Author: Maggie Lake / The Market House

Translation: Shenchao TechFlow

Shenchao Commentary: Stone X global macro director Vincent Deluard sounds the alarm again: the three key indicators of the yen, oil prices, and 10-year U.S. Treasury yields are all approaching dangerous zones at the same time. He is concerned that U.S. stocks will face one last drop this fall. More notably, this person who has been a "massive bond bear" for five years is beginning to change his stance, believing that long-dated U.S. Treasuries are showing value for the first time, while Europe is replaying Japan's "lost three decades".

Vincent Deluard, the global macro director at Stone X, is never afraid to make bold judgments. Yesterday, he shared several heavyweight viewpoints on the Talking Markets program:

Let’s take a closer look…

Three Horsemen

When Vincent last visited Talking Markets in July, he warned us that we were "on the cliff edge" of three key points: the dollar to yen at 159, long-term oil contracts nearing $80, and the 10-year Treasury yield hovering between 4.4%-4.6%.

At that time, Vincent said the market was pricing in "everything will get better." And now, this morning, the dollar to yen has dropped to 155, the 10-year yield touched 5% yesterday, and oil prices are climbing again.

"If you look at gasoline or diesel prices, this is already having an economic impact," Vincent said yesterday. "Yields are starting to put pressure on the stock market, which makes me increasingly worried about the risk of a stock market pullback this fall. We have indeed gone too fast. It seems that stocks are the last shoe to drop, and the string holding it up is getting thinner over time."

Regarding the yen, Vincent pointed out that since 2011, the yen has depreciated more than 50%, which is particularly important because Japan is the world's third-largest economy. "This is truly the elephant in the room," he said. "Even at 155, I feel the yen is still quite cheap."

Vincent vacationed in Japan this summer, and he said he could "see everything functioning well there." "I think this is a point many yen bears are unaware of," he said. "Japan's tax revenue is growing much faster than GDP and even faster than social spending." After decades of pain, Vincent believes Japan has found a way out of the predicament.

So, what will the Federal Reserve do? The market is now saying there's a 90% chance of a rate hike today:

"I think the most likely outcome is a dovish hike," Vincent said yesterday. "As usual, if they take action on rates, they will do the opposite in their statements. So it will either be a hawkish pause or a dovish hike. I think it will be a dovish hike."

However, Vincent's view on bonds has changed: for the past five years, he has been "the largest bond bear in history." "The market was pricing in 8-9 rate cuts... I said, 'Guys, what you should be considering is a rate hike'," he said. "But this swing is so extreme that now I think the market has priced in too many rate hikes. So maybe we will see a rate hike in September, perhaps another one, but I really don't see how we can reach the level the market is pricing in. For the first time in five years, I am starting to see some value in long-dated bonds."

Inflation Outlook

"I still stand with high inflation," he said. "We still need to digest this wave of oil, diesel, and agricultural product shocks, and it will transmit to services and wages. So we will see bad inflation data. Meanwhile, I think the economy is slowing down. So that’s why I don't think the Fed can be so hawkish when the economy is slowing."

So, high inflation plus a slowing economy equals stagflation.

Europe's Big Problem

Vincent likes to compare Europe and Japan, "because I think they are very similar in many ways," he said. He released a report this week pointing out that Europe is now in the position Japan was in during the 2010s. "You have experienced two or three decades of stagnation, tried to expect structural reforms, tried immigration policies, and none of it worked," he said. "Now we have to swallow that bitter pill, the only real solution to the problem, which is a significant depreciation."

However, Vincent is concerned that the depreciation process in Europe may be "more chaotic" than in Japan. "The barbarians are at the gates," he said. "What’s happening politically now is not the usual European nonsense: we're pretending the revolution is right around the corner but nothing has changed. I would say the barbarians have already crossed the walls." He pointed to the rise of the Alternative for Germany (AFD) party and the emergence of the extreme left led by Jean-Luc Mélenchon in France, which he believes the market is "underestimating completely." It is a simultaneous escalation of polarization.

Vincent does not believe the EU will immediately disintegrate; he thinks "there may still be a round of incorporating the 'barbarians'," but he indeed believes that is just delaying the problem.

For this judgment, he has several trading strategies:

Short the euro against the yen. This trade has a negative carry cost, but Vincent says it is "disappearing quickly."

Long British assets. U.K. stocks are "the most hated and undervalued asset class in the world." Even British pension funds are underweight in U.K. stocks, he said. "I’m not crazy bullish on the U.K.," he added. "But if you’re going to short euro assets, you would want something highly correlated. Usually, I use Swiss assets to do this, but this time I think U.K. assets are one of those overlooked trades that can help people navigate this continental crisis."

Thanks to Tengo, Bob Bedford, MrLanius, Hawksmoor Capital, el viejo, and all the friends who watched the live broadcast...! We will continue Talking Markets with Dale on Wednesday, see you then.