Welcome back to Real Vision. I'm your

host Ash Bennington. Today I'm joined by

Michael Howell, founder and managing

director of GL Indexes. Michael, great

to have you back with us on Real Vision.

>> Well, Ash, it's always a pleasure.

Plenty going on markets. You know, is it

going to be a summer panic? We We always

question that one.

>> Well, Michael, it's great to have you

with us. I know many of our viewers are

familiar with your work and I'm I'm sure

are eager to hear from you today. But

for those who are not familiar with your

work, who may be joining us for the

first time, tell us a little bit about

what you do and your view of the world

and markets.

>> Okay. Let Let me kick off by saying that

our lens is is liquidity.

That's been our focus for probably three

decades now.

Our view is that money moves markets.

Economics is downstream of markets and

geopolitics is downstream of economics.

So basically it all begins with with the

liquidity cycle and that's what we put

most emphasis on.

We track liquidity flows through

financial markets and I stress that

difference between liquidity in the

financial economy and liquidity in

generally in the real economy. They're

two very very different things. So we're

looking fundamentally at liquidity in

the financial markets. That flow that's

driving asset markets and we

basically collect data intensively from

about 90 financial systems worldwide.

Clearly some of those are less important

than others, but we we

pretty much cover the waterfront. And

we're looking at granular data. So we

collect about 30 data series per

country. And we've just basically

launched in the last 9 months a system

where we can do that on a much more

granular basis. In fact, high frequency

daily data. So

there's a there's a lot of numbers that

go into these calculations.

>> Michael, I've been following your work

for years since I've been at Real

Vision. You do a very granular job of

going through that data. You've got some

decks prepared for us today, some charts

for us to look at. Let's jump in and

take a look.

>> Yeah, sure. Um, I mean, the first slide

is probably the the sort of centerpiece

of of what we do, which is

uh, looking at the global liquidity

cycle. Uh, you can see what's going on

maybe visually here. Uh, the black line

is a measure of the momentum, and I

stress the momentum, not the level, but

the momentum of liquidity, which is

traveling through world financial

markets. Uh, again, this is not a money

supply measure like an M2. This is

basically liquidity in the financial

sector, which is very different. Uh,

this is showing the underlying rate of

change of that series. Uh, you can see

that the data series goes all the way

back to the 1960s. Um, the red line that

you can see on top of that is a sine

wave that we've put we've put on top.

Uh, that was estimated for those that

are

uh, familiar with mathematical

techniques by Fourier analysis uh, back

about 25 years ago. So, in year 2000, we

did the calculations. We haven't changed

those, and we've just basically just

rolled on the same uh, cycle. That is a

65-month cycle, and it seems to be more

or less uh, tracking uh, the liquidity

cycle as is. Uh, independently,

uh, a group called the Foundation for

the Study of Cycles in the US uh, asked

to look at our data. Uh, we gave it to

them. They're sort of uh, very uh,

they're they're very thorough uh,

analysts for cycles. Uh, they put it

through their algorithms and actually

came up with exactly the same frequency,

a 65-month cycle. So, that's reassuring.

Um, uh, they certainly know what they're

doing when it comes to cycle analysis.

And what you can see is the cycle

basically flipping and flopping.

Um, it uh, bottomed in late 2022 around

September, October of that year. It

peaked in Q4 of um, of last year. Uh,

momentum has been slowing ever since. I

mean, I stress the fact this is the rate

of change, it's not the level, but you

can see the inflection and it's that

inflection which really informs our

asset allocation. So,

what I can do is just give maybe a

glimpse of that

to look at what we really mean.

This is looking at the notional asset

allocation cycle. This is how we uh

basically define

um

investment our investment stance.

Uh we begin, if you look at the

left-hand side of that diagram,

with the equity markets. So, in other

words, equities do very well when you've

got liquidity conditions

uh

very very strong. In other words, when

you've got a lot of momentum in the

upswing of the cycle. Commodity markets

tend to do best around the peak of the

cycle. I mean, that's clearly where

we've been for much of the last 12 15

months. And then as the cycle starts to

affect inflect and lose momentum,

you start to find that cash instruments

tend to do better. And that's a call not

just on the return, that's also on the

on the volatility background. So, as you

start to see liquidity flipping over, uh

not only do returns on risk assets fall,

but actually the underlying volatility

of those instruments picks up. So, the

quality of return deteriorates. And then

by the time we get to the trough of that

cycle, you tend to find that bond

markets uh conventional government

bonds, longer duration government bonds

that is, tend to do uh very well.

