Regulatory System is Absurdly Complex, King Says

have seen over the last couple of days. I'm very pleased to say we've got a snack show right over all over again on are on Bloomberg Surveillance, including Mark Chandler, Brown Brothers, harrim and global head of Currency Strategy Kit Jugs also joining us of soccer say as general Kit joining us from London. I want to begin with you, sir. An important note that came into my inbox from your south this morning. The addiction to low volatility perhaps bigger

than the addiction to low rates. Let me throw a kit Well, it just strikes me that so that they're related, right This, this low interest rate regime we've been in since the Financial crisis, has has pushed money looking for yield either to be taking low volatility strategies, which meant for a long time buying things that were low in volatility and that suffered de volatility picked up across markets, so corporate bonds, high yield, easy examples of high yielding

currencies and so on. And then clearly, you know, we have invented more and moderivatives that allow people to go short of volatility on a retail basis or on a wider basis than just outside you know, a few trading rooms. And and that's where some of the worst of the

pain has been felt in this crisis. And I guess that's you know, it's an evolution of the market away from away from what we saw in two thousand and six seven um as as the as the financial bubble grew, when money was going into be um an addiction to low rate, but an addiction that came through in structured credit and through addiction into the into the property. Mark. Yeah, this feels different in that sense, Mark Chandler. At the moment,

the volatility almost isolates its equity. Do you see it bleeding through to effex bleeding through to bonds, because that's not happening in the material way yet. Yeah. Partly it's what's happened is that the dollar has gotten stronger and the end has gotten strong. It's primarily because people are unwinding these positions where they've used the dollar in the end as a funding currency. But I'm not so sure that that this is that this is a big crisis

or anything. I think most retail investors are not really involved with these vix plays. At the end of the day, I think that this is mostly a Wall Street sort of staring at its navel and not really looking at the bigger picture and the bigger pictures. Essentially, this emerging markets were was up about thirty three percent last year.

There's still up on the year now. The US stock market many people like myself, including some feed officials, dot the stock market was elevated and where are we now basically where we were at the end of say, early January. I think that this is uh, this is grossly exaggerated. The economic impact grosly exaggerated. Like I say, I think

that it hasn't really been a spill over and economic issues. Well, I have to say, Mark, I haven't heard an exaggeration on the economic issues, and I haven't heard an exaggeration from the bulk of the people I've spoken to either on the spillover effect. Let's be clear though, this isn't an exaggeration When we talk about a key trade last year, which was short volt blowing up. The short vault trade has blown up. Now we can talk about what that means,

the spillover effects. But I don't think it's an exaggeration to sit here and say that a lot of investors worldwide bet on an extended period of calm and that has ended. It's blown up in a significant white I'm actually sure that there's so many investors have been playing for this. For example, myself, what did I do? People like myself we've been buying throughout four one key equities.

Is this a big skire for us? Are we playing low volatility as if it's going to last forever by being long starts and being longsome ets, we being long credit? Is it not an embedded low volatility trade? Being long e M? Is that not an embedded low volatility trade? Isn't When you project for low volatility, aren't you expecting to have risk assets like e M and credit outperfore Most people input low volunto that portfolios and expect credit,

a M and other risk assets to out perform. Well, that's why I'm suggesting to you that despite this jump in VIX, the e M stocks are still up on the year. And when I did last year, you know, the Russell one thousand had Russell has a one thousand value index and I Rustle one thousand growth index last year. As you would imagine, the growth index well outperformed the value Last week, when the stock market began selling off, the growth index held up better than the value index.

So I don't see this as some kind of big unworning. I've been quiet, folks, because I'm staring at my navel. That's what we're doing on I'm I'm, I'm I'm just staring there. Good morning everyone. Yesterday we need to say, we need to say thank you to the Bloomberg surveillance team for heroic work from Friday over to Monday and getting smart conversation on and we continue to drive that for this morning. I hate to say this, Kitchen, but I featured your research note this morning when you were

not on. You'll get the royalty check. Uh and within that was wrong? Yen? How much stronger is strong? Yen? If for one O nine, one ten, can this be a news item from March or April? Well, I think the market is you know, the end is being kept deliberately at least ten per cent, about ten percent away from its fair value by the Bank of Japan's policies. That's what the e c D was doing to the Euro year ago. Um, and they mustn't papering under their breath.

