Today Alan and Mark step back from the noise to examine a market environment that feels subtly but meaningfully different. From AI euphoria giving way to harder questions, to gold’s steady rise and a surprising divergence between US and emerging market inflation, the conversation centers on rotation, uncertainty, and shifting assumptions about safety. They explore whether Treasuries still anchor portfolios the way they once did, how fiscal pressures could reshape monetary policy, and why regime thinking matters for systematic investors. Beneath it all is a reminder that correlations change, narratives evolve, and adaptability remains the most durable edge in uncertain markets.

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Episode TimeStamps:

00:00 – Introduction & market check-in

02:52 – February performance: CTAs, trend following & commodities

04:53 – Peak bubble? AI, metals & speculative excess

07:10 – Gold demand, central banks & safe-haven flows

10:40 – The AI narrative shift & tech repricing

13:22 – Global rotation: US vs Europe & emerging markets

15:22 – EM inflation now lower than US — why it matters

21:48 – Why macro still matters (regime thinking vs stock picking)

31:49 – Fiscal vs monetary dominance explained

41:59 – $700B in Treasury issuance — scale of the debt machine

44:51 – Inflation, asset bubbles & fiscal theory

56:45 – Machine learning, regime shifts & why trend following survives

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You're about to join Niels Kostrup Larson on a raw and honest journey into the world of systematic investing and learn about the most dependable and consistent yet often overlooked investment strategy.

Welcome to the Systematic Investor series.

Welcome back to the latest edition of Top Traders Unplugged where each week we take the pulse of the markets from the perspective of a rules based investor.

It's Alan Dunn here sitting in for Niels, joined by Mark this week.

Mark, how are you?

Not too bad.

I was just in Chicago the last couple of days in a 60 degrees Fahrenheit which for Chicago in February is quite unusual.

Very nice.

Well, I'm in Dublin.

It's been raining non stop for about, I don't know, at least two months it feels like.

So I'm off to Miami next week.

Nils is already out there obviously we've got big, big Iconnections hedge fund conference so a lot of people will be out there.

So if you're there, say hello.

Looking forward to that.

And obviously, yeah, hopefully we'll see.

No doubt we'll see some sunshine in Miami you would expect at this time of year.

I'm gonna say that there's so many hedge fund managers in Miami, Florida this time of year, it's almost as though that who's minding to shop if everybody's down down in Florida?

That's right.

Well, yeah, hopefully it'll be a good week.

I'm sure it will.

Lots of, lots of meetings and it'll be very busy.

We always start off with what's on your radar.

Anything out of the ordinary catching your attention at the moment?

Well, everything seems to be out of the ordinary in the last month, since the beginning of the year, between all of the bubbles we've had the craziness in geopolitics.

So where do we begin?

Hard to say.

Fair enough.

Well, we'll get to all of that in a minute.

I think it makes sense to cover off on performance before we get into the main topics.

So on the month, trend following and managed Futures continuing its recent good streak of performance month to date, the Soc Gen CTA index up 1.1% and the Soc Gen trend index slightly better at 1.15% and then year to date pretty much neck and neck.

Both the Soc Gen CTA index and the Soc Gen trend index up 5.9% on the year.

So it's obviously been a good period this month.

Obviously.

Yeah, we've seen a bit of a dip down in equities but continue to see some decent moves on the commodities side, I would say obviously gold higher on the month, and that's been a big trend in the soft.

The likes of cocoa and coffee trending to the downside.

Energy markets starting to move up and then elsewhere, obviously currencies probably a bit more choppy and US Bonds obviously moving up, trending in the last while, but obviously it's been good, period.

Not just this month, last month, but for a few months.

Mark, any thoughts on how performance has evolved more recently in the last few months?

Well, it's interesting is that I like to say that after January, we may have hit, at least in the metals and maybe some of the other markets, what I'll call peak bubble.

And when you think about it, we had the spike in gold and silver.

We've had a little bit of reversal.

What's really crazy is if you look at some of the softs, if you look at what happened to cocoa in the last year or so, we've gone from a 12 handle down to 4, which is the same with coffee.

It's just been a tremendous move.

And this is what we see repeatedly with a lot of bubbles.

This is that you could have a blow off top that near might have some correction and then sometimes they'll just slowly just grind lower.

And this is where a lot of trend followers can make money on both sides of the market.

Market goes higher, you take on a little of that speculative fever on the upside, then if you can learn to get out at near the tops, then you can also play it on the other side.

Absolutely, yeah.

But yeah, I mean, it's interesting mentioning bubble.

And I know in your notes in preparation for today you're talking about peak bubble.

I mean, coming into here and over the last few months, there's been a lot of talk about bubbles in the market and tech stock, et cetera.

And obviously a lot of the momentum has already come out of that.

So is this a pause, you think, or are we in the midst of the initial deflating, do you think?

Well, it's hard to say because you have to go back to what causes bubbles in the first place.

So you're going to need sort of the fuel, which is excess money, which I think we still have.

But you also need a narrative and a story associated with a bubble.

What we find with a lot of bubbles is that it's for those assets that are very hard to value.

Because if they're hard to value then you could be able to get stories or narratives that lead to extreme price moves.

Now an interesting piece of research that studying it was talked about the retail habitat.