They're the better performance. And you

can see as well we've sort of

embroidered the chart by looking at what

the yield curve, which is denoted YC, is

doing at different phases. Bear

steepening, bear flattening, uh bull

flattening, bull steepening, etc. And

what different uh industry groups uh are

doing as well in red. Uh one of the

things to note that if you look at the

cycle where we are right now, which is

what we would deem to be the speculation

phase of the cycle,

uh you would typically find strong

performance from commodities. You'd also

be seeing a bear flattening of the of

the yield curve. And both those two

factors are definitely coming out. The

other thing that's worth pointing out,

which is shown on this uh this other

slide which is sort of putting this in

context uh comparing the liquidity cycle

in red with the uh economic cycle in in

yellow there is that as I said right at

the beginning the liquidity cycle is a

sort of foundation. It leads uh most

things particularly the real economy.

The real economy tends to lag about 15

months maybe 18 months uh after the

liquidity cycle uh peaks and troughs and

you can see there that where we are now

which is around that area that is

denoted by that uh red blob. That red

blob signifies that that's a yield curve

prospective yield curve turning point.

It occurs as you sort of move over into

the downwards phase of the liquidity

cycle but that is the phase as you will

see there when economies are

accelerating. So the third factor to

watch is not just strong commodities,

not just yield curves inflecting but

also economic momentum beginning to pick

up. So we're trying to fingerprint the

markets by looking at a range of

indicators uh starting from liquidity

but also broadening out to understand

that transmission.

>> So this is just an excellent setup for

the way the framework you use how you

think about the world. Uh Mike whenever

you come on the show I do my homework

ahead of time. I was reading some

research that you guys put out last

night. I saw this headline uh which

obviously got my attention. GFC II is

likely by 2030.

Uh that is uh a um quite striking

headline when you see it in a chart

deck. Give us a little bit of a sense of

where we are right now in your view with

regard to the liquidity cycle, with

regard to the economic cycle uh and with

regard to where you see markets heading

next.

>> Okay that's uh um

uh a good segue into uh maybe trying to

understand what the the pressure points

in markets are. So let me just spin on

to uh that part of the presentation,

which is a little bit further on. Uh

maybe the best thing to do is to start

with this slide. This is looking at the

structure of global liquidity. So, you

can see there the the broad numbers. So,

global liquidity is a pool of

uh uh of funds,

190 trillion. Uh that means it's about 1

and 3/4 bigger than the world economy

itself. Uh and that sits on what we

think of as a shadow monetary base. Uh

and that monetary base is consisting of

not only central bank money, so in other

words, Fed liquidity, it's also sitting

on collateral, which you've got to

accept are probably

dominated increasingly, certainly in

financial trades, by US Treasuries. So,

it's that collateral and central bank

money pool, which is, if you like, the

base of the inverted pyramid, uh and

that's what constitutes the bulk of the

shadow monetary base. Now, one of the

things I think to differentiate

uh maybe the world of maybe what we

we're saying is if you go back pre-GFC,

um the sort of credit occurring markets

or the an analysis of what went wrong in

the GFC was that there was generally a

lack of safe assets. Now, you know, I

there's some truth in that. In other

words, there was there were insufficient

um

Treasuries or good quality

uh bonds in financial systems to act as

cushions. That may or may not have been

true, but what we're looking at now is a

situation where it's not so much the

pool of collateral that is important.

It's actually the collateral multiplier.

In other words, how effectively that

collateral can be used, and whether

there is the balance sheet capacity in

the system to basically move that

collateral uh into uh cr- if make it

into credit, and if you like, sort of

make it usable within within the

financial sector. So, it's really a

question of, you know, looking at the

efficiency uh or the efficacy with which

collateral is used is a really important

thing. And that's why I developed that

thing we discussed the ratio there,

which is the collateral multiple out

between that shadow monetary base and

global liquidity. That ratio tends to

change and I'll come on to explaining a

bit later why it changes and why we've

got to look in certain down maybe

different rabbit holes. Now, if you come

to this chart, which again is a

schematic, but it maybe helps the

education of what's going on, is this is

the modern financial system. And this is

how the system has evolved certainly

since the GFC. What you have at the

heart of the system is a debt liquidity

nexus. And that basically says that

liquidity requires debt and debt

requires liquidity. And that is really

the anchor of financial stability.

In other words, what you need is

stability between the amount of debt and

the amount of liquidity. So, let's call

it a stable debt liquidity ratio.

Now,

why does debt need liquidity? Debt needs

liquidity for refinancing. And the

reason for that is that the bulk of

transactions, something like three

quarters,

maybe more of all transactions, primary

transactions in global financial

markets, are debt refinancing

transactions. So, the key point here is

that the amount of new money raising,

or sensibly for capex or whatever

fund new funds are used for, this

doesn't really happen anymore.

Uh you know, financial markets in the

West are mature.

They're not They're not raising new

money for capex. What they're

principally doing is rolling over

existing debt. And there is a lot of

debt, as you will agree. And that debt

is issued by the finance finance term

finance term, and it needs to be rolled

over

or refinanced periodically, probably

with a maturity of average maturity of

about five or six years. So, you get

this continual debt roll. Now, the other

thing is that

liquidity needs debt because as we

argued in the previous slide

liquidity needs collateral. It's

collateralized lending. The repo markets

are re-central to funding. And you need

paradoxically um

liquidity needs paradoxically good

quality debt to sit upon. So you simply

can't default debt because that would

just wreck the whole credit system. So

what you've got to do is to basically

nurture debt and make sure the debt

markets the collateral markets are

stable. So this debt liquidity nexus is

key.

