hard floor underneath primary dealers' core borrowing rate, as the alternative for MMFs is lending to dealers through the tri-party repo platform (TPR). 

Another thing that it is designed to do is handle the overflow of excess reserves/deposits created via QE. Due to restrictions on balance sheet size from Basel III (the SLR), banks have an incentive to be extremely efficient with balance sheet space. What this means is that low-margin, low-returning activities will be dis-incentivized - especially liabilities which banks are required to fully back with HQLA (reserves, govt. bonds) due to the LCR requirement, which include non-operating deposits. Banks have an incentive to price these non-operating deposits to leave the banking system (i.e. invest in a MMF) by charging fees. These deposits then go to a MMF which invests in T-bills and RRPs with dealers, and if there is a shortage of collateral (or the Fed is offering a better rate) then with RRPs at the Fed.

I don't even think QE is really monetizing the debt, because you always have a private intermediary in between the Fed and the Treasury. All you're doing with QE is changing the composition of money and money-like assets in the financial system (less USTs, more reserves) and if a non-bank is the ultimate seller of the security to the Fed (through the primary dealers as a conduit) excess M2 is credited to the investment fund/pension fund/insurance company/whatever which is just spent on risk assets or more likely put into a MMF (due to the non-operating deposit issue mentioned above). 

2. I'm not sure what you mean by the "US's funding franchise"

I'm going to assume you're talking about the money markets/financial plumbing/overnight funding/STIR complex, but again can't be sure b/c I've never heard that term before. I think that over time the RRP has been eroding the private money markets, but this is probably a feature rather than a bug (whether it's a good feature is debatable). After the GFC, the Fed realized that the private S/T wholesale funding markets were unstable, and the private market itself had an existential crisis and nobody could really trust each other. This was only exacerbated by the Euro Sovereign Debt Crisis.

While the death blow to private money markets/repo may have been dealt by Basel III, by 2014 it was already mortally wounded and basically a dead man walking. This is around the same time when you had mass layoffs in S&T (partially in response to legislation, but also partially in response to the recognition of reduced profitability going forward regardless of regulation as the 2009-2014 period demonstrated).

I think the Fed is moving towards a system that is almost entirely controlled by them, by pushing SOFR, capping repo at the top with the SRF and at the bottom with the RRP. This is also why they're leaning towards central clearing of USTs. They're trying to install new plumbing which is basically under the complete control of the central bank (as opposed to the system we have today which is 50/50). We'll see how successful they are.

3. In terms of the limits of QE.. I mean the BOJ has been doing this for two decades, owns almost the entire JGB market (some days there are literally 0 private trades) and they still seem to be doing OK. I don't think that will ever happen in the UST market for a variety of reasons (USTs are far more important globally than JGBs, market is deeper and more liquid, etc.) but in reality I don't think there is a hard limit. 

Something important to understand is that the entire global circulatory system of leverage is built on the fact that for every UST on the planet there are between 6-8 legal owners with equal standing in a court of law and only 1 with physical possession. Due to the reality of collateral chains/velocity/repledging/reuse/rehypothecation (pick your verb), the financial system would arguably be safer and less interconnected if the Fed stopping buying. They continue to do it for signaling purposes, because they operate from a framework of bank-reserve supremacy, and probably to remove a bit of duration from the market.

Unless an alternative settlement mechanism/currency actually becomes feasible on a global level (not an easy task to replace hundreds of trillions USD worth of depth and flexibility) then I think there is basically no practical limit on how much the treasury can issue and/or the Fed can monetize. Obviously if you want to take it to absurdity there are always limits, but with realistic assumptions, I think it's highly unlikely.

This is not a balance of payments issue (trade imbalance, capital account, current account, etc.). BoP only captures ON-balance sheet activities and completely ignores OFF-balance sheet activity. Most of the really important stuff (FX swaps, collateral flows, etc.) never shows up on a balance sheet anywhere except as netted amount or gross market value (for FX swaps, there's nothing notional about their "notional value"). There's people who have been screaming about the US's twin deficits for years but yet UST yields continue to grind lower.

lifeisparty, what's your opinion? Comment below:

This is simply an awesome post! I have went through almost all of your posts and they are very informative and also insightful. Thanks for such contributions.

MacroJunkie, what's your opinion? Comment below:

Take this with a grain of salt as it may be specific to my position (perhaps it's different for more "economist-y" type roles).

Very little/none. I took the standard sort of econ classes in undergrad and have a decent mathematical background (Calc I-III, Linear Algebra, Probability Theory/Statistics, Money/Banking, Econometrics, etc.) but I would honestly say that, for my job at least, further education in orthodox economics tends to be more of a hindrance than a benefit. I've had to unlearn many things that I learned in school and I see others that are unable to do that - it tends to put a set of blinders on your thinking and really limits your ability to understand new ideas.

The only thing that it helps (a little bit) with is when I'm reading academic or staff papers and I can sometimes try to understand their models, but honestly that part is pretty unimportant IMO. Most of what I use to make decisions is based on "economic intuition" that is often diametrically opposed to orthodox academic economics. That's where all the interesting stuff is (i.e. deviations from covered interest parity). 

