Transcription:
Marc Bauer (
The first speaker today is gonna be Priya Misra. She is head of a Global Rate Strategy at TD securities. And in interest of time, we are just gonna go right to her. So Priya coming up.
Priya Mishra (
Thank you.
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Thanks everyone. Good morning. And let me also add my thanks. I got in late last night and it was a very hopping bar scene on the 70th floor. So I was wondering how many would show up for this exciting topic of the us economy. So thank you all. And for those of you that just woke up and did not look at the market, nothing like a better setup to talk about interest rates or the economy than we had another blockbuster CPI number. So we have had a big move in interest rates this morning. now I have only about 20 minutes and I am hoping this is interactive. So feel free to raise your hand while I am speaking. If anyone has a question or at the end, I leave five minutes. If someone has questions otherwise, for those of you that know me I can always fill that five minutes with other thoughts and pontification.
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I should start with a caveat. I am not a muni investor or a analyst. We have a huge contingent from TD that look at the muni market origination, banking, sales and trading. So feel free to reach out to them. We have an expanding muni product landscape at TD. But what I am here to do is to talk a little bit about interest rates. And I know yesterday you heard from Lindsay who's an economist. I missed that session. I do not know if we were on the same page on the economy, but I did wanna spend some time away from just the economy on interest rates on, I should say government bond rates. And that does have a pretty big implication for muni. So we thought it might be still relevant to those of you, you know, us two years up or the treasury two year eight is up 20 basis points today in today, that has an impact on the muni market.
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So how I titled this was the fed because a lot of it is driven by the fed reaction function on the economy as well as interest rates. Let me quickly, and I am gonna skip through a few things, but I did want to spend two minutes on a topic. That is I think we are all living in breathing, which is volatility, and I am here. That is why I am glad they put off that cheery music. Cause I am here to tell you that I do not think volatility goes away anytime soon, the fed is facing pretty big challenges here. I would argue the two sides of the mandate are in conflict. I know chip Powell talks about them not being in conflict and they are not today. If you just look at data today, they are not in conflict. The us economy is very strong on the labor market.
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Front inflation is very high, but as we look ahead and our job is markets are forward looking. Our job is to think ahead. That is where the conflict comes in, where the economy we think is going to respond to interest rate hikes, to QT, to the lack of fiscal stimulus. And That is going to create this tension for the fed. So That is one reason for the volatility. What I show in this chart. There is, That is lots of graphs here, but it is a simple shot. It shows you how many days have we had more than one Sigma moves in the 10 year treasury, and you can do the same thing for Munis. You can do that for the two year. It actually does not look that different. How many greater than one Sigma or one standard deviation moves and the standard deviation I have done over a two year period, trying not to be too cute about this.
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If you run it versus one year or five year, it actually does not change that much. So what I am trying to say is are we getting outsized interest rate moves this year? And I had a prior that we were cuz we were living through days like today. Now today is a little more understandable cuz we had CPI, but explained yesterday or Friday where we did not have any data and we still moved eight, nine basis points, which is more than what the standard deviation of a daily move is. And what this chart shows you is with the highest, since we have data going back and we do not have data in the fifties and sixties, but really since the early eighties or since the late seventies that we have data we are in a year with the highest amount of daily volatility, not only has the tenure risen a lot, it is not done.
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So in a gradual fashion, we have had these pretty wild swings. And my view is a lot of that is here to stay because we are dealing with a dual mandate. That is in conflict, we are dealing with the fed That is I think has lost some inflation credibility and therefore they might overdo it on one end and then we are dealing with a market structure. And you are hearing a lot about this in the treasury market, less so in the muni market, but market functioning issues in treasuries, March, 2020 was a perfect example, but it is not just March, 2020. You look at September 19 or 2014, the flash crash that we had, we are seeing more of these events where I would argue. And There is a lot of debate on why is market structure different in the treasury market? my reasoning for it is dealer intermediation is constrained. A lot of the dealers have had significant capital requirements posed on them and it did not matter while the fed was there as a backstop, as the fed is stepping away and actually they are doing QT.
