Surveillance: Block Trade Fallout

particularly for our global Wall Street audience. Tracy Halloway Behu and Sophia Hardy Acosta with the definitive article on the derivative strategies that have led to this margin callum its. Halloway joins us right now, Bloomberg Markets Managing Editor. Down at the bottom, Tracy of your article, you remind us in two thousand and eight, Financial Ireland almost collapsed over a margin call a busted derivatives to strategy. Is there any sense in this two thousand twenty one of the

Irish agony of two thousand eight. Well, I think you and Jonathan just laid out the scene pretty well there. So far, we haven't seen signs that this is really unnerving the wider market. Uh. Most investors seem to be taking it in stride. I guess the question is when you're looking at these kind of interlinkages in the financial system, like where well, there are going to be more losses, right,

we think there's more exposure out there. And then the question is why did the prime brokers have this different reaction? So Jonathan alluded to that, you know, Nomura and Credit Chice start saying that they have bosses. Morgan Stanley hasn't said anything. Gold Minty to have managed it quite well. What did the prime brokers do differently that resulted in all these different um well results, Trice is it's still too early to tell about the way they've handled this.

Is it's still too early to draw and conclude, gents. I think that's right. I mean, one of the big outcomes of this might be additional scrutiny on derivatives deployed by hedge funds and institutional investors. So this was a family office that seems to have built up these huge positions. We're talking billions of dollars worth of total return swaps and contracts for difference, but no one seemed to have really known about it or connected the dots, certainly not

the prime brokers. Most hedge funds are required to disclose their holdings um if they're actually buying the stop, but if you're doing it through derivatives, it's basically a loophole that allows you to get tons of exposure without having to declare it. And so the question I think for regulators is going to be how endemic is this in the financial system and is there a possibility that it

can be a disturbing force on the wider market. And of course we've seen additional appearing on hedge funds already because of the Robin Hood and game stop scenario. So this is another unflattering spotlight cast on hedge fund slash family offices. It's tracy from your perspective so far, and I asked this in a way that gives you enough room just to say I simply don't know. But from what you're looking at the moment, do you find it strange about the amount of ropes so to speak, that

this particular investment firm was given Bryan Prime Brokers. Um, Well, there is a question about risk management here. It seems to have been very very large positions and again possibly positions in single stock. So there's a sort of whale effect there. The other question is Bill Wang, of course,

is famous for insider trading. I think back in two thousand and twelve or two thousand fourteen, I want to say, um, it was a long time since then, but lots of people are asking why the prime brokers fret comfortable extending this kind of financing. I mean, Tracy, I know that you've done interviews with Bobby exel Rod before a billions and it's all great and fine, but you make the distinction between billions is entertainment, hedge funds and a family office?

Did this occur because the family office is different? That there isn't more of a community that can brace itself and break against too much leverage? Is what we're really talking about. One guy made this happen. I mean, I think there's a point to be made there, but ultimately, a family office isn't that different to a hedge fund? Right? Um,

but there is a question. Yeah, sorry, go ahead. No, it's just that, you know west Tricy, Tom just jumps in and says things and you've just got to carry on, Toll. We just keep on talking, Tracy. You know you're allowed to be rude. I mean, the family office, a family office is fairly identical to a hedge fund. It just that it can't really take outside capital. So the disclosure requirements, you know that regulators are going to be looking at. Yeah, the idea that it acted by itself, I'm not too

sure about that. I mean, what if true is that you have this big fund that seems to have all these interconnections with the rest of the market. Trice Halloway, it's going to see it as always blue back markets managing. Get it set. If you are a black bear from Maine, you get a job in accounting out of the University of Maine forty years ago. That's what Gerard Cassidy did.

He is legendary at RBC Capital Markets and we are thrilled to get his perspective because in my rolodex, he's the only one that remembers the collapse of Continental Illinois in Chicago. Girard, let's cut to the chase. You and I have seen this before. Why is this tobacco of this hedge fund different? I think, thank you for having me on the program, man. I would say, first, it's the size. I mean, this is an enormous size hedge fund. When you put it into perspective over the last thirty years.