What turned out to be the most helpful economics class I took was an economic history elective. That taught me how to apply basic economic thinking/intuition to real life situations where reality is often much messier/different than what standard models predict.

debitrist, what's your opinion? Comment below:

Thanks for the great thread, would be curious to get your thoughts on a few questions:

1. what would it take for the US dollar to lose it's reserve currency status? i.e increasing geo-political tension leading to reduced international trade/emergence of regional trading blocs

2. Is the below trend growth in the US structural and likely to persist ('demographics is destiny'), or is there a good chance that growth actually accelerates coming out of COVID due to increased adoption of technologies, driving a 'Roaring 20s/golden age' scenario where we catch up to the historical trend line growth? How would you prove out these hypotheses or track these? 

3. What is your take on 'secular disinflation' driven by technology and globalization?

4.On a related note, do you have an intuitive framework for understanding inflation vs real growth, and whether it is actually good/bad? It seems that the main benefit of modest inflation is psychological (i.e creates reflexivity in the economy of the illusion that the pie is growing), but are there other mechanisms in which inflation is good for the economy? On the flip side, when is inflation structurally bad? Weimar-esque printing?

5. What do you think of the research done by "Jesse Livemore" (most recently wrote 'Upside Down Markets")

6. Do you have a direct view/structural thesis on equities and the sustainability of performance given we are at all time highs today (i.e passive flow, real rates = multiples structurally higher for good reason)

7. What do you think are the pros/cons of your approach to macro (i.e focusing on financial plumbing). I get that intermediary buyer/seller activity is a large chunk of market activity (do you know what % is this roughly?), but arent prices moved by the i) marginal buyer/seller ii) real world fundamental trends?


  • 3
MacroJunkie, what's your opinion? Comment below:

Great questions

1. what would it take for the US dollar to lose it's reserve currency status? i.e increasing geo-political tension leading to reduced international trade/emergence of regional trading blocs

I made another post about this in the other thread, but I'll reiterate and try and go into more detail.

I think it's extremely unlikely/borderline impossible for the USD to lose its reserve currency status to another national currency today (or supranational like SDRs). The monetary system that will replace the international Eurodollar banking system will not come from the RMB, EUR, JPY, GBP, SDRs, etc. If anything, I think it will almost certainly from the crypto/defi world, but that's probably at least 5-10 years+ down the line. It also depends on how governments react and how controlling/oppressive the global population allows them to be.

People have a very poor understanding of what a global reserve currency actually is. It doesn't just mean that oil or gold is denominated in dollars. It's also not just about the volume of dollar invoiced trade (although that's a part of it, which has actually increased ~2% since COVID and is now around 81% of global trade). Primarily, the global reserve currency is about financial architecture/infrastructure, the global banking system, and cross-border financial flows. There's hundreds of trillions of dollars of financial contracts, securities, and claims/liabilities denominated in dollars. It's not just about what currency is used within each country, but what currency is used between each one. There's nothing else that's even close to the USD in volume, liquidity (high-quality pristine collateral i.e. US Treasuries issuance), depth, infrastructure (SWIFT, the correspondent banking network, the Fed's FX swap lines, Fedwire/CHIPS, etc.)

FX forwards/swaps are the marginal source of growth in FX flows which account for 60-70% of all FX turnover (~$4.3T daily). There's about $90T outstanding right now (vs. ~$30T in cross-border bank claims). The USD has a 90% share in FX swaps/forwards in total, and a 96% share in interdealer FX swaps/forwards. What this means in practice is that any time any person wants to convert any currency to another (even within the Euro basket, say EUR à SEK), you have to use the USD in between.

I once heard someone mistakenly refer to switching out the USD being "easy" because it's just a unit of account, like switching from inches to centimeters. Nothing could be further from the truth. You need deep institutional liquidity and backing in order to perform the complex international banking functions required of a globalized economy. It's more like switching from gasoline-based vehicles to hydrogen-based vehicles and having to rebuild all of the gas stations in the whole world – it's just not realistic. There's a reason that EM governments and corporates choose to borrow in dollars and issue dollar denominated bonds, even if they don't ultimately need dollars – it's because no other currency has the liquidity or depth in international/offshore securities issuance, so it's easier to issue in dollars and swap into the local currency.

The Eurodollar banking system (a longer more complicated topic for another day) evolved to solve a problem known as "Triffins Paradox." Basically, there's an inherent tension between the needs/demands of a national currency and a global reserve currency. The optimal amount of liquidity for a national currency is obviously less than that for a global reserve currency, so it was thought that either offshore dollar liquidity would be too tight (i.e. deflationary) or that onshore dollar liquidity would be too loose (i.e. inflationary). We solved that problem because of the way that the global monetary/banking system has evolved since 1950, and that system has evolved to use almost exclusively USD. If anything, the events of the last 1-2 years have served to reinforce its dominance now that the Fed has provided a solid backstop behind the global dollar system.

Even geo-political tension likely wouldn't reduce the dominance of the dollar. China's been trying to get off the dollar for more than a decade now, but only 20% of their gross trade flows are denominated in RMB. The digital RMB isn't trying to usurp the dollar, it's a means of controlling their population better (IMO). Everybody needs the dollar because you basically can't engage in international trade or (much more importantly) financial/capital market functions without it, because nothing else has the depth or liquidity.

2. Is the below trend growth in the US structural and likely to persist ('demographics is destiny'), or is there a good chance that growth actually accelerates coming out of COVID due to increased adoption of technologies, driving a 'Roaring 20s/golden age' scenario where we catch up to the historical trend line growth? How would you prove out these hypotheses or track these? 