Last May we went, we started moving. The Bank of Japan is desperate to not let that happen, and I think the market can now see that. It can see that the Japanese economy is recovering and the end won't be able to stay this week forever in the middle with turmoil. UM. I think that at the bare minimum in the end is now in a lower range than it was, and it's still going to have to work flat out stop it appreciating tempercent. That was great. Kit didn't answer my question March end. Let me see if

you can, what is the level where yen becomes stronger. Yeah, Kit talks about a new range and all the politics, but ken yen is the litmus paper of the flows system. Can it really go to some dramatic yen strength? Well, here's what I suspect is that is to say that I think the Japanese are willing to accept a stronger yen provided it takes place among a weaker dollar environment.

More broadly, and it happens gradually, And so I think that the fact I don't I don't think you see the Japanese holding the yen down here, but I think that the Japanese are willing to accept a stronger yen partly to help the deflect some protectionist sentiment coming from the United States. As you know, Japan has a large and growing current account surplus, which antagonizes some people in

the administration. So I'll take issue with whether they are accepting a stronger yen, and the reason being, if they are going to accept a stronger yen, are they willing to accept higher yields? And it's quite clear to me that they're not. They're trying to camp the Japanese ten year just ten basis points mark, and what we saw last week, as soon as there was any kind of volatility um rates, any kind of pickup in yields, guess what the b RJ got aggressive. Again, Let's just assume

they are willing to accept the stronger yen. Are they willing to accept high yields? I say so, I agree with you that they pushed back quickly when the yields hit their target. And that is to say that the Japanese. I think a lot of people are confused the Japanese policy. It's not just qualitative quantitative easy anymore, but this yield

curve control, which requires him to buy fewer bonds. So I don't acceptably the fact that they tapered last year because the balance sheet only expanded by forty trillion yen instead of instead of eighty trillion yen. So but my thinking is goes along these lines, is that the Japanese are willing to accept. I mean, look what's happened. The dollars strengthened, excuse me, the dollar weekend most of last year,

the yen strength, and they didn't protest that. And so I think that that's what I mean by willing to accept the especially in the context of a wider move in the foreign exchange market. Kit Jukes, before we let you run off to your afternoon and suck, and he's working to suck John, Afternoon, John, this is like you know two. You know, he's an expert action in French parades. We'll get him in touch with the president, Kit Jukes.

When when I look at yields coming in two basis points today, two year in two basis points, ten year into thirty year bounds three basis points as well. What does that signal to you? Lower yields this morning. I think it signals to me that once we've given the market a bit of a bit of a shock, but there are still buyers. There are still buyers out there

for the fixed in market. That people have seen a bad inflation number, they've seen some volatility, you know that they they've got themselves a little bit alarmed, but that at the end of the day that there were buyers above two eighty and tenure notes, they'll be buyers and there'll be a lot of buyers at three or five. And I just think we might have to see the other side of three three defend at some point in terms I doubt. Okay, that's the end of the year. Kid,

John Ferris my name, I'm flustered. You're forgetting in, John. This is great when we have kit Chicks and Mark Chandler around and it's fantastic to get that real perspective and they're unspending the sex market, are they friends? Okay? Alright? Kit Chicks is state General, We've gotta let you go, sir. Thank you very much for giving its your time without questioning.

