The September Federal Open Market Committee meeting may provide a turning point for monetary policy. Join us live on Sept. 22 at 2 p.m. as Brendan Murphy, head of global fixed income, North America, at Insight Investment offers his thoughts about the meeting, Chair Powell's press conference, the Summary of Economic Projections (SEP) and what they all suggest the FOMC will do next.
TRANSCRIPT:
Gary Siegel: (
Hi and welcome to another Bond Buyer Leaders event. I'm your host, Bond Buyer Managing Editor Gary Siegel. Today we're going to discuss yesterday's Federal Open Market Committee meeting with my guest, Brendan Murphy, head of Global Fixed Income North America at Insight Investment. Brendan welcome and thank you for joining us.
Brendan Murphy: (
Hi, Gary. Good afternoon. Thanks for having me. Looking forward to this.
Gary Siegel: (
So, was there anything in the summary of economic projections, the statement or Jerome Powell's press conference that grabbed your attention or surprised you?
Brendan Murphy: (
So I'd start by saying clearly this was a very hawkish meeting. And it certainly was our expectation that we would get hawkish rhetoric coming out of it. A couple things surprised me on the margin, I guess, one is if you look at the median Fed funds forecast, which is 4.6%, that was probably a little bit higher. Not necessarily higher than I would've expected that they have to get to, but maybe higher than I expected them to come out and say. So that was a little bit of a surprise. The other modest surprise to me was just that looking at the core PCE projections, which as you'd expect are coming down, but what surprised me a bit was that they don't really have them getting back to target until 2025. So I think the 2025 forecast was for 2.1, which is pretty much back to normal. And so that doesn't surprise me, but what did surprise me a bit was the duration. Like, in other words, I would've expected that to come back closer in the 2024 time period. So, clearly though, clearly hawkish is very clear to me that they wanna raise rates to restrictive territory and keep it there until they have a high degree of confidence that inflation is rolled over and that's unambiguously the goal. And I think that that was unambiguously clear from issues events.
Gary Siegel: (
Well, if they don't expect inflation to fall to 2% until 2025, it makes sense that they would be raising rates more than they had originally thought.
Brendan Murphy: (
Yeah, it does. And you know, it's materially higher, right? I think what we've seen this year has been a massive readjustment in terms of how the Fed thinks about where policy rates should be and the market has reacted to that. And so are we at the right pricing now for what they're gonna ultimately deliver? I think it's still a question mark, but it's been material certainly in terms of how much, um, expectations have moved.
Gary Siegel: (
So are the markets and the Fed now in sync with this latest SEP?
Brendan Murphy: (
So, you know, I think the terminal rate pricing is around, I think it's around 4.6% right now. That looks pretty close to correct from, from my standpoint and it's consistent, certainly with their projections. I think where the little bit of a disconnect is just in terms of how quickly they're gonna then pivot, if you will, or start to cut rates. And so the market pricing around that is sort of the second half of 2023, you'll see that pivot and you'll see some rate cuts happen, whereas in their projections, you don't really see that until 2024. So I think there's a little bit of a disconnect between the Fed and the market about how long they'll be able to sustain higher rates and how long will be on hold, essentially. The market's always optimistic, right? So I think markets looking for that pivot, looking for that turning point because that's ultimately where you could see reversal and the chance to to capitalize from a pricing perspective in terms of risk assets and things like that. But right now the message from the Fed is certainly one like, look, we're gonna hike into restrictive territory and we're there until we have a high degree of confidence that inflations fall.
Gary Siegel: (
So how far into restrictive territory is the Fed right now or are they not there yet?
Brendan Murphy: (
Yeah, so, so the way I would think about it is assume the four, four and a half or 4.6% is the right sort of terminal rate. So what does that mean? And so if you look at the sort of core PCE projections for next year, I think they're around 3%, 3.1%. So that would imply, you know, if they hike, the next two hikes are certainly gonna come probably 75, 50 basis points, maybe one or two more 20 fives in the beginning of next year. You do that, you get to that four and a half percent level. If your expectation is that core PCEs three, 3.1, that would imply a real fed funds rate of around one and a half roughly, right? And so is that restrictive or enough or not? I don't think anyone really knows, but I think the assumption is that they at least have to get to 1% real Fed funds, right?