So, so these analysts have looked at retail investors and sort of said what seems to be their characteristics.

So one of their characteristics is, is that they actually gravitate to hard to value stocks.

So, so stocks and other assets that are hard to value that if they have an optimistic narrative then they could lead to sort of extremes.

So, so that's what we sort of see with, with a lot of, you know, tech stocks.

If you don't know what how to discount the future cash flows from these firms, then it's harder to value.

You could be extremely optimistic and that leads to know bubbles in the commodities markets.

I think we're a different situation is this, is that people sometimes forget that a lot of commodities, especially if it's not an annual crop, this is that that there supply constraints for mining for example.

Supply constraints.

So if you have some optimistic euphoria, whether it be in silver or gold, where are you going to get the supply is this supply is constrained so you could have these demand shocks.

And that's what we've seen with the, with the gold market and the silver market is that we're not going to see new supply and in fact we'll so to say some of the discount in gold from the high is just related to the fact that there are fewer retail investors right now because of the Chinese lunar New Year.

Okay, interesting.

Well as you say gravitating to hard to value markets certainly makes sense.

The tech stocks, crypto and obviously there's been a lot of retail participation in the gold market of late.

So that's very much consistent with you know, much more retail participation and obviously as prices rise that encourages new entrants into the market.

So I think that's definitely fair there.

Well, the central bank issue is very central to gold markets and we'll talk about this a little bit later when we talk about the US dollar and US assets as a safe asset.

This is that those countries that feel as though that there might be a potential risk of sanctions have been bigger buyers is their central banks have been bigger Buyers than other central banks.

So we'll say China has been a big central bank buyer.

Some, some of the other countries that we know that you know are worried about sanctions from the us There have been bigger central bank buyers.

Some are on the periphery of where there could be war.

Like Poland has been a big buyer of, of of gold.

And so we'll sort of see that this is a, this is serving as a quasi safe asset.

So if you have foreign reserves or you have your excess reserves, if you're a central bank, say like well if I don't want to put in $, where else can I put my money?

And they say like well if I diversify I should put some in gold.

This is what we've seen has changed.

Yeah, no, for sure.

And you're right, I mean the data I looked at, I think it had the national bank of Poland that was the largest buyer in that period.

And also a lot of the former Soviet countries ending in Stan.

Places that are hard to pronounce but they're not just Uzbekistan but other places like that.

So that's certainly consistent with what you're saying.

Now interestingly you touched on narrative there, which I think is quite interesting and obviously something that we're seeing in markets at the moment is a shift in the narrative around AI.

If we went back 12 months, maybe AI was seen as a positive influence, it was going to change the world.

It was all positive.

More spending was a good thing, it was going to benefit the likes of Nvidia and all of those chips and infrastructure providers.

Obviously that's shifted as we've come into this year.

We've had the SaaS apocalypse.

I struggled to get that one out.

The software itself and I suppose more generally, clearly you know, that shift in the narrative to the fact that, you know, clearly there will be winners and losers from this AI revolution, that's one thing.

And then secondly, obviously in terms of market reaction to earnings numbers and you know, the releases about the amount of capex spending around AI.

So just curious, your take on that shifting narrative.

I mean what does that suggest to you in terms of is that symptomatic more of the end of this move or just a different transition, a different phase of the move?

Well, let's talk about what I mean by the word narrative.

So when we say the word narrative, oftentimes we say, well we think of it as a story, which is true.

But I think that narrative is the use of storytelling when we don't have what we'll call countable risk.

So let's say that there's a difference between risk and uncertainty.

So a risk is something that's measurable.

I can count it.

So that would be our volatility.

So if you say, well, what's the volatility market?

You say, let's look at the vix, okay, it's something that's countable even though that's a market expectation from the options market.

But then there's an uncertainty is that which is not countable.

Okay.

Because I don't have any past events I could look to.

So when I think of AI and the AI revolution is this, is that since this is new technology, I don't have a way to actually measure the countable risk.

So therefore I have.

I'm in the realm of uncountable, which is uncertainty.

And there are, therefore I have to use narrative.

And then when I use the narrative, I have to come up with a metaphor or story for what I think might happen in the future.

And in this particular case this is.

They say like, well, I have to discount sort of say the potential use of AI in, in the future.

And we'll sort of say that AI is revolutionary.

A lot of our behavior, it's going to revolutionize a lot of businesses, it's going to increase productivity.

But is the growth going to be what is embedded right now in expectations or is it going to be a little bit lower?

Is it going to be a little bit higher?

And because we can't sort of count that, that's where the narrative issue comes in, is that you could have a very optimistic narrative that and then discount the price with those values or it may be something in between a failure and these overly optimistic forecasts, we've kind

of fallen into more of a rangy market, particularly with respect to equities in the last while, I mean, if you look at performance, say over the last four weeks or so, bonds have actually gone up.

Equities have come down a little bit.

You had the kind of the, the escalation of the run up in metals and then a correction.

Currencies have been ranging, so nothing, I suppose underneath, maybe the big theme has been the rotation in markets.

Is that probably fair to say?

No, absolutely.

So the rotation has been out of the US into European and global stocks.

It's been out of, you know, US Bonds to some degree.

