The Fed has been hiking rate
and they're planning to hike in the future
but you think that rates are gonna
stay low for a long time?
Can you help me understand?
Sure, yeah.
It depends on which rates
and obviously the Fed is
hiking short-term rates
and they expect to raise
them all the way up to
and above 3.4% by 2020.
So, short rates are going up.
But the rates that really matter for bond investors
are the intermediate to long-term rates.
So what's priced into the market is that their short rates
are going to get very close
to and eventually go above 3% and so
in the interim, while they're raising rates
if the scenario plays out
longer term fixed income securities, even treasuries
may end up outperforming cash.
But the fact of the matter is, this is not unusual.
Usually, by the time the Fed gets around to raising rates
people can see the economy is doing well
they're looking through the cycle
and the rise in long-term rates is often mostly
if not almost entirely over.
So, I think that's what's going on here
and there's a lot of fluctuation quarter to quarter.
Just last September
the 10-year Treasury was at 2%.
We've sold off a lot since then
a lot of things have changed
but now people may be too optimistic
on the economy or on the risks
to interest rates on the high side
and so, as we've seen over
the last couple of weeks
when we went from 291 and now we're
into the 270s on the ten-year
it may become more range-bound
and we're probably closer
to the top end of the range than the bottom
would be our guess.
And when you look at the reaction
to the recent Fed rate hike, what did you learn from that?
Sure.
Well, it's very interesting that since the meeting
I mean, basically long-term interest rates
have gone straight down
and ultimately what kills an economic expansion
is not old age, but it's the Fed getting involved
and raising interest rates too much
and knocking some kind of a delicate situation
over into recession.
And obviously, we're not at risk of that now
but there are other factors that are giving
the market concerns.
We've seen concerns in tech stocks
we've seen more macro concerns about the deficit
pushing down the dollar
and steepening the curve earlier this year
and more recently, we've seen a lot of concerns on trade.
We have a new approach in DC, America first
and one where bargaining positions at the most extreme
are put out first
and then things are modulated as we go along
and the markets are adjusting to that.
But basically, we've seen rates come down since then
and I think this is part and parcel not only
of the rate hike cycle
where typically the long-term rates go up first
I think it also is in keeping with the roll off.
And that may be a little bit counterintuitive
but by the time the Fed gets
around to letting their portfolio roll off
this is very important for the bond market
the impact of their not buying and reinvesting
may already be in the market.
And we've seen this before in reverse
and this is with quantitative easing
of which we had three phases in the United States
We also had a massive program in Europe to judge by
And the European one was easiest in some respects
because there's just one.
By the time they got around to announcing
and telling everybody
what they were gonna do
and exactly how much and all of that
the 10-year Bund was
at about five basis points.
And within a month or two later,
it had sold off to all the way above 1%.
Right now, it's at 50 basis points
and we're basically three years on.
So it has spent most of the time
since the announcement beginning of the QE
higher than where it was at that time.
So the reverse of that is now they're doing
quantitative tightening out of Washington DC
with the Federal Reserve and the FOMC
and the New York Fed extricating their policy.
But basically, we're at the point where now
they are forcing the market to buy what they would
normally reinvest in.
And this is particularly important now
because the deficit is expanding.
So the government is going from having a reasonably small
deficit that was entirely financed by the Fed
to having a much larger deficit
and that is gonna get financed by the market.
So people might think they have a bigger deficit
that is going to push up interest rates.
On the margin, that pushes up treasuries a little bit
versus other interest rates in the market
but it has other effects.
Those effects are pulling liquidity out of other sectors
out of corporate bonds, out of structured products
out of high yield, and we've seen some giveback
in those markets relative to treasuries
and then we've seen higher volatility
in the stock market.
It's been more susceptible to these shocks
in the last few months
and that may be because
these are bigger shocks
but it may be part and parcel of the regime.
And when we think about
quantitative easing, that liquidity
getting pumped into the system
we had a very strong stock market
with very low volatility.
Now, basically, you're going into quantitative tightening.
So, you may have a slightly less buoyant stock market
and more volatility and in the end
that makes people more balanced in their approach.
It's positive for bonds.
And if long-term rates stay low for a while
do you think valuations can stay as extended
in the US as they have been?
You know, the markets that we're seeing here
are reasonable value.
Equities, the earnings are obviously much higher
than people expected based on the tax rates
and that's not a short-term boost that gets given back.
And so, multiples relative to rates look reasonably fair
but you're late in the cycle.
I think this is a point where you're seeing
a pretty flat yield curve
but interest rates have moved up.
You're not at 130 on the 10-year note
and if our supposition is correct that a
close to 3% yield curve is actually high
I think it's very important for investors
to have balance in their portfolios
that this is the point where, as we're seeing
in recent months, you can have more equity volatility.
You may actually have less progress on the equity side,
and it's important for investors to have that balance.
We haven't talked about the non-government parts
of the market.
Although spreads on corporate credit
and emerging markets and so on have come in a lot
from 2016 and certainly from the recession
there are still good values.
And so, for investors coming
into a general market fixed-income investment
there are a lot of opportunities in sector allocation
in security selection and where we're positioning
on the yield credit curve to be able to
ideally, outperform, continue to outperform
the indices over time
and so investors should get a decent return
for their fixed income, probably —
And our expectation would be higher than cash
over the long run by some margin
and would also to provide balance relative
to the riskier parts of their portfolios
if not generally, at least
in a downside recessionary-type scenario.
Because what are you most worried about
when it comes to the markets on either side?
Ultimately, I mean, we're looking
at all the obvious things in terms of trade
and in terms of inflation to make sure
we're not missing something
but if our base case is correct
and this has been our view for a while
that the market is basically in a good phase.
This is a healthy backdrop.
People are traumatized by a lot
of things that have happened in recent decades.
Ah, there's too much inflation.
Ah, there was too much debt.
We're gonna have a recession, we're worried about —
When in fact, being invested at a strategic allocation
in their equities and their high-risk assets
and in their bonds, has been superior to say, being in cash
or to being below strategic allocations.
And I think this is likely to be a very long cycle
because of the cautious approach policy makers are taking
and the lack of excesses that we're seeing.
And when you look at the statistics
what they show is that equity performance
has been so strong that fixed income allocations
are still below normal despite the inflows
that you've seen there.
So, my concern is that people get away from their
strategic allocations, when in fact
that's probably the most effective place to be here
where they're gonna get the balance and the most
efficient return profile.
Great, and is there anything that you think that people
are getting really wrong when they look
at this macro picture and rates in general
I think the focus
and from a behavioral finance perspective
as you're keen on —
People, they wanna think if they focus on something
and they solve the puzzle, they're gonna make money
and know what to do with their portfolios.
And right now, the focus is really
on capacity and inflation and the Fed.
But already what we're seeing is the demand for money
from the private sector is slowing down
and that's giving you the signal that long-term rates
are probably a bit too high.
And we saw that at the end of 2013 when we were
in the zip code for rates. We're seeing it now
and that's a signal and we'll have to keep an eye on that.
That will probably near to the top end
of the range than the bottom
and this focus on overheating in the Fed
may be very misguided.