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This becomes a much bigger issue. So I think the market structure issues remain the macro risk remains. So, you know, keep your seat belts fastened essentially in the treasury market. And therefore by definition, I would say all fixed income markets now really quickly. Cause I do not wanna go over time. I think you are all familiar with these charts. I wanna spend two minutes on the economy on the fed reaction function and then how it translates into interest rates and what is our view. I am also going to skip through many of the slides because after the CPI number, we actually just changed our fed call. So I will be giving you our new fed call and interest rate call what this chart shows you is what the fed lives and breeds inflation. Very high notice the core inflation chart, which looked like it had peaked.
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But if I were to update this with today's number, we have gone back to the highs. So it is very hard to say that core inflation has peaked. I think headline has peaked in our view core may stay around here for a while and then start to decline. We do have a view that it declines. it is just a very sticky variable There is stickiness in prices. People do not change prices that quickly rents, which is the big surprise today that rents came in that high. it is been something we have been nervous about. we have written a lot and I should caveat. If anybody wants to dig into anything that I am talking about, please reach out to me or the TD team can send you pieces on this. Rents has been a concern we have had for a while because rents definitely nobody in renegotiates rents every day, every year when the lease comes up, That is when you see those rent increases and That is why rents tend to be a very lagging indicator of a strong housing market today.
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The big upside surprise actually did come from rents, but you know, whether it is peaked or it it is, it is a high number. Even if it had peaked, we were calling for a 75 hike next week. And we do think that the fed goes 75. What we changed today was our end point of the hiking cycle because it is not even clear that core inflation has peaked. we are now calling for the fed to continue to raise rates until four and a half. But on the other part of the call, I wanna highlight your attention to the job numbers. One of the charts that chair power looks at, which I have to say, I did not look at as much until he started to highlight it. So I do not love the Jo data. This is based on the Joel data, but what they look at is job openings versus number of unemployed people.
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It is almost saying that for every unemployed person, there are two jobs. Now I think it is oversimplifying it. There is a massive skills mismatch. But that is the way the fed looks at it. They look at this labor market as being extremely tight. That is why there is no impediment. This is not like the ECB That is dealing with a slowing consumer right now. The fed looks at it and says they have the green light to keep hiking and to hike aggressively. So we expect a 75 and then what we changed today was we expect another 75. that will show up and actually, maybe this chart will explain it. we are gonna skip over our economic forecast. But the reaction function, what we are hearing from the fed is that inflation is public enemy number one. And even at the cost of the unemployment rate rising, they are willing to tolerate what chip power calls pain.
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And he said, we expect businesses and consumers to face pain, but that is the cost of getting inflation back on track. And so if inflation is at, I will give you core inflation is at 6%. And the unemployment rate, which is 3.7 jumps up to 4.2, I would say That is a pretty meaningful rise in the unemployment rate, but if their target or I shouldn't, they do not call it a target, but Nero or the non accelerating rate of unemployment is four, 4.2 is only slightly above that level that they wanna be at versus 6% is significantly higher than two. I think what they are telling us is when one side of the mandate is so far from target they are, overweighting it, That is the message came loud and clear from Jackson hole. And That is why after today's number where it is not clear that even core inflation has peaked.
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And we particularly rents, you know, we wouldn't have changed the call if it had come from FFAs or used car prices or apparel things that tend to be extremely volatile rent or shelter, does not tend to be that volatile. It tends to be fairly persistent. And so you could have another few months or very high rent numbers. So we have actually changed our call to say, not just 75 in September, another 75 in November of 50 in December and a chance of another 50 or 25 in February. So you can see we have raised that terminal rate estimate for the fed because they are really fighting inflation. Along with that, I should mention they are also continuing QT and I am personally a little upset that the fed does not bring up QT as a source of tightening. I actually think QT matters far more to financial conditions, to real rates and to the real economy than interest rate hikes.
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Because if the fact raises rates a lot, they are raising the front end. Most of us do not borrow. And particularly in this group, how many of you borrow or invest at the overnight point? I mean, it has been the best investment this year, actually, if you were in overnight rates, but most of us live in the tenure five to 10 year part of the curve. QT is what impacts that part of the curve much more. Now QT has been on autopilot. The reason I think the fed does not bring it up is they do not want to view it as an active policy tool. Meaning if inflation is higher, for example, today than anyone expected, they do not want to move QT higher. They do not wanna calibrate it depending on inflation or depending on growth. They have set it in motion. They expect it to continue in motion.