I strongly dislike the demographics, R*, etc. type explanations for poor growth. Explain to me how demographics trends suddenly flipped in 2008 so drastically that they broke a 100-year growth trend? They didn't, it's preposterous. We've gone through demographics cycles before, this isn't demographics. People just default to it because demographics is a large, somewhat nebulous but still tangible and understandable phenomenon that they can use to explain things they don't understand (e.g. inflation and economic growth).

Below trend growth is due to the fact that the monetary/banking system snapped in 2008 and will never recover. It was based on unstainable and unrealistic assumptions that facilitated rapid economic growth due to its efficiency, but was ultimately built on a house of cards and now it's impossible to go back once the system had begun to doubt itself.  That's because wholesale funding/bank liquidity was dependent on exponential growth in interbank/shadow bank loans/lending/credit extension, which were assumed to be stable, but never were in reality (just look at how haircuts on ABS collateral never recovered). This isn't just a problem confined to 2000-2007, or 1990-2007. It had been building since the 1950s with the development of the first wholesale interbank funding markets (Fed Funds, negotiable CDs, repo, Eurodollars, commercial paper, etc.).

In order to return to growth trend, we need a new monetary and banking system. The economy requires growth in money and money-like claims in order to grow (i.e. banking system elasticity). As I mentioned in the previous question, I personally think this will most likely come out of the crypto/defi space.

The problem is that despite the mainstream media narrative re: "so much money printing," monetary conditions in the real economy (i.e. anyone who isn't a Fortune 500 company) are pretty tight. Large banks have almost completely jettisoned their small- and medium-size lending businesses. Same thing happened during the Great Depression – look up MacMillan Committee. Banks had ample liquidity, but no one wanted to lend. It required the emergence of a new monetary/banking system after the Fed-Treasury accord and the development of the private FF market in the 1950s and 60s to overcome that fear and risk-aversion to generate economic growth.

To prove this out – I'll be keeping a look out on the trends in defi. Defi extremely elegantly solves many of these problems. Granted, we still need to wait and see what regulation is going to do to this space and what the government's intentions are. Regulations might squash the sector if world government's continue their authoritarian turn, or they might provide a stable platform from which these technologies can continue to grow and develop.

3. What is your take on 'secular disinflation' driven by technology and globalization?

I mentioned in another comment above a brief sketch on my high-level views of inflation (monetary driven vs. non-monetary driven). Technology and globalization have facilitate deflation in certain segments of the economy just like poorly designed government policies have facilitated inflation in certain segments (e.g. the Affordable Care Act and structure of the health insurance industry causing inflation in healthcare costs, federal guaranteed student loans causing inflation in tuition prices, etc.).

These can affect certain segments of the economy, and if they are large enough have an impact on the overall CPI/PCE index, but are ultimately more contained than inflation due to monetary factors (i.e. expansion in bank balance sheet capacity) which is very widespread.

4.On a related note, do you have an intuitive framework for understanding inflation vs real growth, and whether it is actually good/bad? It seems that the main benefit of modest inflation is psychological (i.e creates reflexivity in the economy of the illusion that the pie is growing), but are there other mechanisms in which inflation is good for the economy? On the flip side, when is inflation structurally bad? Weimar-esque printing?

Moderate inflation is necessary because the economy requires growth in money-like chains of liabilities in order to grow. The best way to understand this is to literally sit down with a piece of paper and write out balance sheets of a simplified model of an economy over time. How difficult would it be to invest/grow if there was no extension of credit? Dalio has a decent framework to understand this process, and while I have minor disagreements about some of his thinking, I think he's broadly correct about the nature of credit.

Credit (when operating optimally) basically allows the economy to operate closer to its efficient frontier because it removes frictions in the medium of exchange. Obviously, there are problems when the growth of money-like claims exceeds the growth in the production of useful goods and services or when capital/financial flows become redirected because they reflexively and artificially distort returns to capital (think about how lending can create and asset bubble which incentivizes further lending which increases the rate of return on that asset).

Weimar is another problem. While they did print excessive amounts of money, their inflation was primarily due to currency/capital flow problems rather than actual money printing.

5. What do you think of the research done by "Jesse Livemore" (most recently wrote 'Upside Down Markets")

I've actually been a huge fan of his ever since I heard him on Patrick O'Shaughnessy's podcast a couple years ago. I haven't taken a detailed look at this piece yet, but I'll check it out and get back to you.

From skimming it real quick, I would tend to agree with the sentiment of "bad news is good news" for equities in particular right now. That's probably been driven the structural weakness of the economy and the willingness of legislators to pass unprecented fiscal stimulus.  However, some markets aren't as susceptible to psychological nudging (i.e. FX) I think we'll start to see some real stresses emerging particularly in EM currencies vs. USD (CNH is probably a huge short right now).

6. Do you have a direct view/structural thesis on equities and the sustainability of performance given we are at all time highs today (i.e passive flow, real rates = multiples structurally higher for good reason)

I used to think that I understood equities, but if I'm being honest, I don't think I do anymore (at least not at a macro level). The only things that I can point to as driving equity valuations today are passive ETF flows and low rates (as you mentioned) and dealer gamma exposure/delta hedging keeping valuations pinned (although I'm not an equity options/vol expert so don't quote me on this).

From a high-level, allocators that are forced to put money to work to meet return mandates are going to have to invest in something, and for those types of people USTs and many other fixed income assets have essentially become un-investable – just speaking purely from an investment return/asset allocation standpoint (collateral requirements are a different matter). Unrealistic return expectations have forced institutional investors to speculate in equities for a long time now in order to pretend like these obligations can still feasibly be satisfied. From that perspective at least, I can sort of understand why equities are so highly valued, even if I don't "fundamentally" agree with it.

