(Bloomberg) — The Fed is most likely to stop rate hikes in June, but inflation is still above the central bank’s target, according to Loomis Sails’ Elaine Stokes. Therefore, a strong easing cycle will not materialize.
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“We think the Fed’s reaction to rate cuts will be a bit delayed,” said Stokes, a senior portfolio manager at a nearly 100-year-old investment firm, on the “What Goes Up” podcast. “The market is a little ahead here.”
Here are some highlights from the conversation, summarized and edited for clarity. Click here to listen to the entire podcast, or subscribe below on Apple Podcasts, Spotify or wherever you prefer.
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Q: You keep a close watch on the credit markets, and there’s been a lot of talk lately about a potential credit crunch. I’m curious as to what you think of the credit macro conditions now.
A: That’s the big question today and what happened with this banking turmoil and really what we’re seeing is that all these moves by the Fed are finally working. It seems to us that we have seen the point of proof. But they are working to reduce people’s risk appetite towards new technologies, cryptocurrencies and even some private equity. But we don’t see it in our daily life. It’s not seen as much as you would expect to see in normal day-to-day borrowing. If the stock market continues to say local banks are unsafe, local banks and banks as a whole will continue to tighten their standards. And it will start to hit small businesses.
And that is an area where we have yet to begin to recognize pain. If that happens, I think we will all have different views on what a recession will look like. Our banking market is not weak. We have strong banks and it’s a game about trust and something needs to be done to counteract that trust. Otherwise, it will start to affect the economy.
Q: Everything goes back to interest rates and Fed policy this year. What’s your big-picture view of where the Fed and rates markets are headed?
A: Given what is happening with the local banks and the debt ceiling negotiations, I think the Fed will definitely stop at its next meeting. Over the long term, however, we believe there are some major long-term trends that will sustain inflation. It won’t necessarily go up to 5%, but I think it will be very difficult to reach that target. We think the reaction to the Fed’s rate cuts will be a little delayed. We think the market is a bit ahead here. I think the market is pricing in that one of the first two short-term items has gone horribly wrong and the Fed will have to step in and cut rates in earnest.
There are what we call the “4 D’s”. Demographics are unfavorable, deglobalization is unfavorable, decarbonization is unfavorable, and fiscal deficits are rising. All four of these things we are all familiar with can cause inflation. And it will be difficult for the Fed to take his foot off the pedal completely. I don’t see a strong reduction cycle in our future.
Q: Where do you see the value in bonds?
A: What I like about fixed income is that it requires triangulation. On the short end it ranges from less than 2% to more than 5%. And over the last few years, when you see the 5% number, you think, “Wow, that’s a nice healthy return.” Remember inflation is still around 5%. If you’re going to take more risk and go for higher yields, you’re talking about yields in the 8.5% to 9% range. That’s really fascinating, isn’t it? So the yield levels got very interesting. Spreads have also widened significantly compared to a year ago. The spread level you get from tights has almost doubled. This means that a higher premium is being paid for taking some risk.
Is it enough to look like you’re getting paid as if you’re in a recession or recession? Not perfect. But the difference at the moment is that the dollar price is going down. We have lived in a market where the dollar price of bonds has been well above par for a very long time. And now, looking at dollar prices, the index average is nearing 90 cents per dollar. So, not only can you buy that bond at 5% or 8.5%, but any positive economic or specific news could move those 10 price points higher.
So when you look at all three of these together and really think about the market technicals, what I’m really referring to when I talk about the market technicals is the issuance shortage. Publishing levels over the past few years. Borrowers went private, and the number of buyers looking for goods made a big shift in the market. So when you put all that together, I think there’s value in this market and it’s possible in the short term. But you can also lower your risk a bit and pick a few good low-dollar bonds where excess yields can go up significantly.
Listen to the rest of the podcast here.
–With help from Stacey Wong.
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