Our interview of the day always timely with a former Governor of the Bank of England, but nevermore so with a terrific news slow Governor, King, wonderful to speak to you again. And I noticed, Governor that Chery Yelling has been relegated in a fashion off the Fed is Aston Villa was relegated out of the Premier League two years are about to come back into the Premier League. Will enjoy her retirement? Well we will see, but we know

for certain she's been relegated. What was the pressure on you when you were relegated out of the Bank of England? How do you keep quiet the first weeks after your life changes. I think the first thing you want to do when you leave the Bank of England or indeed the Fed, is to have a break on a holiday and get away from it all, and then gradually to adjust to a new lifestyle. But do not rush to decide what you want to do next. It took me nine months to decide what I wanted to do next, Governor,

King Jonathan here. Some central bank governors presidents have the luxury of taking some time to to settle in, find a way around the offices, and find a way around the various rooms down the hallway. M J. Pal Jerome Pale. The Chairman of the Federal Reserve turns up at the FED, and the market starts falling out of bed. How to shoot the chairman? The new Chairman of the Federal Reserve approach a situation like the one playing out before us, Well,

I think in the way that he has done. After Ay, he's known for several months that he would become Chairman of the Fed. He's been at the FED for several years. He knows his way around, so he's been able to think through how he would handle the first week or a few weeks, and before long there'll be another meeting of the f O m C and he will be able to put across his views. Then, Governor, I'd like

to address something you've been thinking a lot about. And folks, the history of this is back to mc chesney Martin in ninety one, where the Chairman of the Fed really went up against President Truman over the independence of a central bank. We take that for granted now, Governor King, and you suggest we should not how do we reassert independence in any central bank and as well a central bank and President Trump's Washington. So I think there are

two different dimensions to this. One is monetary policy and the other is dealing with financial crises and in particular problems in the banking system. I think on the first the important thing is to keep educating the public as a whole about the importance of price stability. It's very easy for people to take low inflation for granted in need. The phrase price stability was once defined as when people

stopped talking about inflation. But it's very important that they're reminded of the dangers of going back to a world of high inflation. So constantly explaining the remit and the mandate of the central bank and why it needs to be a set of decisions taken by a group of people, not one person, but a group of people working together independently from day to day political pressures is very important, and I think that's the question of stating it as

well as making sure that's what happens. The second one is I think more difficult, which is that in a financial crisis, it's inevitable that the central bank will be the source of liquidity to keep the economy funckoning, but it should not be seen as providing that liquidity as a favor to the banks. There has to be a political agreement between Congress and said or between parliaments in the Central Bank as to the circumstances and the terms

on which they will provide that liquidity. That is what was missing during the last crisis, and it's what we need to put in place now. You and I have talked about your acclaimed speech in Scotland where you essentially lectured the United Kingdom toward Badget and the idea that there has to be a way to do this, a modern Badget, if you would. Alan the late Allan Meltzer, of course, has talked about this was some emotion. Are we in a good place today? You know, to take

the present crisis. If we have the equity VALL slip over into fixed income vall, are we in a place where the proverbial discount window will be open? No, We're not in a good place. One of the problems is that the response of Congress to the last crisis, understandably so, was to try to restrict the discretion of the Federal Reserve in providing liquidity to institution and the market, and I think that that is the wrong direction in which

to go. I think the Federal Reserve would have been better served by being given the freedom to exercise that discretion, but under a set of conditions which Congress had laid down in advance, rather than simply limiting or preventing the Fed from lending when it feels it's necessary to do

so in a crisis. So when the banks say they're very well capitalized and they're much much stronger than they were before, what do you say back to that, Well, the banks are certainly better capitalized, particularly in the United States and the United Kingdom, less well so in Europe. So we ought to be concerned about whether problems in the banking system elsewhere in the industrialized world could spill

over to our banks and our economy. But it's not just the amount of equity capital which banks issue that

matter here. If people, for one reason or another lose confidence in banks, or simply do not know whether banks will be able to meet their liabilities, then the natural thing is for people who provide short term credit to banks, whether their retail depositors or wholesale depositors like hedge funds, they may run for the exit, and we don't have a system that will cope with a run on the banking system short of the FED actually throwing large amounts of money at it, and as I say, Congress has

been limiting the ability of the FAD to do that. Well. The argument that's being perpetuated by the banks, obviously in the United States and by others in Washington, d C. As well, is that the regulatory rules post crisis, the capital rules, have become a burden and that ultimately it's stopped lending. That for some reason, these banks would have been able to lend a whole lot more if they didn't have these rules on them, and that business would