Or now when we say out of bonds we want to be precise.

There's been a lot of buying of US Bonds even by foreign investors.

But at this particular time, a lot of them are now hedging those bonds as opposed to unhedged.

And we see US Pension funds flows moving from the US and to outside the United States.

And so that's where the rotation comes in.

We're seeing the difference in, say, software companies have fallen, more real asset companies have gone up.

The sort of the AI stocks have fallen also.

And I mean, one of the interesting features has been if you look at it from more of a sectoral perspective, you know, you've seen maybe industrials and materials, which would be kind of typically seen as cyclical sectors doing well, and at the same time consumer staples doing well, which would be typically more kind of defensive stock.

So I mean, from that lens, a bit of an inconsistency, I guess we are seeing a rotation out of growth into value.

But I mean, is there, I suppose, a coherent story around that narrative, apart from, okay, I hear what you're saying about add a view, as it were, which is underpinned by a fairly obvious kind of story.

But the other rotations, what's driving those?

You think, well, it.

Let's go back to some of the facts that we sort of see.

One is this is that, and I'll be leading the witness.

This is that.

What do you think of the US Inflation relative to emerging market inflation?

Which do you think is higher or lower right now?

Well, you wouldn't guess us, but I'm guessing this is a trick question.

It's sort of a trick question, but I found this very amazing that if you look at a basket of EM countries and then you look at their inflation, it's actually lower than US Inflation even now.

So obviously US Inflation was peaking after the pandemic.

But what we'll sort of say that even now is that US inflation at even at around 3%, our core inflation is higher than what we're seeing in emerging market countries.

So this is a really big theme because what that means is this is that EM is much more attractive than the US just from the inflation story.

So that's going to cause rotation.

So if you see that kind of behavior going on, then you have to say, well, what's really going on?

And I think that the major theme that I see is two factors is that we have this K shaped economy where we have very difference between the real economy and then the asset economy in the us and that's being played out in the behavior of assets such as stocks and bonds around the world.

And I mean you touch on the EM inflation versus US inflation.

And I guess one of the upshots of that is that real yields in EM are higher and more attractive than in the us.

And I mean, I suppose linked to this is I suppose historically the EM had a premium because policy was less credible, central banks were less independent, et cetera.

They weren't as rigidly pursuing inflation targeting.

But now everything is shifting.

They're kind of more adhering to those inflation targets, whereas credibility is maybe diminishing in the us.

So I suppose is that rows of attractiveness of US versus EM shifting?

Yes, I think the attractiveness is shifting.

And we'll just say that part of this has to do with the major story of uncertainty.

Now I follow pretty closely.

We have trade uncertainty indices, we have geopolitical uncertainty, monetary uncertainty.

Some of those have peaked in the fall, so and some of them have come down.

But let's say trade uncertainty is still at very high levels.

Overall uncertainty is high, although it's, it's again, it's, it's come off its peak.

But when there's more uncertainty in let's say a G7 country or in particular the US that's going to have an impact on whether, you know, foreign investors or even US investors look at us as a safe asset.

So that's on one level.

And also if there's more uncertainty, it's say like, well, I'm going to need a premium to hold a risky asset in a high uncertain country versus a less uncertain country.

And so we're also seeing sort of flows going out there because you say like, well, maybe I could discount those cash flows better in other countries than the US right now, just on this

EM issue, I mean, is this a structural change, do you think, or we just had a point in time where this is a sweet spot for em.

And I'm kind of thinking in terms of the overall regime that we're in at the moment.

Obviously we're in a higher nominal GDP environment, more inflation uncertainty.

There's various features from an economic perspective, but we're also seeing this shift in the relative attractiveness of EM debt versus a developed or particularly US debt.

But I mean, could EM sovereigns be seen as the new safe assets.

Really?

Or once we get to the next crisis, will all of this unravel?

Well, I'm spending more time thinking about the concept of a safe asset as a relative concept as opposed to an absolute concept.

I think a lot of people when they think about a safe asset, well they, they've always viewed as the US dollar or Treasuries as a safe asset and it was as absolute.

And I think now we have to think of safety as a relative concept is is that you could still be a safe asset the US treasury, but it might be less safe than it was a year ago or two years ago.

So consequently is that if there's your relative safety has gone down even though on an absolute basis you're safe, then that means that people are going to diversify more of their asset flows.

Have we seen a fundamental shift in EM I'm that's probably not my area of expertise and I think that those are longer term structural changes.

But we do see a situation is that the relative safety or the view of the relative safety of US Assets has fallen.

Yeah, fair enough.

I mean it is something I've been thinking about.

I mean you do hear this comment sometimes of bonds are not going to diversify equities anymore.

Look at the bond equity correlation.

But it's very definitive when you say it like that.

Whereas I don't think that's the case.

I mean you can certainly envisage certain scenarios where we have crises, the Fed cuts rate aggressively and bonds rally while equities go down and bonds do diversify.

So you know, I would think in more as you say, like kind of less safe or less reliable as a diversifier, but not.

It's not yes or no.

It's more, less, less so than in the past.

Well, this is the, the key overall theme is this is say like you know, obviously I'm trend follower, a strong believer in trend follower, but also global macro guy.