Personally, I think equities are generally overvalued as an asset class, but I've come to the conclusion that flows matter more than fundamentals (at least for the asset class as a whole, relative performance among companies/sectors is still at least partially performance driven) and just because they're overvalued doesn't mean they can't become more so unless there's a fundamental reason why they should not.

I'm not really confident enough to have a strong view either way. Perhaps those who are smarter/better informed/more experienced than me can chime in on this.

7. What do you think are the pros/cons of your approach to macro (i.e focusing on financial plumbing). I get that intermediary buyer/seller activity is a large chunk of market activity (do you know what % is this roughly?), but arent prices moved by the i) marginal buyer/seller ii) real world fundamental trends?

So, my approach to macro focuses on the monetary and banking system, of which a portion is the "financial plumbing."

That's kind of a nebulous concept ("financial plumbing"), but typically refers to things like short-term interest rates (STIRs) i.e. GC repo, EFF, CDs, CP, T-bills, FX fwds/swaps, etc. as well as the collateral system more broadly (repo haircuts, volume of pledged collateral, length of collateral chains, changes in OTC derivatives IM/VM requirements, etc.). These obviously feed out into to the broader rates complex and FX markets – basically the interest rate hierarchy and supply/demand for funding in a given currency at a moment in time. That's the market facing portion.

However, the other part of the monetary and banking system that I focus on is the banking system – primarily focusing on the large GSIBs, but also paying attention to what larger regional banks and even small/community banks are doing. This includes changes in use and types of wholesale funding, credit extension via bonds vs. loans, how Basel III and Dodd-Frank constrain banks' ability to operate, etc. The behavior of large banks has implications which reach beyond the borders of the US, as many non-US banks make dollar loans/investments in foreign countries.

The reason I focus on these two things in particular (and how they interact) is because the price and availability of credit/leverage from dealers and banks basically drives all other financial and economic activity. If loans are cheap and widely available (and being used for business investment as opposed to asset purchases i.e. mortgage lending) the economy will tend to grow and experience relatively low inflation. If dealers are willing to aggressively engage in more collateral transformation at lower haircuts against a wider range of collateral, then we will tend to see reflationary trends in the financial system. When repo haircuts are low and/or PB terms are generous, investors can lever up more easily. If any of these things do not happen, or go into reverse, we will tend to see deflationary pressures emerge and economic growth will be constrained.

This is an extremely simplified version of the format (and depends on the specific circumstances), but basically:

Reflation (or "risk-on") = USD down, equities up, yields up, commodities up, credit volume up, growth up

Deflation (or "risk-off") = USD up, equities down, yields down, commodities down, credit volume down, growth down

In practice, equities will be equities (per above question), and the behavior of any specific commodity or class of commodities (i.e. ag vs. oil vs. industrial materials vs. precious metals) can behave idiosyncratically. You might see a jump/compression in corporate credit spreads, but that can also be idiosyncratic.

This framework allows me to try to get a sense of how much buying power the marginal buyer has, how motivated the marginal seller is to sell, and structural trends in real economy growth.

The disadvantages of this framework are that sometimes data isn't available for certain things (e.g. securities lending data, haircuts on uncleared bilateral repo, etc.) and you have to try and be creative with sources and using market prices for information. Furthermore, it also operates on a pretty high level, which gives me a decent grasp on understanding rates and FX (and more macro-sensitive commodities), but not necessarily the structural drivers of something more specific like equities or corporate credit (unless these are influenced by something systemic i.e. March 2020, Oct - Dec 2018, Junk bond issues 2015-16, Euro debt crisis 2011-12, etc.).

One of the hardest parts of my job is mapping and understanding the precise interactions between the financial system and real economy - so that's obviously very difficult to understand just because there are so many connections and the relationships between these things are so reflexive. However, I think that it's very important to try and make an effort at understanding (perhaps because it is difficult).

There's a lot of abstract thinking/analogical reasoning that I do as well. I might recognize that something is going to happen because 26 different data points just subconsciously fit together in my head based on research I've done before, real-life experience/conversations with other investors, understanding of history, or something entirely unrelated, but you have to be very careful and check that intuition against as much hard data as you can possibly find (which is often difficult impossible to find).

debitrist, what's your opinion? Comment below:

Thanks for the really detailed and insightful responses!

"In order to return to growth trend, we need a new monetary and banking system. The economy requires growth in money and money-like claims in order to grow (i.e. banking system elasticity). As I mentioned in the previous question, I personally think this will most likely come out of the crypto/defi space."

This quote carries a few interesting implications and I had a few reactions to it (apologies if overly basic!)

If the 'growth trend' from the period between [1970s-2000s] had been in line with the pre 1970s, in spite of increasing financialization/leverage during 1970s-2000s, wouldn't that imply that the real growth trend had already had been de-accelerating thru the 1970s-2000s period? Thus post-GFC anemic growth is a true reflection of the stagnation in growth in the real economy? 

Is DeFi a true successor to the current monetary system? Wouldn't this just be 'secondary' or intermediated flows of capital, as opposed to true 'primary' money creation?

What are the other alternatives to the current paradigm? What do you think about the rise of private non-bank lenders, or debt capital markets? Are these adequate replacements, or just extensions of the current paradigm?

