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I am a generalist investor, but once I get interested in an area I try to get to the bottom of it. My interest in clearinghouse started with this BIS article on the collapse of a small Nordic power clearinghouse. It was further stoked by an a report issued by the biggest users of clearinghouses asking for significant reform. As I was looking for a short selling trade on this, I tended to focus on listed clearinghouses. By far the most important clearinghouse is LCH, which does repo for European bonds, and interest rate derivatives globally. My biggest problem with clearinghouses was that they priced risk, but when things really went wrong, they suffered relatively minor consequences - a critique that is echoed in the report form the large banks.

In my last post, I had stated that CME cleared US treasury Repos, just as LCH clear gilts and European bond repos. This incorrect. US Treasury Repos are cleared by DTCC. DTCC is not listed, and remains owned by its members, which will be mainly large banks. As it was unlisted, I never analysed its IOSCO-CPMI disclosures. Having now had a look, the clearinghouse issue looks much clearer to me.

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In case you missed it, Oracle, reported numbers last week. While earnings was in line, it surprised the market with a huge pipeline of new AI related cloud bookings. An already large stock gapping 36% higher is extremely rare - and this was on top of a huge run up from the April lows.

As the FT points out, Oracle has been able to out compete other cloud rivals to build bigger bookings pipeline in its cloud business.

As the FT reports, this huge growth in pipeline is driven mainly by a huge deal with OpenAI. The scale of growth in mindboggling. They expect revenue from the cloud business to USD 144 bn in four years time. Oracle sales were stuck at USD 40bn for a decade. It essentially saying its new business will create nearly 4 times the business in 4 years time.

While the FT article suggests that Oracle was able to undercut some of the bigger established cloud operators, what seems more likely is that demand is so strong, the large cloud businesses are reaching capacity constraints. Google, Microsoft, Meta all have their own AI systems that they are trying to compete with, while Oracle seems exclusively focused on cloud, making them an ideal partner for OpenAI. Oracle seems to be implying that OpenAI is going to be giving them around USD 100bn of business a year in 4 years time. For me, the only comparison I can think is when Chinese demand started to take off in 2000, the market simply could not get its head around the scale of demand.

My problem is that this sounds bullish, and is bullish. But how do I match up such a bullish announcement with the continued outperformance of gold relative to the S&P 500? It feels like a US centred tech boom should see S&P 500 outperform gold, not the other way round.

Big gold turning points against the S&P 500 have historically been times to show caution. Oracle numbers suggest the opposite.

Perhaps gold is just responding to a weakening dollar. The turning point in markets in 1970 and 2000 also marked points when the dollar weakened then too.

There is a possibly bullish read on this.

In a recent post, I wondered if the Trump administration was going to force the Federal Reserve out of the “QE Business” - or in other words ban them from buying assets, and get them to focus solely on interest rate markets. This could be a huge issue for markets. Whenever asset markets have threatened to unwind, central banks have stepped in as buyers. The UK gilt market is good example, where the Truss budget was a shock, that caused initial margins on gilt trading to rise which caused the market to have no bidders and yields to surge. It required the BOE to restart QE to bail out basis traders.

When looking at basis trades (typically buying physical treasuries and then selling interest rate futures or derivatives) there are two different market to look at. LCH owned by the LSE Group and has dominant market share in interest rates derivatives and European bonds. CME dominates Treasury trading, and JSCC dominates JGB trading. We are mainly concerned with treasuries here, so we will look at date from LCH and CME. Looking at variation and initial margin data, there is a cyclicality to this. Spikes in variation and initial margins SHOULD be correlated. As of the most recent data point, q2 2025, margins look low at LCH.

CME data is more interesting. Q2 data shows much more of a spike in both variation and initial margins, more inline with the air pocket we saw in Treasuries during the “Liberation Day” tariff sell off.

More surprising was the lack of margin breaches at LCH

Something we also saw at CME.

Having studied clearinghouses for a while, this would match up with market moves. The MOVE Index (a measure of bond volatility) tends to match initial margins, and spikes from low levels to high levels tend to march up with margin breaches. So 2020, and 2022 saw margin breaches, but since 2023, the MOVE index has tended to be moving lower.

