00:00You have a bold call. You see the Federal Reserve reversing the three insurance cuts
00:04and starting in December hiking rates and maybe going past one rate hike, perhaps stopping at
00:11three, perhaps more. What do you see happening between now and say year end that would prompt
00:17the Federal Reserve to start aggressively hiking rates? Yeah. So let me start by saying that the
00:22inflation expectations point that we just discussed is extremely crucial to why the Fed
00:27will need to react to this inflation upsurge. We all know inflation has been higher than target
00:32for at least the last five years. But the bigger problem has been it's a series of what might
00:37be called transitory shocks are now starting to seep into inflation expectations. The surveys
00:43are pretty clear. The University of Michigan survey pretty pretty obvious that inflation
00:47expectations short term and long term are going up. But the problem is the break even market
00:53I think is a is a miss malfunctioning fire alarm. I think the problem is the break even market
01:00is not reacting to the actual inflation risk. It's reacting more to the trading conditions
01:05in the rates market. So in the work we have done break even should be higher by about 20 basis
01:11points
01:11versus where they are if it truly reflected the inflation risk. And then if you couple the break
01:17even level with the surveys the anchoring I think it would be pretty clear to the Fed that inflation
01:23expectations are on the on the rise and in the wrong direction. Add to that finally the point that
01:30unemployment rate is also trending slightly lower also tells you there's more inflation risk in the
01:35pipeline. That's why we think free hikes beginning in December this year are going to happen. It's
01:40definitely an out of consensus call. Nisha you are thinking that the Federal Reserve wants to maintain
01:45optionality. It'll probably drop the easing bias next week. How do you think about inflation
01:50expectations. Mike just showed us that chart that showed consumer based measures are different than
01:55market based measures. Yes. And I think that's a key distinction here because why I think the Fed
02:00will want to keep that optionality. Again markets pricing in further rate hikes is one thing. I think
02:06the Fed is going to want to really communicate while a hawkish hold the optionality and not necessarily
02:12signal the hike. The key reason is that inflation is kind of the key component here and there's two
02:18two ways to look at it. There's a scenario where inflation continues to seep into services and goods
02:24and perhaps we haven't reached the peak. If that is the case to Guneet's point you know perhaps you do
02:30start to see more of that positioning towards a hike. However the other scenario is that does this at
02:36some point create a scenario where you just have a softer consumer in the back end of this year. Right.
02:43So does this get displaced with more of a disinflationary approach if we have peaked in terms of
02:48inflation. And again I think the Fed at least for next week's meeting cannot be sure of either
02:54direction which is why you know that optionality is going to be key and it's likely to be kind of
02:59a key
03:00component of this a little bit more of a hold for longer watch and see for at least for the
03:04next two
03:04meetings in my view. So Guneet is the market wrong in thinking that that 4.2 percent print that we
03:10got
03:11for CPI is the peak and things will kind of ease from here on out. Yeah. So I think the
03:154.2 headline
03:16percent or headline print might actually be peaking here because oil prices obviously are going to
03:21decline on a year on year basis. But the problem is core inflation typically lags headline inflation.
03:27And I know in the in the in New York we're all excited about the Knicks sort of going for
03:32this
03:32historic you know championship in 1973. I think the 1973 parallel also comes to inflation
03:38because back in 1973 we had oil prices going up headline CPI rose sharply and the core CPI followed
03:46six months later. And of course what did we get rate hikes and a much higher bond yields.
03:52So I guess to put this into perspective here what do you see happening Nisha next week? What do you
03:59see
04:00Kevin Warsh? How do you see him setting the table for that maximum optionality? I mean he can't
04:06he can't lock himself into any kind of position because he's got a president who's watching him.
04:11He needs to kind of perform and deliver what the president wants which is being able to cut as needed.
04:17Yes which is why I think this optionality component is so key and so you know this is going to
04:22be a
04:23meeting about establishing credibility and so perhaps you know the appease of the hawks on the
04:28committee is by dropping the easing language but again not necessarily creating any further language
04:34to instigate that the next move is going to be a hike. So I think again that optionality could appease
04:39both the administration perhaps the pressure at the same time really kind of appeasing the hawks that are on
04:46the committee. Again this is such a big meeting for Chair Warsh that first this is going to be I
04:52think just for the market in terms of the credibility the tone the communication and I imagine there would
04:59be no immediate surprises. So again I go back to perhaps there's a way to make both sides happy at
05:08least next week and I imagine that in some ways that is what Chair Warsh will try to do. Okay
05:12threading that
05:13needle essentially. Ghani let's talk about the buyer base for U.S. Treasuries. It used to be tracking
05:18central bank flows but you say it's now shifted to another group. What is that group and what did their
05:23flows
05:23depend on. Yes I think one thing that's very visible if you look at the official data on Treasury
05:27holdings particularly overseas buyers is the net buying particularly since Liberation Day has not been done by
05:35the traditional buyers in Asia or even Latam or even Europe 90 percent of the net buying in the last
05:4212
05:42months or so has come from what you might call financial centers. Think of Luxembourg think of
05:47Cayman Islands think of the U.K. What that means is the buyer base is no longer yield sensitive.
05:53They are not stepping in the bond market because yield levels are 5 percent in the 30 bond.
05:57They would come in if they felt comfortable with a macro situation. They would come in if they felt
06:03comfortable with inflation and with the Fed. We don't think those conditions are there yet. So
06:07that buyer base being absent keeps the bond market more vulnerable and that's why we think yields are
06:13going well above 5 percent on the long bond. Do you see that Nisha? Do you see this differing buyer
06:19base
06:19creating more volatility especially at the long end? We do and I think it depends on which market you're
06:25looking at. So at parametric right across a variety of fixed income markets you're seeing this in the
06:29treasury market that has seeped into other markets because again the main story is that clients are
06:34being very wary of taking on duration. Now on the flip side I will say when you have the buyer
06:40base
06:40pull back you do see a component of just higher right and more attractive yields over time. So then this
06:46really becomes about right creating some sort of a quality bias and really thoughtfully adding duration.
06:53You know if to Guneet's point if we do see more of that shifting to hey the Fed is going
06:59to hike we do
06:59see that later on this year there's no doubt in the short term then you will see yields possibly go
07:05slightly higher. But I would make the point then that can possibly create even a better entry point
07:09and timing this is always so so difficult. So right yields are higher on absolute basis. I think there's a
07:16thoughtful way to add duration and I go back to especially our client base who are looking for a hedge
07:22right when you have valuations as high as they are they're possibly sitting in cash. Clients are
07:29finally getting paid to step out of cash and add some duration and fixed income. Speaking of hedges
07:34Guneet that you were talking when with us earlier this week about how there are parallels to 2023
07:40when stocks were also on a tarot when they're also being led by big tech. What happened then is
07:44now instructional for how to hedge against a correction or maybe something even more dramatic for stocks.
07:50How do you think about that. Yes I think going back to 2023 one thing you've found in 2023 in
07:55the late
07:56in third quarter and fourth quarter is that when equities had had massive gains from late 22 to mid
08:0223 a lot of investors were thinking about what can go wrong. What can change here that kind of quote
08:08unquote
08:08spoils the party. And the risk at that time was bond yields could keep going up. We've seen this inflation
08:14driven correlation in the last five years. We think a similar risk exists today where if bond yields keep
08:21going up that could effectively become a hedge to locking in your equity market gains.
08:26So
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