Brendan Murphy: (
You have to at least get to that 1% real Fed funds level. And then you can say, if you look at history, alright, that's at least somewhat restrictive. The challenge with that is trying to figure out, because inflation's moving around, right? So it's gonna depend on how, how quickly actual spot inflation falls and how inflation expectations play out is gonna dictate how restrictive that policy, uh, rate is or not. So I think another important metric to look at is just financial conditions, overall, financial conditions in clearly financial conditions have tightened a lot, but there's probably more room to go on in that scope.
Gary Siegel: (
You said something very interesting, Brendan, you said nobody knows, and I think that's the key. You know, they're projecting inflation will go down to 3.1% next year, but who would've thought it would still be around 8.1% this year?
Brendan Murphy: (
Right? Clearly it surprised most people, it surprised the Fed, it surprised most market participants. I think the uncertainty is because no one really knows the sort of effects of this tighter policy. At what point does the rate get high enough that it starts to really bite, in terms of the economy itself, Right now, it's pretty simple, right now I think because it's a dual mandate. They're targeting inflation and the labor market, and the labor market's pretty strong, right? The labor market remains very strong. And I think if you think about that dual mandate, as long as they're missing on the inflation side and the labor market continues to chug along, it's sort of a free option, right? You can continue to kind of fight that inflation battle because you don't have to worry about missing on both sides of the mandate.
Brendan Murphy: (
I think the challenge is gonna come in when the dual nature of the mandate comes in conflict. In other words, they're comfortable with the unemployment rate rising somewhat, they're comfortable with growth being below trend or below normal. What happens if they really start missing on the growth side? What happens if the unemployment really starts to spike and they still haven't achieved the objective on the inflation side, right? So that's a, that's a huge question. And right now it's not an issue because it's sort of a free option to push on inflation because that's where the immediate problem is. And I think Powell was very clear yesterday in his assessment like, look, there's one goal here, right? And it' really one goal because essentially they don't have to worry about the other part of the mandate. If they, at some point, if they do, then that's gonna become a much more challenging situation. So I think that's why, um, the pace has been increased, right? Why you see these 75 basis point moves is sort of, let's tackle this thing while we can tackle it basically, right? Rather than, you know, if we delay or not aggressive enough now, it's gonna make it all the more difficult later to make up for that.
Gary Siegel: (
And it's interesting how for 10 years they were trying to get inflation up to 2% and they would always say, Well, it's a lot easier to get inflation down than to get it up. I think they're finding out that it's not so difficult, not so easy to get inflation down either.
Brendan Murphy: (
Yeah, well, a hundred percent agree. And I think part of the challenge there is sort of the nature of the inflation shock, right? So in that this is unusual, right? There it's really supply driven in a lot of ways. If you think about the shock that first had in terms of supply of goods, which then became a problem in terms of the supply of labor, which is now morphed into a problem with supply of energy with the Russia-Ukraine situation, right? So you had these series of supply shocks and they can't really control that, right? Like that's really difficult for them to control. They can control the demand side. And so what they're trying to do now, essentially is to lower demand such that it's more in equilibrium with supply. And so that's why I think when they said it's much easier to fight inflation, you think that, well, I'll just squash demand and that'll fix it. And so we're going through that experiment right now. The question I think is gonna be how far are they willing to squash demand to bring things back in balance.
Gary Siegel: (
How do the projections in the SEP on inflation on growth, how do they measure up to your, your projections? Are they in line, are they out of whack?