And the reason why I am a global macro person is because I think we go through regime changes or there are different regimes that we might be in where relationships change through time and by being aware of we'll call it the regime changes or how all of our analysis is conditional, then you might be able to get an edge and how you should form your portfolios or where you think that the opportunities might exist.

Now I was going to start with a quote earlier in our podcast.

This is that that was from Peter lynch from Fidelity.

This is work for Fidelity for a number of years.

But I don't believe this quote, but I thought it was a great one.

He said that if you spend 14 minutes on macro then that's 12 minutes too long.

So I don't know if I will actually believe that.

I think you should use the whole 14 minutes or maybe more to spend time macro.

But I think that there is this view is that that you don't need to know what's going on in the global macro economy.

And I'll, I'll take the opposite point of view is, is that we do need to do this, that has a big impact on all types of assets because most of our asset price relationships are conditional on the environment we live in.

And yeah, you know, let's give a simple example.

There is an interesting paper.

I was looking at this, it was talking about beta.

And then if you just look at, you know, what is the beta for an individual stock or what is the beta for you know, a given asset and once you break it down into, you know, you know, different regimes, whether we're in crisis, non crisis, recession, non recession is the concept of a beta for a individual stock is a fairly fluid one.

This is that and I, I remember one discussion I was having when I was at John Henry, he said like what's the beta for the stock?

And I said well it's, it's, it's this, but if we measure it differently we'll get a different beta.

He goes well what do you mean there's a different beta?

He said there should be one.

What is the beta?

And I said like well there isn't a beta.

It's, there are many betas because they, they like his hands are thrown up frustration and say like I ask you a simple question, can't you give me a simple answer?

And the answer is no, there are no simple answers.

Now that could just be because I'm an economist and there's always.

On the other hand but in some senses is that a lot of our relationships that we see are conditional and that's why we have to spend a lot of time looking at different regimes, looking at different environments because that's how we create an edge.

Yeah, no, fair enough.

Well I agree with you.

I mean Peter lynch was a bottom up stock picker.

So I mean in terms of how he ran money, obviously hugely successfully, he wasn't a macro oriented investor.

But I think for the rest of us, if we're thinking about portfolio construction, certainly good to be cognizant of the macro picture and the regime changes.

But just on the regime change I mean, we always talk about it, you know, that there's a regime change underway.

Now you could look at the equity market and you wouldn't really see much evidence of a regime shift.

It went up back then, it's still going up now.

So nothing there.

But it is curious to think about what are the elements where we're seeing that change in the regime.

And so the bond equity correlation is obviously one obvious example of that.

I guess another one is maybe the US dollar.

Going prior to Liberation Day, the dollar was kind of strong on talk of tariffs and it was rising on relative interest rate differentials.

And since then that relationship has been weaker.

And obviously you could say there's some kind of negative premium or a discount or whatever being applied to the dollar maybe on the basis of credibility, et cetera.

And maybe gold is the flip side of that.

Historically you would have explained it in terms of real yields and the dollar, but obviously it's been accelerating in the last one to two years independent of those factors driven by central bank buying, ETF buying, et cetera.

Anything else you look at or any other signs that you see that, that point to that that are evidence of that regime change, do you think?

Well, we can think of regime change on a number of different levels.

This is that.

So you can think of regime changes and use sort of techniques so called like hidden Markov processes to just sort of say like well, are we in a high vol, low volume regime or risk on, risk off regime?

And I'm not saying that those are easier to forecast, but we could sort of say that's very data dependent.

So we do find this, that for example, is that if we're in a higher risk regime or a higher risk environment, that the behavior difference, strategies and tactics are different than if you're in a low volatility regime.

And we also do know, and in particular, let's look at the vix.

This is at what you find is that the VIX is a very skewed distribution.

We do find this is that once it gets above like 25 and it's, and it's moving higher, so it's above a certain threshold level and moving higher, this is that it's bad news for a lot of assets.

So then if it gets to above you know, around 40 whatever, then we know it's sort of peaking and then we know it's going to come back the other way and that's good news to get back in.

So, so there's a nice non linear relationship and we could use sort of like techniques to look at high versus low volume environments.

So, so we could do that.

There's also regimes when we think about the environment, you know, what type of monetary environment we are and what type of fiscal environment we, we're in.

So, so and we could think about, you know, the view of geopolitical if there's high level of uncertainty that's going to change the demand for safe assets.

So there's, we'll call it the, you know, price driven regimes.

There's policy structural regimes, there are sentiment regimes.

So we could decompose these different types of impacts.

And so you know, in a, in a simple podcast we can, we can be flip with our definitions but when you look underneath the surface that you have to decompose this into a lot of different types of regimes and that, that's where, this is where you could be able to create your edge.

So, so by you know, sort of decomposing the kind of regimes that you're in.

Now we do know for example the stock equity correlation regime, which is usually negative is that inflation goes up that usually then that, that that stock bond correlation is also going to go higher.

So it's inflation dependent.

So you can use sort of third factors to give us some indication of what kind of environment we're in.

And why do we want to look at that?

Because if, let's say that the stock bond correlation changes, well that has a big impact on what type of alternatives you want to buy.

Is this, is that if the stock bond correlation is negative and highly negative and rates are reasonably high.