be a whole lot better. That's the argument coming from this administration as well. To some extent, do you subscribe to that argument, because I sense from listening to you now you don't. But I have a sympathy with one part of the argument. The regulatory system has become absurdly complex. If you have a system that can only be described in tens of thousands of pages, there is something really wrong with it. And I think the attempt to put in place so much detail in the regulation is an

attempt to prevent the last crisis happening. What we need is something very simpler, much broad, broader bart brush, which would both ensure that the leverage of the banks is capped and ensure that we have a method for dealing with bank runs if they were to occur. What we don't want is a system of banking in which the people who determine banking decisions are compliance officers. But then, critically with this, what your comments Government, King are extraordinary,

They're very very timely and very very important. What does the quote unquote next crisis look like to governor King if it's not the last crisis? Well, I don't want to speculate on what the next crisis will look like, and we have no idea when it will come. But the areas of a weakness in the current system are really focused on the amount of debt that exists, not just in the US and UK, but really across the

world as a whole. Debt in the private sector in the world relative to GDP is higher now than it was in two thousand and seven, and of course public debt is even higher still. So what one might fear would be that if there were defaults, not very many. A few defaults where people then revised their view about the value of assets on the balance sheets of financial

institutions and intermediaries around the world. Then you would find that not only would the value of the assets go down, but so with the value of the equity cushion available to absorb losses. And that's the kind of thing that can induce financial panic. Now I'm not saying it will happen. It may never happen, but that is the area of weakness that I would look to at present. This is incredibly important. Comments from Irvin King Folks of course at university,

the former governor of the Bank of England. Why do you bring in a really esteem guest from Washington, Mr William Hogland. Yes, he is the senior vice president of the Bi Partisan Policy Center, and that really just scratches the surface of Mr Hogland's career in Washington and service to the country. Formerly staff member director of the Senate Budget Committee, reporting to former U S Senator Pete Dominici, chairman ranking member, and he's really an expert when all

things related to Washington and the government. And he's also a former attendee of the US Merchant Marine Academy. So um, he knows a thing or two about the Jonesack. Mr Hoglan, thank you very much for for being with us. I just leave it open to you to to give us your reaction to the back and forth the slanging match that seems to be taking place on a regular basis in Washington. Uh, do you believe that they people in Washington, the politicians, do they recognize that every time they do this,

there is the level of a steam sinks lower. I can't get much lower than it already is. I think when you look at the ratings out there in terms of Congress, they are at one of the lowest rates they've ever been in terms of recording of that particular statistic. So do they understand it? You would think they would understand it. I think you understand. I think they now understand that the last government shutdown that we went through a few weeks ago here for three days is something

they do not want to go through again. And I think you're hearing that both from the Democrats and the Republicans. And I didn't hear it from the present yesterday, unfortunately, but that definitely is UH an understanding that we don't want to shut down over with. The difficulty here is, of course, can they come to some sort of an agreement.

We're almost five five months into the current year and we still haven't fixed and set what our spending should be for the current year and continue to operate over these things called continuing resolutions, which is not a way to run government at all. Um and and quite interestingly enough, come Monday, under the law, the president is to submit his budget for the fiscal year that begins this October.

So we haven't even finished up the current year and we're already starting to get into next year's budget process. So it's a it's rather disappointing and uh and and despairing on on the way our government is working today. Well, in your thirty three years of federal government service, what have is there something that you could impart to the various participants in this drama that would lead us maybe not to an agreement or some kind of uh compromise,

but some kind of amicable divorce. I mean, you know, like actually maybe share the same kitchen but still be divorced. Well, be nice, first of all, if they would work five days a week instead of but basically three days. If they would basically stay in town like everybody else does, work a four hour work. We could a minimum and be here throughout and get to know one another and get to know them on an individual level. Democrats and Republicans.