So when you think about long term capital and what happened to them, and back in the late nineties, you might remember, you know, they weren't as large as what we're just saying from this one situation developed on Friday. And so to me, that's the implication is that you know, we allowed or companies grow very quickly into the billions of dollars and they get their watch amounts of leverage, and as you know, leverage leafs to problems when asset

prices moved very quickly. We've seen this lesson so many times before, and again the leverage is extraordinary, Gerard. What does a bank actually do when this event occurs? What's happening this morning for Mr Gorman? What's happening for the leadership of Nomura, the new management of credit suites? How do they unwind a trade in tobacco, a prime brokerage

tobacco like this? Well, hopefully Tom that the assets involved but have to be liquidated aren't very illiquid, because the more liquidity that these assets may have, the greater the losses will be. We'll find out more this week. Is

this story unfolds? What exactly happened here. But the first thing that these obviously management teams will do, we'll go to seize collateral, liquidate positions, and then unfortunately in cases and in some of these cases, you're going to see losses as I think No More may have already announced

as well as Credit Swiss. So the first thing they do is seize the collateral, liquidate the account, and then follow up hopefully by seizing other assets if there are any other assets that they're permitted to go after, to cover those losses, and try and price this dedicately. Because some of these banks don't fall under your conference, so let's keep things as general as possibly if I can, so you're able to comment them on them in detail.

What would it be that would take say, a couple of banks to face significant loss is and a couple of other banks that seem to say it's immaterial. Would it just be the size of exposure or is it something about the way they handled it when things started to blow up? John, I think it's it's it's both. But your first point is very well said, the size of exposure, so that that, to me is probably going

to be one of the real distinguishing uh. Factors between companies that have your material losses versus multibillion dollar losses. But second, it's also the controls and procedures and the level of skill and experience of the people involved in handling the account. And so you may have people that have fifteen twenty years of experience handling this account and therefore can move quicker, or you have, see the science more clearly, the inexperienced person. Well, let's talk about this account.

There's something about this particular account that generated a lot of competition, a lot of demand to have this client on the book's chair, and that includes government sax and our latest reporting saying that compliance basically rejected this client again and again and again. And that's something changed a couple of years ago. Jed, what's you'll take as an

analyst to here that this morning? That's a little disturbing that, you know, when you hear about an account opening that has been rejected more than once by the compliance department and eventually they can get to open the account, you know, obviously shows how aggressive certain companies are in trying to you know, win new business. Obviously, to grow their business, you grow with existing customers. We all know that but also adding new customers into the fold is very important

as well. Gerard a question, and I don't want to get you in trouble with OURBC, but I think you know we've known each other long enough where we can ask us for our audience worldwide. The heart of the matter is a meeting where a manager says, we're number four in blah blah blah, and we need to be numbered two by September so we can bonus out and keep our jobs. Isn't that the heart of the matter in this repetitive reality of too much leverage leading to

difficult losses. Tom, I think that has a real influence on it, no doubt about it. The so called league tables, which are more in the investment banking area than the trading area. But these companies to pride themselves and being at the top of those stables. And I know when you look at the big broker dealers here in the United States, clearly they're not going to be happy being at the bottom or the lower portion of those tables. So there's that pressure there, no doubt about it. I

don't disagree with you. Would you change by old cell on Golden Sex or Morgan Stanley not on this news alone. You know, this comes with the territory, and it sounds kind of glib, but it's truly the case because when when you think about what they're doing every day, this type of risk is there and if you have the controls and procedures in place to mitigate the risk, which again we'll find out if that's the case, and we'll really could separate these broke the dealers like a more

constiling in golden from the others. If they are exposed and there's minimal loss or no loss, then that's obviously sets them apart from the people that super sizeable losses. Do you know what question will be asked that this morning? One of the many questions is just how many bill flanks around there right now? And if you're overseeing the prime brokerage unit any of these banks that fall under your coverage, what do you think they're doing right now?

We do a full scale rep price of every single client on the books that we're looking for more bill flanks out there that we need to actually trim exposure to Johnathan, I think they're definitely gonna do deep dives to make sure that their books are in order. Um as you pointed out, Um, they want to make sure that you know there's not exposures like this to other customers, So you're right, there will always be. But I would

also point out they do this regularly. You know, it's not one and done, so they're constantly monitoring their brain rug Ridge accounts. But maybe a more in depth review is warranted considering what happened on Friday. To be rude of me to let you go without getting its help pick what is it right now? Uh done? Them was still we're importing to Bank America. I think you guys talked about how strongly vaccinations were for this best week.