On your first response re the US as a reserve currency you made really great points. I was trying to get to a more hypothetical  'What do you need to believe' scenario for the US dollar to be displaced as a reserve currency.

Ray Dalio suggests that per historical precedents, the 'base rate' for the replacement of a reserve currency is about a 100-year cycle that coincides with the rise and fall of relative geo-political power. Is there anything particular about how the modern monetary system works today: i.e much more interconnected and globalized which makes the US dollar structurally much stickier and harder to dislodge vs preceding reserve currencies? From your point DeFi being an elegant replacement to the modern monetary system - could this weaken the US dollar's position as the world's reserve currency?


  • 2
MacroJunkie, what's your opinion? Comment below:

Short answer: I don't know

Longer answer: I don't like to make specific predictions, but it's not looking good. The reflation trade stalled out in March and started really going backwards in June, plus economic data coming in just recently (Atlanta Fed GDP nowcast, Goldman GDP forecasts, global PMIs, G7/China credit impulse, etc.) are all looking bad. It looks like we're going through an accelerated version of the 3–4-year reflation/deflation sub-cycle that we had the last 15 years (i.e. short mini-cycles instead of longer cycles with an actual recovery).

Notice we haven't actually had a real recession (aside from COVID obviously) since the GFC, but that's not necessarily a good thing. Since the monetary/banking system is more inelastic, we haven't been able to have a real recovery/growth cycle. We grow for a couple years, then stall out, stop, and have a recession scare. In 2011-12 it was the Euro sovereign debt crisis, Euro double dip recession, and near-US double dip recession. In 2014-16 it was oil, commodities, China slowing. In 2018-19 it was trade war issues and near industrial recession (again). I don't believe for a second that these are all idiosyncratic – they may have been the final trigger, but it's definitely a weak/broken monetary system that is the structural cause of this fragility.

So, we've had 3-4 mini-recessions (or recession scares) since the GFC, but nothing big or serious except COVID, so we haven't gone through a debt-default cycle.

I made a string of comments on another thread about my analysis of the COVID crisis (real economy and financial system) that you can read here: Macro Folks: Why didn't COVID cause a 94/02/08 Style Crisis? | Wall Street Oasis

If you're asking me when we're going to have a real credit event/debt-default cycle, I honestly don't have a clue. These things are behavioral, and sentiment can change very quickly. The stuff going on in China right now might be a trigger, but there have been many things over the past decade and a half that I also thought "should" have triggered a real credit event, but never did. I suspect that when the sugar high wears off from the reopening (it already is IMO) and extreme fiscal policies run off, people begin to reprice the possibility of MMT (not feasible IMO, Manchin seems like he's not going to approve another massive spending package w/o ability to pay for it), then things will get ugly again.

The labor market seems to have suffered another structural blow to its integrity and LF participation hasn't recovered in a year. That's on top of a labor force that never recovered after the GFC anyways. We're kind of stuck in this hellish purgatory in between recession and growth, where we keep almost getting "real growth" (2017-18), but not quite and we keep almost getting a debt-default cycle, but not quite (or Fed/congress steps in to prevent that). Economic gravity can't be defied forever, but I don't feel comfortable predicting when it will re-assert itself.

Deleveraged Sellout, what's your opinion? Comment below:

This is one of the best threads I've read here and I've been reading WSO since 2012. You mentioned DeFi elegantly solving some issues around the availability of credit. Could you expand on that? Do you have any examples?

MacroJunkie, what's your opinion? Comment below:

Thanks - I've been a lurker here for a long time as well and some of the older threads by macro bruin, bondarb, etc. inspired me and I've gotten a lot of other useful information here along the ways. I thought I'd try and pay some of it back and figured I might meet some interesting people to talk to as well. Always looking for interested people to discuss with who can call me out on my bullshit, but happy to help others to the extent that I have knowledge they might find valuable.

Regarding DeFi, I don't feel 100% comfortable discussing that yet because it's a very tentative judgement and I still have a lot more research to do, but I'll give it a shot. If anyone is more familiar with blockchain technology/DeFi, please chime in and correct me if I'm mistaken because there's a good chance that I will be misrepresenting something.

As I've alluded to in this post, some of the biggest problems with our monetary system revolve around the fact that we are overly reliant on central intermediaries to perform some of the most essential functions required to keep a global economy actually operational. This is a much longer historical discussion, but basically informal interbank networks form the backbone of our actual monetary system. When there is profit to be made, they are more than happy to perform the necessary financial intermediation (lending, trading, hedging, providing balance sheet capacity, etc.) to run the economy and financial system.

Now, there is no longer profit to be made, because the entire thing was like spinning top (the illusion of stability as long as it was growing, but highly unstable otherwise). I'm not just talking 2002-2007 or 1990-2007, I mean the whole post-WWII development of the monetary system from 1955-2007.

Now we have low risk-adjusted returns. In other words, the profit is mediocre, but the risks are enormous, just ask Lehman or Bear. Do you want to use a bit more S/T wholesale funding to take advantage of a few bps of profit on arbitraging spreads and lending to businesses or just hoard liquidity and stay solvent?

Here's one of my favorite quotes from Fed transcripts (which I spend maybe too much time reading through) from March 18, 2008, right after Bear Stearns was "merged":

"The fact that to the extent that there is stigma [about the PDCF], they are not going to want to come, and that is going to reinforce the deleveraging process that is clearly under way, as is the fact that they just saw Bear Stearns go from a troubled but viable firm to a nonviable firm in three days. The lesson from that for a lot of firms is going to be, oh, I need more liquidity, I need to be less leveraged, and that lesson, from what happened to Bear Stearns, isn't going to go away."