Brendan Murphy: (
So the one, the one issue I'd have with the projections are on the sort of economic side. So if you look at their forecast for the unemployment rate, which I think they have going up by 0.6% or so to 4.4, I think it is, if you look at history, I don't think it's ever happened, but the unemployment rate has gone up by more than half a percent without causing a recession. So there's a little bit of discontinuity there, I think about the forecast for what the unemployment rate's gonna do and the growth rate which they have coming down to a low level, but not recessionary, not negative, right? In terms of the growth rate. So I think there's a little bit of an issue there, right? Where either the unemployment rate can't go up that much or growth has to be more negative in terms of the forecast. The other challenge is knowing right, is growth at 1%, is that really enough to tackle this inflation problem and do in fact need more negative growth outcome to really bring inflation down? And I think that's gonna depend on to what extent the supply side of the equation sort of repairs itself and how that plays out.
Gary Siegel: (
I think I would be very surprised if the SEP ever projected a recession. So maybe they're tempering their projections on GDP, so as not to scare everyone.
Brendan Murphy: (
Right? And I think the nature, the nature of the SEP is, you know, it's a tool, right? To try to manage forward guidance and at times, they'll wanna emphasize that at other times they'll want to de-emphasize, don't worry about it, it's just numbers we write down on piece of paper, right? And there's other times where they're really trying to use it as a policy tool. So you need to read between the lines a little bit, I think to figure out what they're thinking. But you know, away from that, I know everyone gets hung up on the numbers, I think away from the numbers, it's clear they're gonna keep pushing until something breaks, right? And by something breaking, I mean either they create some other problem in either in the U.S. or outside the U.S. in some sort of way, or it breaks in that inflation just comes back, right? And that's the magical soft landing situation they keep pushing and inflation just comes back and then they can ease off. And the odds on that, I think Powell said it himself, that the odds are on that soft landing scenario are a bit lower than maybe he would've thought at the last few meetings.
Gary Siegel: (
And how low do you think those odds are in your opinion?
Brendan Murphy: (
Well, I mean, I don't know. I don't wanna put odds on it. I think there is a possibility there is a plausible scenario where we do get a soft landing. I will say the U.S. economy has been pretty resilient so far, right? So now clearly monetary policy acts with a lag, but the data has been pretty good. The labor market remains really strong. We have seen a lot of rate increases already seeing some softness in terms of the housing market. But the reality is labor market strong, consumers have a lot of cash on their balance sheets. Companies have a lot of cash on their balance sheets as well. And I would say overall the economies is whether fairly well in the environment considering how rapidly monetary policy expectations have changed. So I don't dismiss the soft landing, right?
Brendan Murphy: (
The challenge though is it's gonna be really hard for them to measure in real time to know when they've done too much. In other words, because of that lag in policy, you know, they'll be hiking, potentially sowing the seeds for lower, slower economic growth going forward and not necessarily know when to stop at the right moment. And so that's the the tricky part. And I do think on some level it's the supply side part of the equation that can build a mountain some way. Like if somehow we can can fix that, then you could get this soft landing scenario. But you know what I would say recession versus soft landing, I think the odds are quite higher on the recession scenario at this point.
Gary Siegel: (
And if you look at the SEP unless you're chair Powell, you see 125 basis points of tightening in the next two meetings. And he said it could be a hundred because there were a number of people who thought it was a hundred. What do you see? Do you see another 75 and a 50 or 50 and 50? Or where do we go from here?
Brendan Murphy: (
I mean if I had to pick, I'd pick 75 at the next meeting and then followed by 50. So you get the 125 by the end of the year and then one or two 25s in the early part of next year. So that would be sort of my base case. We'll see, could they go 50 next meeting, could be if you make some progress in terms of the inflation outlook with the next print, it's possible that you only get 50. But like I said before, if I'm them and I'm as long as, you know, unless the labor market starts to weaken or unless you get a material drop in inflation, I'd keep going. Like I'd stick with the 75 and then start to taper after that. That'd be my inclination. I do think it's gonna be important for markets when they shift to 50, right?