Let me put this way, this is that I don't really need to buy alternative strategies.

But when that correlation starts to go positive and rates are lower, they say like well that's a great time to own a lot of hedge fund strategies or other types of strategies.

So that's a perfect example where we could use sort of regime analysis to help us build portfolios.

How we look at and then from a, you know, we'll say a more micro basis, this is that we know that when we build portfolios, even based on trends, the correlation relationships may have a big impact on the kind of risk exposures we have.

So knowing the regime that we're in could help us, you know, on the margin change our tilts and our Exposures to make sure that we're not overexposed to one sector versus another.

One of the topics you touched on there was the kind of the monetary regime, and I think you might have mentioned the fiscal regime.

But certainly we're into an era now where there is a lot more talk of possible fiscal dominance.

I mean, people have been drawn around the term fiscal dominance for a while now as if we're here already.

I don't think we are quite there yet, but it is obviously a risk because fiscal dominance is when the debt and deficit levels are so great that they are dictating monetary policy.

I know the pressure is on monetary policy at the moment, but we're not quite there yet.

But taking that angle, that lens, what would you say about the regime now versus where we were from a kind of a fiscal and monetary dominance perspective?

Right.

Well, I think that this is this issue of, or at least trying to frame a lot of the discussion about Fed independence.

Frame who is going to be the chairman of the Fed?

Frame, you know, how.

So the tussle between, let's say the current US administration and the central bank has to be looked at through the idea of fiscal versus monetary dominance.

And so of course there's a political agenda going on here, but I think sometimes is that we have to take ourselves away from the politics and look at the economics and try to say, is this that what causes this?

The tension between the Fed and the Treasury Department.

So we'll try to take out the administration.

We'll call it Fed versus Treasury.

And this is the issue of fiscal versus monetary dominance.

And in a monetary dominant environment, we'll say the Fed could focus on, or the central bank can focus on inflation, employment, regulation, and the fiscal focus is just on financing.

They say, where can I minimize the cost of my debt?

That's all I have to worry about.

You know, say the Fed could do whatever they want and in fact the fiscal side or the treasury could say, yeah, you could follow whatever you're doing because your objective is full employment.

We're just going to then try to pick on the curve where we want to issue our debt and we're going to finance our deficits, which we don't think are going to be persistent and everybody's happy.

Okay.

If we have to go into a fiscal dominant situation, well then, you know, the government and we'll sort of say that even the central bank, even if they're appointed for a long period of time, they're still authorized or there's oversight by Congress.

Fiscal dominance says that debt is so high, the central bank or we're going to put pressure on the central bank to use its powers to control interest rates and then buy up excess debt.

So like, well, is this abnormal?

Is this should be shocking?

Well, they look at World War II, you know, the, the whole idea is that the Fed kept interest rates low because we're financing huge deficits to pay for the war.

And then they are actively buying Treasuries.

So this is what happened in World War II, post World War II.

And then we had the Treasury Fed accord.

The Treasury Fed accord said this is that, well, now that we're going to split the Fed and Treasury working in tandem to lower the cost of financing because in the effect of doing that erased inflation.

Now we're going to allow them to sort of move in different directions.

So now what's important here is there been another recent paper about debt.

And then they talked about debt as a safe asset.

So like.

Well that's true except if we're having a war, then if you buy debt and if in you're in a war scenario, because there's a lot of financing of war science and then there's usually inflation because of perhaps pent up demand after the war ends, is that you don't want to be a debt holder.

And what these authors actually said is that the pandemic had all the characteristics of a war.

We had constrained demand, we had excess monetary policy, we sort of drove down interest rates, we had excess fiscal policy.

It's sort of, sort of offset, you know, the, the war on the pandemic.

So what happens when we came out of that is that, well, that's why we had a sort of inflation burst because of the excesses of fiscal policy.

So when you think about it, this is that the excesses from that pandemic war is now we're still having that issue today because in some senses that we should have said like, well, all of those spending was temporary, so we should have seen a big budget deficit increase.

Now that the pandemic is over, we should have reversed all of that.

If you don't reverse that, well then you have a problem.

And this is where now you have the tussle between the monetary and the fiscal side.

A lot to get into there.

Yes, as you say, you've got this tussle and as you rightly say, I mean Covid was treated just like a war.

That was the kind of narrative at the time.

And I think in the UK there was actually direct buying from the bank of England of bonds issued by the treasury, whereas in the US it wasn't direct buying, but it was all.

But in May, I mean, the treasury issued more debt and the Fed did more qe.

And so they didn't finance it directly, but effectively they did.

As you say, we had a surge in deficits which haven't been addressed since then.

It's also a form of financial repression of course as well, isn't it?

Because obviously you pin down long term rates and you allow inflation to be higher so bondholders experience negative returns.

And then ultimately in that scenario, the Fed did flex its muscles again and demand its independence back.

And that's why you had this kind of standoff between the Fed and the treasury, which ultimately resulted in the Fed treasury accord and the Fed got its independence back.

So this is all relevant in the current context because people are now saying you've got Kevin Warsh and you've got Scott Besant, both linked via Stanley Druckenmiller, interestingly enough.

But they obviously already have spoken about a possible new accord.

But I mean, I've spoken about it in some kind of positive light.

