Editor's Note: Below is a transcribed excerpt from Hedgeye CEO Keith McCullough's recent interview on Macro Voices hosted by hedge fund manager Erik Townsend.
In the excerpt below, Keith describes why the European economy is slowing and investors should short European banks. Click here for a very special deal we offered to all listeners. To listen to the entire conversation, click the podcast player below or visit the Macro Voices website.
Erik: Moving on to bond yields, the twos-tens curve has been flattening and again we are taping this before the FOMC outcome, where do you see this going? Is this flattening just anticipation of a dovish hike at today's meeting on Wednesday or do you think there's more to this trend and what does it tell you about where bond yields in general are headed from here?
Keith: Well I mean naturally any kind of compression in the yields spread tends to hurt the banks. That's one reason why the banks aren’t the place that we like to be on the long side. Like I said, I like to be long real growth, which is Tech (XLK) and Consumer Discretionary (XLY).
What you see functionally is the Fed is going to raise rates, unless they do what they rarely do which is go against fund futures expectations. They're going to raise rates. So, they raise rates. The short end of the curve has actually been rising and that's why you're getting a compression, because the short end of the curve is rising as the long end of the curve is falling. The long end of the curve is falling because inflation expectations are falling.
I don't expect to see a super type of flattening from here, I think that most of it is probably in there. I'm looking at a range on tens-to-twos of probably 75 to 95 basis points. I think we're right in the middle of that so I don't think that there's a lot to do there right now.
Plus, I also see a lot of people are screaming bloody murder on the U.S. stock market – stop it from going up, stop it from going up, because the yield spread is compressing – it’s like no just short the banks. I mean, it's not that complicated.
And moreover I actually think that the better place to be short banks isn’t in the US right now. It's actually it makes sense to go back to the great short call that was shorting European banks because that yield spread of course is compressing within a lower level of yields to begin with.
Erik: Let's broaden that to Europe in general. It seems like everybody's jumping for joy that all the problems in Europe are solved and everything's better. I'm not quite sure I buy that. What do you think, in terms of exit risk contagion? OK, so the world did not quite come falling apart in these last couple of elections in Europe but it seems to me like the direction is kind of clear. There's a lot of trouble ahead.
Do you think that this rally in the euro is going to continue? How much farther does it have to go and where is this all headed? And maybe tie that into your view on European banks particularly. Is it all of Europe? Is it Southern versus Northern? What's the view there?
Keith: I think when we started the discussion and you started with the dollar. You could easily go back and start all over with the euro versus the dollar. That one is super interesting to me.
The euro versus the dollar is the biggest consensus net long position in all of global macro. I define it by looking at futures and options contracts, noncommercial which basically tells you where the institutional consensus is.
So, you see the biggest net long position currently is in the Euro and I think there's a couple reasons for that. One, Macron won in France and a lot of people had euro short versus dollar coming into the year not because of Trump, but because they had to hedge against Le Pen risk. Le Pen risk obviously evaporated so that net long position came unglued.
Then, on the U.S. side of the trade you obviously had inflation expectations come down so people start to mark down their Fed fund futures expectations on a September hike and going forward. So, I think it's kind of been the perfect storm of everyone falling in love with Europe because the stock market had been going up and now they're trying to translate that into its different this time which clearly it's not. I mean European data on a sequential basis is already slowing. It was already slower than U.S. growth to begin with.
The reason why you have such a great audience on Macro Voices is because these are the people that wake up in the morning and look at the cover of Barron's, which said buy Europe a month ago, and they say that was not a buy signal for Europe. That was the beginning of the end for Europe.
I think because Europe is Europe and the reality was that France voted to remain France, I think that as we look forward we actually have European GDP growth forecasts that are the lowest on Wall Street for the third and fourth quarter of this year.
So, I think that what's going to happen is the catalyst for the short side of the Euro. You have to be timing specific here because the dollar still has some downside and the euro still has a little bit of upside. But between 1.13, 1.14, 1.15, I think that you're shorting euro's into an outlook. Of course the euro has been going up because people have been hoping that Draghi would get hawkish. But I think Draghi, by the end of the year, will be the world's most dovish central banker.
Click here to read the first excerpt we released, "McCullough: We're Bullish on Tech, Bearish on Energy."