Brendan Murphy: (
Because I think the move to 75 was, was important and it did. If you think back to that June timeframe when they shifted to the 75 basis point increments, you did see a near term peak in terms of Treasury yields peaked around three and a half percent, S&P 500 sort of bottom to that point. And then there was this period of stability, right? For a couple months anyway. And I think that stability was a direct reflection of like, okay, this move to 75, this is a big deal, they're starting to get things under control, they're serious about this, they're gonna get inflation under control and markets responded positively. So similar to that, that's sort of second derivative I think is real important. So in other words, the second derivative to go from, 50 to 75 was important. I think when they downshift as well, it's gonna be equally important because it's gonna show, all right, we think we're past the worst of this, right? So we're gonna go from 75 to 50. So, and I say all that because if I'm them, and I think that's the way the market would react when they start to down shift it, you don't want to be too early in that if you're not confident that you've got the inflation thing under control. So I would look for 75, 50 or two more 25 early part of next year and then an extended pause, probably for the rest of the year.
Gary Siegel: (
It's funny because the markets after the first 75 didn't believe how strict the Fed was gonna be with these 75s. They thought there were gonna be a couple of hikes and then next year we were gonna have rate cuts. And it didn't turn out that way,
Brendan Murphy: (
Right? It did not turn out that way, it didn't turn out that way at all.
Gary Siegel: (
But I think the market now believes the Fed is committed to raising rates until inflation is under control. And that will take a while.
Brendan Murphy: (
Yeah. And I would say to anyone worried about, you know, critical of the Fed, I mean I think they can certainly be criticized for staying easy for too long, right? And doing QE potentially for too long, keeping rates low for too long. But if you look at the reaction function this year, if you're being critical the Fed, I'd say, well, what do you want? Like what's the alternative? Do you at this point, do you not like they clearly need to tackle this inflation problem? And that should be first and foremost. So it's almost in some ways, they need to be aggressive because the alternative of them not being aggressive means that inflation's gonna get even worse, which means risk asset performance is gonna be even worse. And that's not a good thing. Like you want them to be on top of this to restore price stability and ultimately that should be good for risk assets and for markets in general. So it should, you know, in some ways over the near and the long term, right? You should, you should view it positively that they're taking this seriously and trying to tackle it and have more confidence that they will be able to tackle it than if they had just done the 20 incremental 25 basis point moves that they've done. You know, historically meeting for meeting.
Gary Siegel: (
It would've taken them years to get as high as with 25 as they did.
Brendan Murphy: (
It would. I mean, I remember having discussions about a year ago about, okay, the Fed's gonna hike in 2022, what's that gonna look like? And a lot of people didn't think, you know, doing math of like, okay, well if they hike 25 every meeting, what does that get us to at the end of 2022? And a lot of people pushing back saying they can't hike every meeting, are you crazy? Like they can't possibly do that. It'd be more like every other meeting. And if they do that at every meeting, they're gonna the economy and now they're doing 75 basis points at every meeting, it's crazy compared to where the mindset was a year ago.
Gary Siegel: (
I was having that discussion with someone this week who asked me if I ever remember the Fed raising rates like this and I said I never remember them raising more than one meeting, skipping a meeting and then coming back with another hike. And I said, let alone three 75s in a row.
Brendan Murphy: (
Yeah, I 100% agree. It was, you know, this was completely off the radar. I think it's probably off the Fed's radar too. I don't think they expected to be in this situation. But yeah, you look at history and I've been doing this for a while, but yeah, 25 per meeting, okay, that seems like that's reasonably aggressive. No, not really. In terms of what we've actually gotten, this is aggressive.
Gary Siegel: (
They didn't say anything about quantitative tightening. They were supposed to double the rate of quantitative tightening this month. Have you seen anything about that? What's that gonna do with the rate hikes or to the rate hikes? Obviously it hasn't impacted them to this point.