So now, the financial system and therefore the economy don't operate very well. Those layoffs in FICC at banks from 2014 onwards, those are the people who actually operated the monetary system and they're gone now. We're left with this dead husk, this shell of a monetary system that cannot or will not perform as necessary for the economy to grow.

DeFi changes this by removing the need for a central intermediary by allowing borrowers and lenders to connect directly and using software and smart contracts in place of the role that trusted central intermediaries used to play. Now obviously there's huge fucking problems right now – the place is the wild west. But the potential is there.

Basically, DeFi just goes around the problem (banks and large primary dealers) to directly connect those who need capital with those who are willing and able to provide capital. The basic problem is that centralization is not just an issue from an individual rights/ownership perspective (e.g. wanting to "own" your own data/assets instead of a custodian) but it's also inefficient because that intermediary needs to provision balance sheet for transactions to occur. If you outsource that need for balance sheet capacity to the whole world instead of just relying on large dealers and banks, you can unlock a lot of wasted productivity potential IMO.

Think about how much potential GDP is and has been wasted because entrepreneurs with good ideas didn't get funded? Or all the people who never tried to invent something because they weren't sure if they could get funded? Even if many of these people try and fail, over the long run it's far better for the economy if people are willing to take actual risks and innovate rather than just relying on these centralized institutions (who don't have perfect foresight, are risk-averse and operating under sub-optimal conditions having to perform relative to investment mandates, LP demands, etc.) to decide who does and doesn't deserve to get funded.

GDP Potential

You can already see this around the edges of the traditional financial system: fintech doing direct lending because banks are unable/unwilling to, direct listing for IPOs, etc. However, I don't think that you can successfully make this transition within the architecture of the traditional financial system just because of all the problems that exist (that I've detailed in this thread). You need a complete revamp to just side-step these institutions altogether. If you want to get really deep, you can take a look at DAOs (decentralized autonomous organizations).

Here's a quick video that's a decent primer on some of DeFi's applications:

They're a bit superficial on the financial system aspects, but I think the potential for DeFi is well summarized. All this stuff is still in its infancy and needs a lot more polishing (and sensible regulation that purges the scams without squashing the whole sector) before it has a legitimate shot at lasting success, but so far from what I've seen, it looks very promising.

Deleveraged Sellout, what's your opinion? Comment below:

That's great stuff and I say it as a massive crypto bear. Subscribed to your substack, love reading about pipes

Fill-or-kill, what's your opinion? Comment below:

Good stuff. I did the normal rotation through rates & fx as a kid and I always felt that experience, coupled with my interest in economics, gave me a much more nuanced perspective when looking at any other asset class. The center of the universe is the US treasury market. 

With that being said, what kinds of ideas do you generate? Are you more tactical or do you a take a longer term view?

MacroJunkie, what's your opinion? Comment below:

My PM usually gives me a starting point to work from, but it's a collaborative give-and-take relationship so if I find a rabbit hole to go down that looks like it might be interesting, then I have the freedom to do so.

In terms of ideas, it kind of breaks down into two different types of research.

One type is more conceptual – something that I recently did that might fall into this category is the prospect for inflation going forward and the status of the USD as world reserve currency. My PM just recently asked me to take a more serious look at crypto, so you could probably put that into this category as well.

These are usually pretty long (6-12 weeks of research, maybe 80–100-page deliverable) and incorporate a bit of everything: academic research, staff papers from various central banks/govt. agencies, market data/prices, fundamental economic data, even a lot of economic/financial history, etc. The deliverable is both for posterity's sake/our quant team, as well as just to force me to be more precise with my thoughts and views. Usually for these, we're trying to understand the structural drivers of important processes – so a big picture, typically long-term perspective.

Some recent specific examples (that I've written publicly about) would be:

If you're interested, you can PM me and I can share some of the other more interesting ones with you.

Oftentimes, trade ideas fall out of this, but they're not necessarily time-sensitive nor are we doing this specifically in order to generate trade ideas (we consider these, generally speaking, to be "non-proprietary" views). Also, this is the kind of research that I tend to do a lot of on my own anyways (would probably still be doing this even if I was unemployed) and enjoy writing about and debating with other people.

The second type are more tactical pieces, typically building on larger theses that I've developed earlier. Sometimes these involve a separate, shorter deliverable (maybe 10-20 page thesis write-up) if the situation is unique enough and requires more specific validation, but sometimes it's just an informal discussion between me and my PM.

One recent example of this would be a long US duration trade recommendation I had back at the end of March which came indirectly from my research on inflation (seeing that reflation seemed to be rolling over and that the move in long-end treasuries was probably overdone). That one was fairly time sensitive as I wasn't sure when rates would be repriced and there seemed to be a large dislocation from macro funds betting on the steepener trade and the SLR exemption rolling off which probably caused some excess selling of USTs.

Another example that I'm currently working on is a potential currency short which came from my research on the USD's status as a reserve currency and global FX flows. The currency short is very time sensitive as this country is currently having major dollar funding problems, has some forwards rolling off in the next few months, and using FX reserves will just paint a target on their back (and they've publicly stated they don't want to use FX reserves to defend the currency anymore). They don't have an FX swap line, but there is the new FIMA repo facility (which they could use to repo their USTs and keep it off-balance sheet as long as this is a temporary dollar liquidity problem) and this country has a lot of USTs they could use, but I still think it's going to be ugly. Probably sooner rather than later.