If you cannot um

essentially turn

debt into liquidity you get a problem in

the repo collateral markets on the left.

And you can see that in terms of the

move or the move index of bond

volatility or sofa spreads which are the

measure of market rates on repo versus

what the Fed is is signaling through

either Fed funds or interest rate on

overnight uh reserve balances. Something

like 77% or accurately 77% because the

World Bank figure of all global lending

that was collateral backed. That

includes real estate deals but it also

predominantly uh

also includes US Treasuries or German

bonds as collateral for lending. So if

you see that leg breaking down you'll

get the move index or the sofa's move

index spiking or sofa spreads breaking.

On the other side if you've got a

problem on refinancing you can't

essentially refinance debt where you're

going to get problems you're going to

get problems in term premia. Term premia

will start to collapse or you start to

see credit spreads uh beginning to blow

out. So those are the things to watch.

Now

this is the ratio and this is

um my long-winded answer to your uh your

question. Um this is basically saying

look here is the ratio of debt to

liquidity

um across the advanced economies.

And if you look use this particular

lens, I think it explains an awful lot

about what's going on in terms of

markets, and it also will explain, if we

have time to go on to this, what's going

on in China right now. And what this is

basically illustrating is that when the

debt liquidity ratio gets too high,

you'll start to see tensions,

refinancing tensions, and policy makers

will come in, and they'll start throwing

liquidity at the system, okay?

And they'll try and stave off a

financial crisis, but you'll notice that

financial crises tend to occur around

the peaks in that ratio. So, this is all

about the debt liquidity

ratio spinning out of control. On the

downside, if there is too much liquidity

relative to debt, what is the vent? The

vent is asset bubbles,

and you can see those examples that I've

illustrated.

We've just come through what, you know,

I loosely call the everything bubble.

Maybe that's the correct, you know,

label for it, but you'll see that after

that everything bubble,

the orange line, which is shown as

projection for the next

four, five years, basically goes from

from

the bottom of the chart towards the top,

and crosses the threshold of 200%, and

that is the danger area we're moving

into. It may not be hit in 2026, but

clearly on this extrapolation, we're

getting up there in the next four to

five years, and that's when you start to

get problems. In other words,

refinancing problems. Now, what are the

two issues that we're facing?

Number one is

something we've already touched on, but

liquidity tends to be cyclical, whereas

debt growth is exponential, and that is

not a happy marriage, because if you

start to see liquidity turning down, as

we're seeing now, you're only going to

get more and more pressure

for refinancing

in the markets, and that maybe is what

we see. But, the other problem that it

exists goes back to the COVID crisis,

and that is best illustrated here with

something called the debt maturity wall.

Now, one of the things that policy

makers came up with during the COVID

time was the brilliant, tongue-in-cheek

comment, or cynical comment, of zero

interest rates. Now, zero interest rates

may well have fulfilled a a short-term

policy imperative, but the problem is

that what it does is it incentivizes

debt. And, not only incentivizes the

take-up of debt, but it also encourages

existing borrowers to term out their

debt, refinance it, and basically put it

out maybe 5 years into the future. And,

that's what happened during the COVID

period. And, if you look at this chart,

the orange bars are the actual data

points

annually for showing the change in the

amounts of debt

that needs to be refinanced every year.

Now, what you'll see during those COVID

years is because the debt was termed

out, it wasn't refinanced. It was issued

as as new debt, and it basically is

coming back into the system in the later

part of the 2020s, shown by that red

area. So, what you see here is a debt

maturity wall which is facing us. In

other words, there are a lot there are

many, many more,

you know,

debts to roll over in coming years. And,

let me stress, this is coming on top of

all the new debt that may be issued for

government spending, you know, the big

deficit. It's coming on top of the AI

issuance, etc. These are big numbers.

So, the strain on financial markets is

beginning to tell. And, that means we've

got to start monitoring very closely

what is happening in the repo collateral

markets, which we can turn to next.

>> And, this is mechanistic. This is just a

consequence of the term of of debt. This

is not a a market-driven

uh spike that you see. This is literally

just the the internal debt dynamics and

the necessity of this maturity uh yield.

>> Correct. Absolutely correct. Yeah, I

mean, this is this is just an echo

effect, if you like, of the COVID crisis

coming back.

>> Before you go, that was just the

preview. The full conversation goes much

deeper, what's really driving markets,

where the risks are, and how the best

investors are positioning. That's what

we do at Real Vision. We connect the

dots before they become obvious. So,

don't stop here. Watch the full episode

now and more on Real Vision.