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And I think it will continue until the first rate cut. I mean, they have not officially said that, but we know that in 2019, when they cut rates they stopped QT as well. I think they stop QT either when they cut rates or when they hit reserves, scarcity reserves, bank reserves right now are in well in excess. So I do not, if you tell me they are never gonna cut or they are not gonna cut rates for the next five years, I would tell you we would expect QT to continue until 2025. There is a massive R P program that becomes the buffer for who that QT can continue. And it comes out of R R P, which is why reserves are not that impacted. However, we expect the fed to be easing next year. Now I know That is not what they are saying. it is not, I think this might be where we are most out of consensus is yes, the fed is saying, we are gonna stay.
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we are gonna be restrictive and we are gonna stay there for a long time. I, I would argue it is easy for them to say it now because the data has been so strong on the real economy side side on the labor market front today. But you know, There is a lot that can happen between now and a year out. And this is where I think understanding how the labor market develops will actually be key to determining if the fed does have to ease and in our call. And we did not change that call today. in fact, I would say my conviction level is higher on that call that they would have to cut by the end of next year because they have taken rates to such restrictive territory QT, which will also continue until, you know, until they cut is also adding pressure. And where does QT really add pressure?
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The reason I have all these numbers in here is to show you how much supply the treasury market has to take down. And for those of you that are looking at the last two weeks, why has the 10 years sold off as much? The 10 year tends to be less dependent on inflation readings? Why is that selling off? I would point to QT. I would point to QT. I would point to global rates. they are much more correlated with the tenure than just whether the fed raises rates 75 or 50 QT doubled in pace in June from June to September, There is been a doubling in pace. it is not gonna double anymore, but even with those estimates, look at the amount of supply that we are looking at 2.4 trillion in tenure equivalents, even though the deficit is much less, the treasuries cut coupon sizes, you have the fed, That is essentially selling bonds.
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Now they are not actually selling bonds. They let the bonds mature the us treasury sales bonds. So I am making that distinction for anyone That is particular. it is not the fed selling, but it is more supply that the private market has to take down. And That is what pushes the tenure higher, but where rubber meets the road in our mind is real rates. I am gonna show you one chart on real rates. The one I look at the most is five year, five year, but you could look at tenure. You could look at 20 year real rates. This ultimately impacts the economy. And our view is when this gets to 1% or higher, it starts to impact financial conditions, call it equities, credit spreads, volatility. It starts to impact the real economy in nominal interest rates. You know, people often ask me at what level of the tenure does the economy slow down.
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Now tell me what's happening with real rates, because if I am getting paid more sure I can pay more for, you know, everything I am buying. If you are telling me no, I am still having to, you know, I am paying a higher real rate of interest. I actually do not have the offset from inflation. So how can I handle hire real interest rates? If population is going up, if productivity is going up, the young people on my desk, no offense to any young people in the audience tell me that they have become more productive since the pandemic. I do not know that it, the data does not bear that out. Maybe we'll just realize that we have all become more productive, but I do not think the fed is taking that for granted either. we have certainly not altered our long run GDP estimates or productive capacity of the economy. In fact, I could argue that it is a little bit less because the labor participation rate is lower immigration, I think is an issue unless it gets resolved and certainly this can change, but for now the labor dynamics actually support a lower rate of growth.
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But even if I assume it is the same in 2018, 5 5 year touched 1% and that did have an impact on the economy. And I do not think fundamentally we are that different of an economy from a productive capacity point of view. So all this to mean as the fed rates raise raises rates to four, I mean we are four and a half. Maybe it is anywhere between four and a quarter and 475. They keep rates there. QT continues. That is how we are we are forecasting interest rates. it has an impact on rail rates and rail rates have already moved higher. They moved again a little bit higher today. It starts to impact insensitive sectors first, which then spill over to the rest of the economy. I mean, you look at housing. Of course, if you look at today's CPI number, you will say housing is on fire. Well in the CPI numbers, it is, but you start look at housing starts, look at home sales.
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You are seeing science high frequency. The most insensitive sector is already struggling. Consumer durables would be the next one. And at some point I think the consumer starts to face negative. Well, the consumer's already facing negative, real income growth, right? Wages are growing at 5% on average inflation today. And I will give you headline because we all have to pay for food. And energy headline is running at eight and a half. The those savings that people built up during the pandemic is coming down every day. As people spend more than their earning on a real basis. Those the income growth is negative. We expect the consumer to start to show signs of stress by year end, and therefore it then ends up with oh, I will come to global rates in a minute, but this is why we do have the feds starting to cut rates next year.