Time horizon on trade ideas varies depending on asset class and situation. I've done some equity-sector specific stuff that looks more like fundamental growth investing than anything else. The time horizon on that was 1-yr and then 3-5 year expected returns with a strong focus on industry fundamentals and more tangential relevance to "macro" factors (e.g. growth, inflation, interest rates, etc.).

For some of the other more tactical trades (rates & fx), time is obviously a bit more sensitive, so that would be more like 3-6 months (or perhaps less depending on how events evolve, things seem to be accelerating very quickly the last few weeks).

It's kind of difficult to separate my "tactical" view from my "longer term" view because they're basically linked together and I'm simultaneously paying attention to both the short-run and the long-run. My tactical views usually come from my understanding of structural processes and the ability to see dislocations in real-time. I have a mental map (still a work-in-progress) that I've developed and I compare what market/economic signals are implying against that map to generate tactical views. Time horizon is then a function of how events develop and based on changes in what I'm seeing in various signals (both market-related and fundamental economic data).

That was a bit long, but hopefully answered your questions.

Escheresque, what's your opinion? Comment below:

Hey Man - as a Student which is highly interested in stuff like this (but doesn't learn it in his master bcs equilibrium models) i am very grateful for your post and the replies! 

Just a quick thank you! Maybe there will be some follow up questions, but I think this will be really helpful for me!


Pizz, what's your opinion? Comment below:

Thank you. You seem very bright. Hope you crush it there 

  • 1
Victor-Schmidt, what's your opinion? Comment below:

very very helpful. which tickers do you follow on Bloomberg on a daily basis to get on top of these flows and understand on a timely basis what is going on?

MacroJunkie, what's your opinion? Comment below:

Some of the measures I use are proprietary (custom measures that I built in-house) so I don't want to give those up.

But, the publicly available ones would be like the STIRs (bill rates, gc repo, FF, libor-ois, SOFR, SRF/IOR/RRP rate), other short-term funding stuff like RRP uptake, auction demand between funds vs. dealers vs. foreigners, primary dealer net UST positioning, fails to deliver, etc. Also FX related measures like FX basis, USD funding gap, trade-weighted and EM-weighted USD exchange rate. Then there's also data about the notional/gross market value of OTC derivatives outstanding, other things like commodity prices, etc. The TIC data is also pretty informative if you know how to use it and interest rate swap spreads can be indicative of changes in implied balance sheet capacity costs. Even measuring stuff like various credit spreads (corporates, peripheral sovereigns) and monitoring moves in the the yield curve itself (steepening, flattening, parallel shifts, etc.) are very important.

It's kind of hard to describe because it's really an amalgamation of hundreds of different signals, indicators, datasets, even qualitative things like news stories, policy changes, statements by regulators, CEOs, etc. that together paint a mosaic that allows me to be a bit more informed on the margin around these turning points. 

I've recently been working on trying to turn more of these measures into systematic signals and it's been kind of difficult because a lot of my understanding is very conceptual and relies on abstraction and analogical reasoning, not necessarily super strict formalized rules. I work at a hybrid fund and our quants don't understand the intuition behind my signals so I have to do some of the heavy lifting myself (teaching myself R and dusting off my old econometrics materials), but I'm not naturally a super "quanty" person.

LocoK, what's your opinion? Comment below:

Hey, great thread ! do HFs value bank macro and FI strategists or do they favor traders ? I have an offer to join a BB's macro strategy desk in Fixed Income research but would ideally rather join a macro fund

MacroJunkie, what's your opinion? Comment below:

Really depends on the fund and PM (for a larger multi-manager fund) to be honest. Some funds/PMs are more biased towards traders and some are biased more towards research/strategists. My fund is biased more towards research/strategists rather than traders just because of the investment style of my PM, but I know others that take different approaches, for which a trading background would be more beneficial. 

I think joining a macro strategy desk in FI research would be a fine place to get your feet wet and start your career. If you feel like you need to develop a trader's skillset, it would likely be possible to lateral within the same firm. The most important thing is to continuously think about markets from an investor perspective (as opposed to a market maker) and consistently put out high quality trade ideas. 

  • Intern in HF - EquityHedge


[email protected], what's your opinion? Comment below:

Really really helpful, thank you for the thread. One question I have is for desk/strategy named related to cross-asset (multi-asset) portfolio or investment. I was wondering if it is the same thing compared to the macro strategy fund? (or macro strategy refers to money market/rate/fx specifically in our context) Also, you mention the equity research you did to understand the industry, how would you describe the relationship between macro and equity in general? In terms of macro research that you are doing, I was wondering how much of it would be quantitative (i.e. what types of model would be needed, could you give an example)

Once again, thank you!

MacroJunkie, what's your opinion? Comment below:

There are a lot of definition of "macro" as it pertains to investing styles. I'm somewhat partial to the definition used in Steven Drobny's Inside the House of Money

More than anything, macro is a framework, a prism through which to see the world, filter ideas, and ultimately express and manage risk in your portfolio, whether that portfolio happens to be run in a hedge fund structure or not.