But I mean, you know, would that be, should we interpret that as more financial repression or what do you think that might look like?

Well, here's where the situation we're in right now is that we'll sort of say that the current Treasury Department would love for the Fed to lower interest rates because that lowers the cost of debt and you could use that instead of paying off interest.

You can use, you know, that money for other purposes.

It could be used for other expenditures.

So you have the desire to do that and you sort of say, well, if you can't default on your debt, what's the easiest way to reduce the value of your nominal debt is that if you have inflation, so you have a Treasury that would sort of say, I'd like to have lower interest rate to lower my financing costs.

I really don't mind if, let's say there's a little bit higher inflation, even though they'll never say this because that reduces the real value of the debt.

And we'll sort of say then you have, we'll call it this K shaped economy.

And if you look at some of the data on the employment side, you can sort of say that I may want to be, if I, as a current administration, I may want to run an economy hotter because I don't believe the data that I have.

And a perfect example is that we just had in January, the revisions for employment.

The revision for employment said that there was probably a million fewer jobs created because we changed the benchmark rating year before we actually did a seasonal adjustment and we got like lower job product production.

So if you said like look, we didn't create a million jobs in the last year or so, this is that the economy may not be doing as well as we expect on the, on the one leg of the K. So you may want to say I want to run my economy hotter.

Now you could also say that these benchmark revisions was caused by demographics.

And so if let's people are moving out of the United States, we'll call that euphemistically they're moving out of the United States and you have less people in the workforce, well then it may not matter as much.

So we don't see the unemployment number going higher.

But you'd say like there's this tussle between fiscal and monetary policy because we do have, you know, these competing interests.

Now the interesting part and the reason how we get back to this recurring theme of always uncertainty and is that worse has said is that he never really liked QE in the excesses of what we had.

So if some sense, if he actually follows through on what his behaviors, he's going to reduce the amount of, of, of Treasuries on the Fed balance sheet.

That's reducing the overall liquidity.

That's going to cause a major deleveraging which should have an impact on asset markets.

At the same time is, is that it's exactly what the treasury does not want him to do.

They like the fact that the Fed has a large balance sheet and we'll say like look at the size of the financing.

This is that again, you know, Alan, I throw out these questions just to be provocative.

You, you know, you're going to, it's not the obvious answer.

Like how much debt do you think the US Actually issued just last week?

Just, just take a guess.

Half a trillion or something there.

So you're, you're, you're close, but you're still off by about $200 billion in one week.

The treasury that we had sort of like some, you know, quarterly refinancing.

This is it.

And not all of this was new money.

Some of this was rolled over.

But, but we, we did like a $700 billion of treasuries being auctioned in one week.

Now that was between bills 2 years, 10 years.

So it was along the entire curve.

So, but that's a huge amount of money.

This is it.

Now the world can absorb that kind of stuff.

But if, let's say that there was a change in people's buying habits for Treasuries, that's a big number.

And so when you think about, in one week you could do that, then you look at the size of the balance sheet.

That's, that's a pretty good portion of the entire Fed balance sheet.

Now you again, we have to look at what is the net new money and what is this total demand from a number of different sources.

And you can cut, you know, sort of overnight repos.

So, so there's ways to do this, but that's a big number and that, that should give people a sense of, you know, what we're dealing with in terms of the size of the issues.

Yeah, well, as you say, the demand is there for it at the moment.

I mean you could have to, you'd have to look to see where it's coming from.

Obviously that's shifted over time.

Maybe it's less foreign.

I mean, and also they've talked about changing the SLR to make it more attractive for banks to hold it.

So there are things, but, but I mean, coming back to Warsh, I mean his idea is, is the smaller balance sheet but equally lower rates.

And then I guess the upshot of all of that would be maybe more TBL issuance to take advantage of lower short term rates, if that's how it played out.

But one thing that we're missing in this, we're talking about fiscal dominance.

Central banks are only targeting inflation.

And now we're talking about no adjusting rates to target, you know, to be cognizant of debt.

But of course that forgets about asset prices.

So if we had this scenario of the Fed being more cognizant of debt considerations and lowering rates for that reason as well, not only could it be inflationary, but presumably as you say, it would run the economy harsh and potentially fuel acid bubbles as well.

Which is another part of the discussion from the 90s that, that kind of is kind of getting lost in, in the current debate, I think.

Well, let's go back to what we started with.

We always talk about regime changes.

So first this is that this could be a regime change.

This is that if we get a new Fed chairman because he might have a different view.

Now let me put this way, there could be a regime change because he has the view that is consistent with what he said he was, is interested, which means have a lower Fed balance sheet because we could also have a regime change, is that he's going to sort of follow more of what the Treasury Secretary would like and allow for fiscal dominance.

That's a different regime change.

So, so, and the other third will, will sort of say that if we just continue to follow the path of these large deficits in the US and probably the most interesting piece of research the last couple of years in the macro side, it hasn't got as much attention as John Cochran from the University of Chicago now at the Hoover Institute.

So he's written about the fiscal theory of the price level.

And so he said, well, if we really want to look at this shock to inflation, you know, post pandemic, we have to look at it as, it's a, it's a fiscal theory of inflation.

It's not a monetary theory.