It is something that we, uh, we really have lost that kind of connection and getting to know the other person, to know the other person's position, understand that we have differences of opinions. Uh, it might be helpful, But more importantly, it just seems to me that what we have to understand you cannot do. You cannot govern in a country that's as large as the United States, with as many diverse views as we have out here in a in

a partisan way. It has to be a by no surprise coming from the Bipartisan Policy Center that I would say that the way you get things done is you you comper Wise, I think Madison a head and mine and uh uh or we just don't see the compromise up there in the time that we've got left too short a time, Mr Hogdon, We'll do a longer about soon. Mr Madison did not know a trillion dollar deficit. What does the phrase a trillion dollar deficit mean to William

Hoglan It's unbelievable. It's something that I would never have expected we would ever see. It is something that creates a high level of debt that is going to be a pressure on future generations. It is attacks on future generations which will lower the standard of living in the future. That's what a tree and dollar deficit means to me today. Well, thank you so much, William Hogan, way too short today, uh joining us. He served in the Madison In administration

with Albert Gallaton. A few years ago. Bill Hoblan a legend in Washington with his work, including with a senator from Tennessee, Mr frist uh In. He is with by Artisan Policy Center. I'd like to tell you this is the most important interview of the day of it. Of course I can't say that, and Mr Worther won't hang up the phone because Mervin King was on and that's an important interview. But everybody at Bloomberg Surveillance are huge. Hee. What do we have a team? Is it like we're

up to forty two people? Is on the team? I think it's forty two. That's just the people that opened the door for me and get me lunch in that hold the umbrella. Yes, very good. Anyways, they know I've been a complete pain for forty hours saying get Stewart war thero on joining us now from b MP Perry BA and someone who writes abcusely professional derivative Greek symbol lettered articles on volatility is the authority, Mr Stewart. Thank you for taking your time away from b MP Perry duties.

What is the single thing you're writing this morning about as you observe the VIX index? Tom, thank you very much for having me on a pleasure to be here and for the kind introduction. We put up a note this morning, and I really I want to focus on the fact that from here volatility is likely biased lower rather than higher on a technical basis, and when talking about the VIX complex, I think there's been some misunderstanding in the market as far as what does that lead misunderstanding?

You know, I think people are looking at the vix e TV products the headlines around those, because they're you know, highly observable and well known and observable in financial press. But really the the dislocation is in the VIX spot index, which is really true a reflection of the cost of SMP options on a third day maturity, So it's the SMP options themselves in the front rather the VIX futures

which drive these products. That where we see the real trigger of the dislocation and see the current opportunity in the market. The the the spot market, the present market has, the carnage of the credit sweez product, the number of product, etcetera, etcetera, etcetera. What did the future pricings of the VIX tell you? So we see that at the the cash fix is

trading above the future levels. The curve is inverted, and so really what the market is telling you is that there's volatility now, but we're expecting a version in the future. And you know, I think the positioning has changed dramatically, um. As I said when we had that discussion yesterday morning on your show, the you know, there were large inflows into UH exchange traded products that were short volatility on Friday.

Those essentially those flows of those positions were unwound, and now we actually see that the market is very long VIX. So if anything, it's suggesting that the market is actually well hedged at this point. Um I would say, as far as flows that we've seen, um, they've been primarily unwinding of hedges, which is really constructive, and it seems that the market is now at least anticipating that the worst is over. Shout out to my colleague Carl Rica Donna.

We make jokes about aerospace that we end up looking at the Greek letter theta, which is the time function. Stewart Orther, you look at alphabeta, gamma, the acceleration of all these trends and other Greek soup, vega, etcetera. If I look at theta out the X axis. There's a belief that if you have a stochastic spike in VIX and it come back down, it dampens out over days, weeks, or even months. Do you have a sense of when VIX dampens back to normal? Is it's six weeks out?