That means that a macro-related investment strategy could technically be used in any asset class (equities, credit, rates, fx, commodities, etc.). Whether or not it a "macro style" is actually used, is highly dependent on the specific views of your desk or PM. There are plenty of STIR/rates/fx traders who trade "macro products" but aren't really "macro traders" in the sense that they don't necessarily use a big-picture point of view (even if they have to pay close attention to central banks, the macroeconomy, etc.). There are also equity PMs who might use what one might call a "macro strategy" even though they don't trade interest rates or fx. I personally prefer interest rates and fx just because I've found I have the most edge in trading these types of products and they offer the most "pure" expression of the types of investment theses that I tend to have.

I don't use any particularly quantitative models, I'm very much a qualitative sort of person. That doesn't mean that I never look at these things, I'm always looking at BB macro research, some with pretty dense econometrics, but I don't really do much of this myself as I don't really find it helpful. I look much more at what market prices are saying about the state of the world than econometric models.

What is Upstart, what's your opinion? Comment below:

What do you think about the effects the Russian invasion could have on the USD as the reserve currency (in the long run)?

Obviously it still is the currency of choice but with China and Rusia deviating from it, choosing euros instead, do you think this would have important long term effects in such matter?

MacroJunkie, what's your opinion? Comment below:

Interesting question, I've been thinking about this for a couple weeks since the US decided to freeze the Russian central bank's USD-denominated FX reserves. I think you have the same problem with EUR-denominated FX reserves as you do with dollars (namely, confiscation risk), so I don't think EUR is a realistic alternative. Russia is just as short of EUR right now as they are short of USD. I also happen to think the EU has long-term structural issues that threaten the euro as a currency (unified monetary policy, separate fiscal policy, integration issues, etc.) so I don't think the euro is a real contender.

The most likely to win out in this type of situation would likely be CNY, especially if China's rollout of their CBDC is even halfway successful, but realistically you have the same issues as USD (namely, you're still at risk of confiscation). China will likely make some inroads around the margins by strengthening ties to Russia, Iran, etc., but the majority of the world is still going to use USD for trade settlement, and especially funding and financial flows. China can't even denominate most of their OWN trade in CNY, let alone the rest of the world. Beijing is also far too paranoid to allow for the true proliferation of an offshore CNY market that needs to happen for CNY to become a real competitor as a global reserve currency (see Triffin's paradox). 

Long-term, I think this just strengthens the case for digital assets (i.e., cryptocurrency) more than anything else. Zoltan recently wrote (with a bit too much hyperbole IMO) that this was the end of Bretton Woods III. I do agree with his take that "outside money" i.e., money that is not someone else's liability including gold, BTC, other crypto assets, etc. will become more and more important as the risks of "inside money" i.e., financial claims like most standard national currencies become apparent.

What is Upstart, what's your opinion? Comment below:

Thanks for your reply. I think you are right regarding the 2 first points, but I just don't see crypto becoming a standard currency.

No one yet knows how crypto will be regulated, and its volatility will discourage many parties from doing business using it. Its potential is overestimated IMO, even criminals don't really embrace it, with NFTs being more popular among them.

mufasatheking, what's your opinion? Comment below:

Hi there. I would just point out that I am impressed by a person this young, with this level of knowledge. Just out of curiosity, how on earth have you swept through all these articles and books (yet understand and connect them into one single picture) at the age of 23/24? Have you studied these topics outside of your curriculum during undergrad?

MacroJunkie, what's your opinion? Comment below:

Consequatur ipsum reprehenderit iure possimus. Qui beatae tempora voluptatem. Repellendus ducimus consequuntur aperiam dolor eos ut. Repudiandae pariatur optio et quia.

Sequi dolorem architecto eos error voluptatem accusantium et. Ullam et sint et eligendi rerum aperiam suscipit quas.

Esse accusamus ab consectetur reiciendis perferendis voluptas et ipsa. Et ut aut beatae sed quasi labore. Est labore ullam eaque fugit accusamus id sapiente.

Quas suscipit cupiditate deleniti cupiditate neque doloribus maiores. Illum et ut dolores sapiente eum ea ut. Veniam rerum dolores cum et sapiente et suscipit. Aut consequatur qui occaecati at.

Start Discussion

Career Advancement Opportunities

January 2023 Hedge Fund

  • Point72 98.9%
  • D.E. Shaw 97.9%
  • AQR Capital Management 96.8%
  • Citadel Investment Group 95.8%
  • Two Sigma Investments 94.7%

Overall Employee Satisfaction

January 2023 Hedge Fund

  • D.E. Shaw 98.9%
  • Magnetar Capital 97.8%
  • Blackstone Group 96.8%
  • Citadel Investment Group 95.7%
  • Millennium Partners 94.6%

Professional Growth Opportunities

January 2023 Hedge Fund

  • D.E. Shaw 99.0%
  • Point72 97.9%
  • AQR Capital Management 96.9%
  • Magnetar Capital 95.8%
  • Citadel Investment Group 94.8%

Total Avg Compensation

January 2023 Hedge Fund

  • Portfolio Manager (9) $1,648
  • Vice President (22) $464
  • Director/MD (11) $434
  • NA (5) $306
  • Manager (4) $282
  • 3rd+ Year Associate (23) $275
  • Engineer/Quant (66) $274
  • 2nd Year Associate (29) $251
  • 1st Year Associate (71) $192
  • Analysts (217) $178
  • Intern/Summer Associate (20) $130
  • Junior Trader (5) $102
  • Intern/Summer Analyst (237) $85