Generally speaking, clearinghouses tend to cause trend following to work well. So when things are going well, for example the MOVE Index is going lower, then initial margins will fall, and asset markets will behave. It is only a problem when volatility inflects higher. So generally speaking, IF the Fed gets out of the bond buying business, AND the Trump administration delivers inflationary fiscal policy or we get an oil shock, then we will have a problem. But the data above suggests that will be more likely a 2026 or 2027 problem. The only data point that I found particularly bearish was a huge drop in KCCP - which determines the capital charge for trading with LCH.

This fall in capital charge is very good for basis traders and other users of the clearinghouse, as it allows less capital to be put aside. The fall was driven by a regulatory change, which in essence allows the clearinghouse to net trades. But netting is the key issue with clearinghouses. Netting is the fundamental driver of basis trade, and leverage. LCH reports initial margin numbers on a total and net basis. As I understand it, the net number is purely hypothetical. Is the amount of initial margin LCH calculates would be necessary if all trades could be netted.

Theoretically this should be fine. But analysis suggests that we are ending up with a bifurcated market, with hedge funds all one side, and banks all the other side. As an old report form the BIS noted, all US banks have become a net lender to the repo market.

Putting it all together, conditions are nearly perfect for a clearinghouse blow up - but not yet. A sustained period of the MOVE index trading in the 50 to 60 range should allow sufficient leverage to build for a blowout move. I still think long dated government bond yields go higher. But an air pocket move like we saw in gilts in 2022, or treasuries earlier this year looks unlikely until 2026.

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A few year ago, I could see the political winds were moving to getting real wages up again. This could be achieved either by raising wages, or lowering asset prices (the political aim was to get house price to income ratios down). This line of thinking lead me to a long gold (GLD)/ short Treasury (TLT) trade. It has been a good trade.

However the TLT side of the trade has not broken to a new low since 2023.

Is the GLD/TLT trade done? Or is the TLT side just a waste of time?

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If you have never read or heard me talk about the clearinghouse trade before, then there is a tab on the home page, where most of my research is housed.

The theory of the clearinghouse trade was that the regulatory driven move from an investment bank model, where there were numerous bilateral agreements to a clearinghouse model, while simplifying the financial system, had two big flaws. First, the clearinghouse cannot go bust, and prices risk on a backward basis. If yesterday was good, then today is also likely to be good. Investment banks were far more forward looking in pricing risk. And secondly, profit maximising nature of clearinghouses means they will price risk at very low levels, before a crisis forces a rapid repricing, with causes prices to fall further.

The “practice” of clearinghouse theory has broadly been correct. A good example is the gilt blow up of 2022, when the Truss budget shock caused margins to be raised, and the gilt market went no-bid. A similar thing happened in 2020 during the Covid crisis. The problem from a hedge fund perspective, is that every time the clearinghouse model has blown up, it has been bailed out by central bank buying. Fed buying in 2020, and in the gilt market in 2022 by BOE buying bonds, even as they were raising interest rates. So the problem with the clearinghouse model as a short trade is that the politics has been supportive of “pre-emptive” bail outs.

Reading Scott Bessent’s recent interview on the Federal Reserve made me wonder if the politics may be moving “anti-bailout”. So I had a look at the share prices of the main clearinghouses, and they were surprisingly weak. Time for the clearinghouse trade?

I had viewed the political machinations around the Federal Reserve as a transparent attempt of the Trump administration to control interest rates and push them lower. The market has agreed, with 2 year Treasury yields touching 3 year lows.

The pressure on the Fed has also led the price of gold to surge, as investors question the safe haven nature of the US dollar.

My preferred inflation measure, the 30 year yield to the 10 year yield, has also surged to new highs. That is market seeing yields lower in the short term, but needing to be higher in the long term.

So far so simple. The Trump administration puts a friendly team in at the Federal Reserve, the dollar tanks, the stock market surges and everyone is happy. And that would be fine by me. But I just read an interview of Scott Bessent in The International Economy, and he had the following criticisms of the Fed policy in recent years.

And then this:

It is particularly noticeable that since Covid, (and really from 2016 onwards) the spread on corporate debt to treasuries has become low and stayed low (COVID aside).

The market has learnt that the Federal Reserve will always be the buyer of last resort. The Fed happily expands its balance sheet at the first sign of trouble. But what Bessent is saying is that this is a policy that Fed should not be doing. To be fair the Fed, it has run down its balance sheet in recent years, but I don’t think markets have priced in any removal of a backstop.