Also the employment members coming out Friday, which means this U S economy is really geared up for some real strong growth. Bank America is the best way to play that. Jared a cash up, so I gotta see it. John Cassidy, that of Obvious Capital Markets, head of US Bank Equity Strategy. Away from the story, David Kelly will join US. He's the JP Morgan Asset Management as their chief global strategists. He wouldn't know a derivative strategy if it hit him

over the head, so he's lucky this morning. He doesn't have to talk about this. What you can talk about, David, this is so important is given a boom economy, how your allocation, how your temperament at JP Morgan asset Management changes, How do you adapt to a boom economy? Well, I think the first thing is you recognize that people have not fully priced in what's going on here. I mean, this is the calm before the surge. We're still looking at about four GDP growth in the first quarter. Nothing

terribly exciting going on. But what we're seeing is this road out of vaccines. We're seeing this road out of fiscal stimulus. You've got the President about to announce another proposal UM in this week in Pittsburgh, and this is going to build to a lot of momentum as this year goes on. So UM, I think the environment is going to heat up a lot more than is really

pricing into markets. That means higher interest rates, and what that really means is the rotation probably continues, the rotation from growth to value, rotation from large cap growth to small cap value, the ROA, and perhaps uh some continued rotation to international I think all of that is still on the table. Given the heating up in the in the economy that we expect over the next nine months.

What you just said. I've also heard of black Rock David that maybe this is all under appreciated still, that this data are about to get it is still going to be unexpected to some people. How do you gauge that in this market at the moment? Well, I think the real point is that people have not seen this before. I mean, we have not seen this magnitude of fiscal stimuls along with a full pandemic recovery. It's it's completely unknown territory, So I don't think people have a good

way of measuring what this is likely to do. But I think the important point is if you've got all the stimulus, it's can only go in one of two places. It's either going to get push up real output or it's going to push up inflation um and either of those you know scenarios, uh you know does benefitsypnical stocks, does suggest higher interest rates. So I think one way the other we're going to get higher interest rates out

of this. And I think that it's just because this is so new and there's still such uncertainty about how an economy recovers from a pandemic. I think that's why people are under appreciating it right now. That's the mystery of what's about to happen in the next couple of months is how people respond to the data we're about

to see. What's your game plan? How do you think people will respond to the data were about to see the payroll sprint which could be huge this coming Friday, inflation print when the base effects start a kick in this month and next. Well, obviously know you know people have to keep an eye on on their tax exposure.

But if you can rebounce to make sure you're not underweight value, to make sure you're not underweighted international, to make sure you're not overweight the most you know, the highest pe and the most exuberant sectors of the economy. Because you know what we what we're seeing right now, you know in the story you're just covering is to something said part of a much broader story, which is, if you have a mismatch of lots of exuberance and lots of liquidity, you end up with excess leverage and

bad things happen. And you can think of plenty of various markets where people are too exuberant and that exuberance is being fed by low interest rates, and those low interest rates are going to go away over time, and I think that's what people really need to pay attention to. Here, walk down the income statement. Dr Kelly, I'm gonna get revenue. I'm going to get organic revenue growth like I've never

seen before. And into Q two, Q three, Q four, do we get margin compression down the balance sheet or does revenues just drift away? Which is I think the margin compression comes a little later. I mean, we're going to have such a surgeon demand over the second third, fourth quarters, first quarter of next year. At the same time, you know, I think the Fed has put out this forward guidance which forces them to be, you know, easier than they really should be. And so I think rates

will rise, but just a little slower. And and particularly because you know so many companies have locked in long term financing, I don't think that squeezes margins too much. And we'll also see wage growth pick up, but again it's going to take a while these things lack of it. So I think the real margin pressure is going to come in two particularly as the economy then slows down again. I mean, what we've got right now is a crull,

then a surgeon, and then a normalization. It's that normalization later on in twenty twenty two, which I think will so down Profit group. But right now profit growth looks extremely strong for this year. It's the eight point on my dashboard. David. When is David get back to the office.