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Now it is very hard to say, is it the fourth quarter or the third quarter? you know, I struggle with that really because it depends on not just inflation. I think There is a different threshold for them to stop hiking. If inflation starts to get to 0.2 0.3 on a month of a month basis, I think they stop hiking to cut is a much higher threshold. I think they need to see the unemployment rate four and a half five actually. governor wallow on Fridays at 5% is the level that he is looking at. That is a high threshold. You know, if you tell me that the unemployment rate is at five at any point next year, it is going to six much faster, because That is a very sharp increase in the unemployment rate, which tells you the extent of pain that the fed is willing to tolerate to make sure they regain inflation credibility.
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I think That is the problem. they are sort of looking a little bit at the past, the fact that they missed on inflation as a result, I think they might be late to start to cut, but what that means, and now I am gonna get to what this means for interest rates. What that means for the long end is actually they might have to cut much more than the market's pricing in the market's pricing in right now about 80 basis points of rate cuts in 2024, it takes the fed funds rate to 3%. Well, 3% on any historical metric is high it is restrictive. I think once they start to cut, we are going to, I do not know about zero. I think the inflation dynamics might make zero hard, but they can absolutely get back to two, one and a half. And that has implications for the tenure.
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So we are actually forecasting a record inversion of the yield curve and an inversion that lasts much longer than what most of us are used to historically the yield curve inverts, the fed panics, and they start to cut traits. Well, this time round, we have already inverted. I think we invert some more because that front end is just going to struggle to rally. And the fed says, yeah, you know, we told you There is gonna be pain. Inflation is too high. it is forcing our hand and they wait for the unemployment rate to rise. I do not know, five seems high, maybe 4.7. And the speed of the rise in the unemployment rate will also be important before they say maybe it is time to cut. And again, I do not think they cut with let's cut a hundred basis points one day. I think they start very slowly because they are terrified that they have to go back to fighting an inflation problem last point.
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and then I will see if I have time for questions. global rates I would be remiss if I do not bring up that a lot of what drives the long end. This is not. If you look at correlations, the zero to five year is all about what I talked about, the economy the fed reaction function cut pricing hikes, but you start moving to the seven year, 10 year, third year. What a lot of you here will care about. Watch global rates. One of the moves in the last that last two, three months that we have noticed is the coordinated rise in global interest rates. Look at the UK, look at Europe except JBS every other developed market and emerging market. But the correlations are higher with developed market bond deals have risen significantly. Now our call is that That is sort of done while on the us.
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I am still a little nervous that until the fed does not or until the economy does not slow down, I think interest rates can generally head higher led by the front end. Our view in Europe is that they are heading into a recession as we speak and they will get there 1 75, maybe another 75 basis point hike in by the ECB. And then that is it. They have a gas crisis, the consumers already showing signs of stress in Europe. So we do not think European rates. And what I show here is how bones have backed up and That is helped us treasuries also sell off. I would watch what is happening with global rates, especially further out the curve. I think that can cap how high us rates as well rise. We have a three 50 cap for or not cap, I should say forecast for the 10 year we have been in this three 50 ish ish camp for the last six months, thinking that That is the high level that it'll get to we are now back to in the 3 30, 3 40, and then it is gonna start to come down.
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The speed of that decline might be a lot slower because it really needs the us data to start to turn. But if global rates stop rising, I think it provides better you know, macro backdrop for those rates to have clearly found a top, but I will stop here. I think I have my rate focus, which already outta date. So I will not spend any time on this, essentially. What, what we changed today was all the front end. If you look at my long end focus, it actually largely unchanged. But I will see if I have a couple of minutes. If anyone has a question, sorry. I know I ran through a lot of things quickly, but any questions I know it is early in the morning. I was, yes. There is a question right there. If there is a mic, I see a mic. Perfect.
Audience Member 1 (
Hi there. thanks for the information you had said that you expect core inflation now to, you know, stay elevated for a period of time until it starts to decline. Do you have any idea how long you expect that to be?