As a percentage of GDP the balance sheet is down from a high of 36% to 22% today. But prior to 2008 it was only 7% of GDP. With US GDP at USD 30 trillion, 7% would imply a USD 2.1 trillion balance sheet, or a USD 4.5 trillion reduction.

Is this just talk, or is it Trump administration policy? Would it really allow credit markets to operate freely again? If true, it would be extremely bad news for leveraged bond trades - or basis trades. After dipping in 2022, basis traders have come back in vengeance.

The basis trade has expanded massively since the GFC for two reasons. QE and clearinghouse reform. Clearinghouse reform has meant that hedge funds can get all the leverage they want from clearinghouse, as the clearinghouse can not go bust, and the lenders have no transparency on who is borrowing. This should be a recipe for disaster, and we have seen moments when this looked like it would be a disaster, but central banks have stepped in to take the other side and bail out hedge funds. If Bessent is putting political pressure on the Fed to reduce its balance sheet, then the risk of malfunction in the treasury market is rising.

I think the base case for most investors would be the the Trump administration and the Fed would bail out investors, but politics is a funny game. And not all asset owners are the same. Hedge funds and private equity guys being zeroed would not cause much of a political problem I think. Let’s see.

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The Gold/S&P 500 ratio got back to the 200MDA, and then spiked again.

Which makes a larger turn in the market more likely, implying either a bigger fall in the S&P 500 or a larger spike in gold.

And GLD/TLT finally broke out of its range.

Credit spreads have widened a tad - from very low levels.

8 month VIX continues to trade richly - something I have taken to imply that investors are keen to hedge risk.

Spot VIX still looks too low compared to UX8.

With tame commodity prices, my best guess is that the movements in equities, bonds and UX8 are markets positioning themselves for some sort of government debt crisis. The widening in French bond yields to German bond yield remains unresolved.

And the back up in long dated JGB yields suggest a market that wants higher yields.

For now, long dated US treasuries remain well behaved. But a decisive move about 5% beckons in my view.

Markets seem to be saying that inflation is building, and the current enthusiasm for interest rates cuts seem misplaced. I would agree.

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Someone asked me about Yen the other day. It was a good question. The old widowmaker trade was shorting JGBs. Short JGBs was a very popular if unsuccessful trade from 1994 to 2016 or so. As Japanese bond yield were so low, hedge fund used to love shorting JGBs and going long higher yielding bonds like US treasuries or Aussie bonds. The problem was that every crisis would see hedge funds gross get cut, and they would all buy back the shorts at the same time, and yields went lower and lower.

As well as selling JGBs, hedge funds also used to love shorting Yen - even though the Yen was generally a strong currency until 2011 or so. Since then, the Yen has lost half is value against the US dollar. In this graph, up mean weaker Yen.

Despite its weakening bias, markets have gotten very long Yen in 2025. CFTC data use to be very useful for working out when to go LONG Yen - such as 2008 or 2015 or late 2024, when the market was extremely short Yen. But as you can see, even with some reduction of late, the market is the longest it has been on Yen since data started. This suggests short Yen is the better trade.

The long Yen position is not due to high interest rates. 2 year yields are among the lowest in the world.

But Japan is running a near 5% current account surplus. This should be bullish. And the Fed being attacked by Trump, should also be bullish Yen.

And many macro traders are looking at the Yen versus the Swiss Franc, and calling for a turn, as it has fallen to life time lows against its safe haven comrade.

So why is Yen not moving? My take is that Japan has moved from being a totally separate part of the Asian financial world, to an integrated part of Asia. And this is probably accelerating under the Trump administration. Yen weakness is completely in line with Asian currency weakness.

So the better question is not why is the Yen weak, but why are Asian currencies so weak. The Trump administration has decided to tariff the two Asian giants, China and India at over 50% (potentially).

The problem Asia has is that Chinese imports are not acting as counterbalance to the US anymore. China imports have been weak last few years, even as US imports have surged.

From my perspective, currencies seem to be in an era of fiscal dominance. The Euro has rallied when Germany began to spend to rearm. Asian currencies probably need a fiscal push from China to move higher. Is there any signs of that? Well Chinese 10 year yields have stopped falling.

And domestic equity market is looking better.