When does that happen? I'm thinking the middle of summer, summer twenty one three one, and I want, want, want to get back to and we say good morning to Mr Diamond, David, Thank you, David Kenny J F. Mulganasid Management, Shape Glove Strategists. Right now on Suez and our assumptions of hydrocarbon's is Stephen Shork of the Shork Report. He

writes a hyper detailed inside Baseball Hydrocarbon Report. I don't understand two thirds of it, but I do understand that Stephen short is encyclopedic and how oil moves around this world, how open seas Steve Shark are are open seas right now when we see Suez shut down or the tensions of the South China Sea. Absolutely, Tom, it's great to be here. Thank you, and indeed with what we're looking

at with Suez. We're talking about one tenth of the global trade in seaborn oil transits through the Suez Canal. A good deal about oil coming out of the Middle East, Saudi Arabia, create so forth going to markets in Europe and in the United States. So with the blockage, some I I understand, are papusing it. They're saying it's only ten percent, it's a minimus amount relative to the global trade.

I will disagree. Uh. So the question now is that in a market that is as tightly traded as oil, any sort of disruption, let alone every ten barrels is not an in comparing contrasts to self China, see wrapping around the Straits of Malacca and up north of the Pacific rim with Suez Canal. Yeah, these are are significantly those two points at they're very narrow waterways where and

they're global trade routes. Uh And there are two of the most important potential choke points with the global trade, not just in oil, but of course in all commodities. And I think that is really the story here when it comes to oil, whether it's at Suez or South. Trying to see South, trying to see straits, and the lock of course, is extremely important because all of your demand growth for oil and for consumer goods is primarily

being driven by Asia. So to that standpoint, this while the headline of Suez and so forth is a supply side story, the overarching story in the oil market has been and will continue to be for the psillable future on the demand side. And this is where the issue really persist, because we forgot a bibrocated demand scenario here in the United States. The macro economic headlines we've been

seeing have been very positive. Now keep in mind that over the next month, when we get the the ice storms and the debacle that we saw in the Mid Continent and the power markets last month, that's going to be factored into the next batch of numbers. But overall, that's a one off event, and the general trend is extremely positive for demands here in the US, and that's a great story, and it's bullish for commodities. On the other hand, you have the kind of sloppy rollout of

the vaccinations in Europe. You have parts of the European economy once again shutting down the fear of actintagent spreading. So regardless of the supply, the supply situation will be fixed in the foreseeable future. The big question now remains under the demand side, Stephen. I hope you can indulge me just a little bit. When it comes to commodities and all we're talking about tankers going through the Suez. Can we talk about container shipping just for a moment.

I hope you could just weigh in on this, because I think it's so important. Beyond what's happened in the last couple of weeks, what we saw coming into the new year was container shipping costs absolutely go through the roof. We've seen the same with air freight as well. Clearly, there was a massive demand slump twelve months ago, then a huge inventory rebuild and increased demand off the back

of that. In your mind, Stephen, how long does it take to work out some of these kings in the supply chain, work out some of this demand to be met with supply in the months to come. Yeah, absolutely, Jonathan. And to your point, the numbers that we're seeing out of your DADA being kept by the Federal Reserve Bank of Saint Louis. With regard to your point air freight travel and in shipping channels, I mean the amount of goods being shipped on US waterways on US flagged barges

UH is surging right now. And again this goes to my thesis of a very strong demand picture here in the United States. But to your point, demand is strong, but there's only so much of an ability of capacity to move these cargoes. For instance, when we look at the ports of Long Beach in Los Angeles in southern California, those are the two largest container points for t e U S t e U s or twenty foot equivalent units. Basically, those are the metal boxes that you see on top

of the Evergreen ship stuck in the Suez. That is a picture or a snapshot of the global trade. And when we look at these numbers UH, and these numbers are very important here in the United States in the months of July and August because that's all the goods coming into the ports of Southern California coming from Asia and this is always a great bell weather for retail

demand in the fourth quarter going into the holidays. And so when we look at these numbers, we've been smashing numbers with the container flows coming into the United States beginning summer and those flows continue to the point where we have containers now hundreds of containers now anchored off the coast of southern California because there's no room in

the end. So, to answer your question, while we've already been at this for going on nine months at at this point, and there's no uh site as to when this is going to end. So we've been in it for nine months, I'm gonna double it. I'll say at least another nine months before we can up this glut. Steven great to catch up. I'm really important dates how that Steven Shock that the Showgroport founda and at its up.

This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten am Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment, and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course on the terminal. I'm Tom keen In. This is Bloomer