Now, the two of them were working together, but his view is that you're going to get inflation because people are going to take your money out of, you know, going to start to buy real assets as opposed to, you know, debt assets if there's the expectation of permanent large deficits or we'll call it negative surpluses on the fiscal side.

So that's going to lead to inflation.

So what are you going to do is that you're going to put your money into real assets, which we've seen in the gold.

If we say you're going to put it in other financial assets, we're calling this sometimes a bubble because if, let's say too much of it goes into one type of assets, but generally financial assets are being bid up because people, you know, sort of feel as though that, you know, they may have excess savings, they may not want to buy real assets or they purchase goods so they, they're bidding up financial assets.

Yeah, I mean, it's interesting because if you go back to last summer, I think it was Kevin Warsh gave an interview on cnbc.

He talked about all of this.

2022 has been one of the, I think it's the biggest macro forecasting mistake in 40 years.

And he talks about a need for regime change at the Fed.

And he also blamed, he saw the Fed as being complicit in the, the deficit expansions that we've seen because they've effectively financed it.

And he had a definition for inflation of something like inflation happens when the government spends too much and lives too well or something like that which is consistent with the Cochrane perspective.

This is consistent with this.

So let me put this way.

It's possible, this is that if you get the Chairman Walsh of his comments over the last 10 years, you know, we'll sort of say the current administration may have no idea what they're really getting.

If, if, if, if they, if he's the person that they choose and he follows through on what he says he's going to do, we're going to be in a very different monetary regime because we're going to have, we're going to be cutting back our, you know, our, the balance sheet.

You could sort of say there's going to be a different view on how we're going to look at interest rates and we say that that may not be inconsistent with what the Treasury Secretary would like.

This is.

So, this is.

So when we talk about uncertainty and then we talk about, okay, why might you want to be a trend follower?

Why do you follow certain strategies?

This is it.

I don't think people fully appreciate the amount of uncertainty they could have.

If, let's say you just, you know, it's almost as though that at different times you like, you see people in government and you say, like, I'm surprised by what he did.

And if you said, if I, if you just read his speeches and read what he said, you might have a pretty good idea and you'd say like this is not what you were expecting.

Well, there is, I mean, there are different views in this.

There is the, the kind of, the, as you say, that's a very literal reading of what he's saying.

But he has also said that he believes in the disinflationary effects of AI and he sees scope for lower interest rates.

So presumably he was emphasizing those comments when he was doing his interviews at the White House.

But there's also, I mean, have you seen those charts that show whether he was dovish or hawkish, depending on whether it was Republicans or Democrats in power?

So, so there is a suspicion that he might be a bit more political than maybe than other central bankers.

We'll say Wall street and many, you know, voters actually sort of project what they would like to see on a candidate or on someone as opposed to what they see as reality.

And sometimes they actually then respond to what they think that, you know, their, their constituents want.

So yeah, so we'll just sort of say there is uncertainty here because we don't know what worsh we're going to get.

Yes.

So, and I think that you often see this with Supreme Court justices is that that's not the current court, but if you look historically, is that there are a number of Supreme Court justices that have picked and there is assumed that he was going to behave a certain way.

And then we say like after it becomes the justice, his behavior is, is, seems to be significantly different than what they thought that they were getting.

So this is the kind of uncertainty have.

And so what we're saying, be prepared for something that may be different than what you're reading about in the newspapers.

Yeah, I mean, that's fair enough.

I mean from a, I mean maybe moving it to more of a, a quant model trading perspective.

Obviously this is more qualitative, but obviously, as you say, when you do get a regime shift, you could get shifts in relationships that would be relevant.

So how do you think about.

And obviously the Fed is at the heart of the financial system.

So if there was a change in how the Fed is operating, whether it's a shift in towards less balance sheet, more active on the interest rates, or if it's fiscal dominance, whatever it is, that could have pretty widespread implications.

So how do you think about that when you're maybe building models?

Right.

Well, one is that we've talked about that you want to try to pick up regime changes.

So when we know we have the technology to do that.

So if we see that using, let's say the hidden Markov processes, we can be able to say if asset prices start to delink or have a change in behavior like a volatility, we can pick that up.

And so we can adjust for that.

We also know is that there, there are breakpoints in data sets.

So, so we have technology to, to what we call change point detection to sort of see if there's a change or break in a time series.

So, so now what we could have is now of course you're never going to pick a peak or a trough in a break point because it has to break before you actually then pick it up in the data.

But that being said is that if we're sort of aware that there's these structural changes, then we could be more sensitive to when we look at the data to see if there's a break point.

So, so what does that mean?

Is that one of the things that, you know, you know, I work with, with my friends with, you know, firm, we're involved in Asanthur, is that we're looking at, you know, the connections across markets.

We think of it, the markets as, as a connected system.

We think of it as a Network.

And so what we're trying to look for you, what are the causal relationships between markets?

And then sort of say, like, how have network connections changed through time?

And if we see that there are changes in network connections and we are willing to accept or, or adapt to these changes, then it's more likely that we could get ahead of it.

Now, any type of trend following any type of quant model is always sort of looking into the past.

Okay, so the question is how fast can we react to past data or how can we sort of react to these changes as they occur?