Putting it all together, I think the Yen looks okay. I would say is not your “father’s yen” - its a new currency for a new era. But currency markets have become political. The recent strength in the Euro reflects a belief that Europe is finally at least trying to get its act together. Asian currency weakness reflects a lack of that belief. But perhaps rising yields in China and surging equity market suggest long Yen might be okay? Time will tell.

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A surprisingly good month, despite relative tame macro moves.

Economists really don’t like thinking about politics. If forced to choose between an economic reason and a political reason for something to happen, they will always choose the economic reason. I used to be exclusively “economic” in my thinking, but around 2021 I realised that politics was a far bigger driver. I have tried various different political ideas to make sense of the world, and give a framework for investing with various degrees of success. When I started to think about politics rather than economics, I started to wonder if Japan’s lost decades were driven by a political choice rather than an economic choice. That is in the 1980s trade fiction with the US was rising, and Japan remembering how conflict with the US turned out last time, “decided” to enter a period of weakness. I liked this theory for many reasons, as it would explain the very different tendencies in Yen and JGBs we saw from the rest of the world. While everyone else moved with the economic cycle, Japan chose to lean the other way. Its a nice theory - but for it to have any meaning, it would need to explain why the Yen is no longer strong, and why 30 year JGB yield keep rising.

As we have seen with the AI boom the ability to create and access to cutting edge semiconductor is the key to modern economic dominance. Back in the 1980s Japanese dominance saw them capture fifty percent of global market share. Using semiconductor billing data, we can see that Japanese semiconductor dominance coincided with Nikkei dominance.

What went wrong for Japan? Under American pressure they agreed in 1986 to increase imports of US semiconductors, and to keep prices high in the US. This was good for profitability in the short run, but threatened market share in the long run. With the collapse of Soviet Union in 1989, investing into other parts of Asia became far more possible - which saw the rise of various Asian Tigers. Japanese investment was instrumental in the rise of Asian semiconductor industry. Korea and Taiwan, both former colonies of Japan, have become dominant chip players.

In other words two political changes led to the decline of Japanese semiconductor industry and the rise of Asian semiconductor manufacturers. One was the rising trade tensions with the US and the second was the opening up of Asia after the collapse of the Soviet Union. Japan had become expensive, and geopolitics and economics encouraged Japanese corporates to invest overseas. First in the Asian tigers and then in China. When your most successful corporates choose not to invest locally, then is there any surprise you suffer economic decline? But using a similar analysis, political changes are now favouring Japan again. China is now perceived as the bigger threat to the US and Taiwan is seen as too risky to have nearly all high end semi production. One big advantage is the Yen has materially against the Taiwanese dollar.

Japan also faces much favourable tariff regime relative to China and most of Asia ( of course subject to the whims of the White House).

From a geopolitical stand point investing into Japan makes sense for Japanese corporates again. And just like in the 1970s joint government and corporate cooperation is beginning to take hold.

As an article in this week’s Economist highlights, residents of Kyushu can’t believe the wages that TSMC are offering for cafeteria staff (USD20 an hour). Last time I was in Japan most unskilled jobs were being offer a rate of 1000 Yen (USD 7 an hour). Rising wages is very bullish.

What does this all mean? Well in 1990, Japan was expensive and a geopolitical rival to the US. For reasons easy to understand, Japan chose to become non-threatening to the US (and for easy reasons to understand, China is doing the opposite). They invested overseas, and often licenced a lot of technology to Taiwanese and Korean companies. Japan Inc success became a much more palatable Asia Inc success. But now, China has become the main threat, and the geopolitics of Taiwan being the only producer of high end chips has changed the logic again. Now the US wants Japan to be a competitor to Taiwan and to China. And with such low costs, and great infrastructure Japan is an easy sell. We have become so accustomed to Japan being a big investor overseas - what happens when those flows reverse? It is currently has the largest net international investment position surplus in the world. Something that started to surge from 1990 - unsurprisingly.

Economic analysis suggests Japan is dead. On my preferred measure of market capitalisation to deposits, domestic Japanese banks are priced for no growth and low return on assets. This seems wrong to me.

Geopolitical and industry analysis suggest Japan is at a huge turning point. What is even more exciting is so many domestic stocks still trade at below book. This looks wrong to me. I am uncontrollably bullish on Japan.

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