Priya Mishra (
Great question and one that is very humbling for me personally, why I do not focus inflation, but I do look at it. And we have all had this timeframe wrong. so There is a couple of ways we think about core. I am glad you asked me about core because if I often get the headline question and now we have to forecast the war, you know food and whether There is a good planting season, et cetera, but let's talk about core. I do think even if headline comes down I think the fed will care about core BEC they care about core and headline. I will say this fed cares more about CPI over PCE. CPI tends to mimic the consumption basket of lower income consumers, which is why I think they are actually, they care more, more about CPI and PCE is not as high. So it will also look odd if they suddenly start looking at PC.
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So you asked a pertinent question, core CPI, our forecast, and actually I can go back cuz we have not changed that as much. Based on today those are our numbers for core CPI. You can see we have got about by the end of next year, 2.7. What we did change today was you see, we have 5.6 by the end of the year, we are probably thinking it will stay around six. The key question about core CPIs. There is, There is a couple of components. There is core goods, There is core services. And I think of core services as shelter and everything ex shelter, core goods. Our view is and I am the reason I am spending so much time on this, sorry to the organizers is it'll tell you if we are wrong. What is it driven by? we are assuming core goods gets to about zero by year end. it is running core goods inflation right now is running about 4%.
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It was running 20% last year, supply chain, There is another COVID wave or China has some other lockdown. All of that will drive core goods. Our thought process is tracking shipping costs and all that core goods is heading lower. it is just, it took longer than most people thought, but I have more faith that That is gonna be closer to zero. Then within core services, it is shelter, That is the big upside risk. What we are going to, what we did today was we said, it is not coming down as fast as we would've expected. we are keeping rent inflation high for longer. There is also a thought process that maybe I am in a rental and I would like to buy and I should be by, I should. It might make sense for me to buy rather than rent. That is normally the logic that equilibriate the, the housing market, but mortgage rates are high.
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And I, you know, home prices have fallen, but they haven't really affordability is still an issue. I might still rent. So actually rent inflation can stay higher for longer. That is what we upsize today. And then there is X shelter, service inflation, which has been running high. We are thinking That is gonna come off. Most of the reason it is running high is leisure hospitality E everyone wants to travel. And I think that was a large part of that was also driven by the fact we were in lockdown. I mean, we were basically not able to go out for two years. So people took their vacation in two year end. What I would expect is cause services comes down X shelter and That is what's behind it. So thinking back to numbers, 6% stays around five and a half to six by year end gets to on a year, over year basis, it gets to 4% by the middle of next year four, still too high. What the fed will wanna see is a three or a two handle in order to stop hiking, certainly to cut. I think they need a two handle. That is why I do not think they can cut until you see 2.7 or something on, on core CPI, which is what we have. And we did not change that. We just bumped up the near term trajectory for core CPI.
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But great question. If somebody had a quick one, I can try otherwise.
Audience Member 2 (
How about housing for housing?
Priya Mishra (
So, you know, given our rate forecast, we should be more negative on housing, but I am looking at some of the more structural trends of, for housing and There is been lack of new units being produced. So There is a shortage of homes. There is also a pickup in household formation, which is great. As I tell my kids that they can not live with me forever. So it is actually a good thing that millennials, you know, there was at one point I was reading up surveys that they do. They never wanna get married, never have kids never move out of their parents homes. there is evidence that they are doing it, they are doing it later than earlier generations, but they are. So That is a positive for housing. So overall we have got a 3% home price appreciation so positive over the next 12 months. I do think there are areas that saw outsized home price appreciation regionally because of the pandemic, people who are moving out.
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I think regionally, you could have negative. I really struggled with negative on a national basis, partly because it is driven by the tenure. So this is a little bit because I do not expect the tenure to sell off if I am wrong. And the tenure is at 5% or four and a half or 4% which takes mortgage rates higher. I think you are looking at a risk of a negative national home price appreciation, but we are thinking zero to three, it is kind of hangs in there. Remember we were at 20%, the last two years, so it is still going to feel like a weak housing market and in certain regions negative. But I, you know, we are a little bit more positive because of, as I said, the structural forces, people still need to live. Their households are being formed and you look at housing starts, the builders are saying, we are done. Look at the mortgage rates we are not producing. I do not think that changes. So you just have that positive, fundamental within housing. All right. I do not want to delay your agenda anymore. So thanks a lot for the patient hearing and I am happy to address any questions offline. Thanks again.