Is that this Friday? When would that be? So? I think this is an interesting question because what we saw in was any VIC spike was immediately followed by a reversion back to extremely low levels. Solve you know cinematic volatility sellers that looked at this market which was auto realizing at low levels and would sell into any of those rallies. Now I think it's different. We're going to

see a reversion back to a lower level. UM, but it's not going to happen as quickly because I think a number of market participants of now, UM, you know, experience what we would call of our shock in the sense that case scenario happened. You don't go right back in after that, UM, if you were at least in that positioning before you know. This is the critical point, folks and Stewart. I don't want to get you in trouble with your general counsel. So if you don't want

to answer it, fine. What you just heard their, folks, is the pro analysis at this time is different. There's been the var value at risk shock where the legal types are gonna say, no, you can't do that. You can't reinstitute those habits that lead to the spike up, spike down. Fine, how does that translate over to other

asset classes away from equity dynamics? Are there the police gonna say, we had a var shock and equities, so we're going to change our behavior in the hedging and derivative structure of fixed income markets, foreign exchange and foreign exchange markets as well. So this is really one of the interesting parts about the sellout that we saw, which was that you know, all the all those treasuries and you know rates broadly have been selling off over the

last few weeks. The uh, you know, the market moves and equities were enormously larger in relative magnitude terms versus other asset classes um. And one of the things that we had noted was putting pressure on the SMP ball complex last year was really selling from other types of investors, such as fixed income investors. Selling equity volatility realizing that it prevents potentially was a better risk reward at the time, um than selling fixed income volatility, and same thing with

FX for that matter. So um, you know, I think there was a prolifer ration of cross asset volatility trading last year that might not return to normal as investors look back to their own asset classes and play it a little closer to home from here, What will you do here? What will you what? What is the trade recommendation as we go from ten to five zero four point three standard deviation move back down to under two standard deviations twenty four point six nine on the VIX?

What is the to do list for Stewart warther So we actually looked into a few different scenarios, UM. And if we look at history and use that as a guide, we find that when the SMP declines by oversea in a current week, then it actually tends to his historically bounced back in the following week. However, when an event like Monday happens over the preceding or the following month, it's really split fifty fifty as far as what the

spot market does, what the price of stocks do? UM. You know, I I think the more obvious implementation, or the more obvious answer to this is, you know, it seems that because of the unwind in some of the volatility space, that we would see vicked futures biased to the downside, and that we would see vall under pressure as opposed to the stock market rallying back to its priory.

No go ahead, No, I would say that. I think this is the million dollar question and the thing that a lot of our institutional investors are probably grappling right now, which is does it all normalize or does the spot market go back to where it was, or even PIM, does VOLL normalize or leak over to other asset classes. Most of our interviewers say, no, that will not happen. Well you want to jump in, Yeah, well let me have a Greek letter you'd like. Do you want to

talk about me? No, I was gonna do critosis, but I'm not going to start. Stewart helped me here. Just to simplify this, is it possible that what happens is the same thing that happens all the time? You have institutions or smart investors who use a product to hedge a position, and then that hedge looks profitable and then they turn that hedge into something that is designed to

actually pay the money. Is that what happened? Yeah? I would I would answer it this way, which is that volatility tends to trade at a premium because you know, generally there are it is a cartotic asset which involves a number of spikes. Generally people are compensate thus have to be compensated for selling options. But you know, as far as the use of options, I think there are a number of uses both for hedging and for um, you know, for instance, premium at risk only long investing,

as well such as a call replacement. So um. The interesting market change though, and this I think that someone answers your question has been with yields extremely low. We're in an environment where people are seeking yield. When volatility is low, a yields are low, then selling options creates another form of yield enhancement, either through underwriting or call overwriting.

It now, um, those strategies have worked extremely well. So the fact that you know we have a one or you know a few day market moved to the downside, doesn't, you know, um, nullify gains in those types of strategies that have occurred over the past number of years that have been extremely profitable. But I think it makes people more cautious about and going forward. Thank you so much, Stuart. Whether greatly appreciate time out from your BMP Perry bod Day.

Maybe you look forward to speaking to you later this week or into next week. Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at I'm keen before the podcast, you can always catch us worldwide. I'm Bloomberg Radio