One of the advantages of having a macro view is that when you start to see changes or we expect changes, we could then be more sensitive to say, is there something going on in the data that we should be aware of?

And we're a highlight.

Yeah.

So I mean, is it a case that you would see a shift that is consistent with what you're expecting from a, from a macro perspective?

Is that it?

One would hope that it's consistent with what we see in a macro perspective.

But what we're finding is that.

And also say that this is one of the key issues that we're seeing in economics in general and especially in finance, is the issue of trying to identify causality.

So this is the number one issue in finance now.

And we'll sort of say that ADIA had their labs, had their causal discovery challenge where they sort of said like, you could use different machine learning to look at sort of finding causal relationships.

But the reason why this is so important is that because we, over the last couple of years, what we have is what we call the factor zoom that, you know, you look at enough data, everybody's finding all these new risk premiums or risk factors in the data.

And then what you find out is that you find them in the training set or you find them in past history, then we look at them in the future and they no longer exist.

So there were sort of spurious causality or we are trying to find something that we overfitted or we found something that didn't really exist or it only existed temporarily in the disadvantage peers.

So now I said like, well, look, if we're having this, we'll call it the factor zoo.

We're finding also is that, well, what we find in the data sometimes doesn't persist through time.

Well, maybe we got to go back to square one and say, let's look for what are the important causal agents.

Let's look for causal factors and then make sure that, see if our models are consistent with the actual data or can we find causal relationships that we need to rethink our models, that this is going to improve the amount overall science for quant modeling.

Interesting.

I mean, in the current context, where is that relevant, do you think?

Or what are the ones, you know, we'll say this is causality uncertain, would you say?

Well, we'll say this is a work in progress because, because what we'll sort of say that when we've analyzed some of the interesting work in machine learning right now is this, is that they've, they've done some, some testing, some research where they said like, well, is it the number of features we look at that gives us value added or is it the complexity of our model?

So linear versus nonlinear?

And you know, the machine learning world says this is that, well, you know, we want to add more complex, you know, sort of techniques to try to tease out relationships in data.

And what some of the research is now telling us this is that it's not the complexity of the technique that matters, it's the number of features that we have or it's the domain knowledge we have that actually adds more value.

So that, you know, that if it's an arms racer choosing, you know, more complex machine learning techniques, we may not get as much value.

So we talked about peak bubble.

We'll sort of say that for different techniques there's a while is that everyone thinks that this is going to be the new holy grail.

And then in reality what we find out is that it's a lot tougher to come up with a new model solution than we thought.

Another thing we find with machine learning is for example is this, is that machine learning is very good on stationary data.

So and I'll use the analogy if, if we're using machine learning to look at visual interpretations of can we find a picture of a dog?

So, so we show, you know, a hundred thousand pictures of dogs is after a while it learns how to, how to, you know, find a picture of a dog in a photo.

Okay, well, if the dog is changing through time, its characteristics are changing like a market that we find that it's a lot harder to do this.

And so, so a lot of the techniques that have in machine learning that have been very promising in different areas of science, science which has very stationary dictionary data, it's been very successful when we apply these techniques.

When we're looking at time series data that seems to be more follow an adaptive markets hypothesis, which is what Andy Low developed.

Well, we find and that we find that agents Behavior changes through time.

We find machine learning is a lot harder to, to sort of, you know, increases predictive power.

So markets are complex, they're non stationary, they go through regime changes.

Which means this is that the quest for finding the perfect model is ongoing and we still haven't solved it yet.

Very good.

So I mean it comes back to robustness, doesn't it?

I mean obviously what you're suggesting is you can't overly optimize given the complex adaptive nature of the system.

And when you think about, okay, for your listeners and for a lot of modelers, you say, well, should I tool up for machine learning?

On the one hand, the answer is absolutely, you got to know what's going on in AI, you have to know what's going on in machine learning.

At the same time, this is that your benchmark standards should be more simpler models.

So, so, so I don't want to sound like I'm a, you know, talking out of both sides of my mouth.

Basically.

I still believe in trend following.

It still seems that it works, especially in uncertain regimes, especially when data is non stationary.

At the same time as they say, like, well, how do I always try to try to improve on that?

Because so many people are already trend followers, so many people are already using similar models.

So you're always trying to say like how can I look for some small improvements that's going to differentiate myself from everyone else and also give me a predictive edge.

The problem comes in is that on margin it's sometimes hard to do that.

Now when we say it's hard to do, is that just when I think that you've solved it, come up with a better model.

Markets may change slightly and they go through periods of, you know, strong performance.

Then you get delayed perform or fall in performance and it improves.

And that's even finding for momentum and trend following.

There are periods that when it does really well, then at my period where, where it, it wanes in performance and it goes back and this is what we've seen throughout history.

So right now we've had a good performance and trend following.

You know, will that persist?

Well, I could sort of say over the next five years.

I could still be a believer in momentum and trend following over the next five months.

That's a little bit harder to say.

Who knows?

Well, we'll be here anyway to evaluate that over the next five months.

So we shall see.

But yeah.

Thanks very much.

Thanks very much for your thoughts, Mark.

Great to catch up and get your perspective on all of that.

I'll be back again.

Actually, next week I'll be back from Miami in time to record with Jem.

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