Brendan Murphy: (
So I think with quantitative tightening, I think first of all, I think they think of it separate from the rate decision, right? So all is equal doing quantitative tightening, reducing the size of the balance sheet, should all is equal mean that they, they don't need to do quite as much on the rate side, right? Because that should be, it's a tightening of monetary policy, just like QE was an easing of monetary policy. QE is a tightening and monetary policy, but I do think they think of it separate. But one thing that came up yesterday in the press conference that was interesting I thought was the discussion around mortgage-backed securities. And there was a little surprising to me that he was, Powell was, very unambiguous about like, look, we're not even thinking about that, right? He's like, that's way off. In other words, sales and mortgage-backed securities. So they're gonna let the mortgages roll off so to the extent that they mature and pay down and that'll shrink the balance sheet, but they're not gonna engage in direct sales. And it sounded like not for some time around that. So I thought that was interesting and should all those be supportive for the, the MBS market, which did pretty well yesterday afternoon on the back of that. So, I thought that part was interesting.
Gary Siegel: (
So we touched on the fact that monetary policy works with a lag. We kind of got into this, but I'll get into it a little more. Obviously there have been a massive amount of rate hikes in the past three meetings, which haven't fully made their way through the economy. Is the Fed being too aggressive or is this they have to be this aggressive?
Brendan Murphy: (
Well, I think the policy is warranted, I guess is what I'd say. I think it's appropriate. I think it's aggressive and I think it's appropriate to be aggressive. And it's similar to what I outlined before. There's no reason not to be, you have an inflation problem, you don't really have a growth or a labor market problem, go get it, right? Go tackle it, bring inflation expectations back to more normal. You know, Powell talked about this yesterday as well, the sort of stability, right? The long period of low stable inflation and how good that was for the economic cycle. And so I think they want to bring us back to that, to that point in time and that's why the policy is warranted. So I think it is aggressive, but I think it's warranted and I think it's appropriate to be aggressive in the current environment. Now last year, clearly not aggressive enough, right? Clearly they should have been a little bit more proactive last year about trying to get ahead of this a bit more, but now that we are where we are, I think it's, it's appropriate.
Gary Siegel: (
Well obviously if they had raised rates last year, they wouldn't have had to be so aggressive this year,
Brendan Murphy: (
Right?
Gary Siegel: (
So does it make the fact that they're moving so quickly, raising rates at every meeting and by so much that has to make it harder for them to figure out where we are because you have all these different rate hikes moving through the economy at different paces and it would make it difficult for them to figure out when to pause. Would it be any different if they went every other meeting? Would it be easier to figure out when to pause that way?
Brendan Murphy: (
I'm not sure that it would make it easier if it was every other meeting. I think, like I said before, I think they have a window, right? They realized, look, we've got this window, we can be aggressive. We have a big gap to close, 25 basis points every meeting or 50 every other meeting or whatever it is, right? It's not gonna get us to back to where started with this sort of what's the real Fed funds rate that you need to get to, right? And it's gotta be restrictive, right? And so from where inflation is to where the policy rate is, that gap is, was ridiculously big, right? Between the Fed funds rate and inflation. So you need to close that gap. Inflation's come down a little bit, but the funds rate has a lot more to go to get there.
Brendan Murphy: (
So I think it's right to be aggressive. I think it's right to go every meeting now, you know, you can make a case as we get, again, that's what's happened over the last six to nine months going forward. We'd expect at some point that they start to slow down that pace, not in the next meeting or the December meeting, but probably in the next year. And the hope is once we get to that point, right, you at a more appropriate sort of level, they start slowing that pace down. The hope is that things haven't gotten outta control, I guess by that point. And so it remains to be seen once we get there.
Gary Siegel: (
So how is the bond market reacting to all this today?
Brendan Murphy: (
Today's not good, right? So it's funny because yesterday the market was sort of sanguine, I'd say, about the response to it. You saw a lot of flattening yesterday, right? So you saw pressure on the front end of the yield curve and the back end rallied. And that's logical to me. You know, I think a Fed that's gonna be aggressive and hawkish should put some upward pressure on the front end, but ultimately that's gonna be good for the overall outcome of the economy. And so the back end was relatively stable today you're seeing this a selloff really, you know, across the board. Part of that's because it's not just the Fed that's that's hiking rates. There's a lot of central banks that are hiking rates and I forget what the number is, I should have wrote it down, but there's I think seven or eight central banks over the last few days that have all come out with policy decisions and they've all been pretty hawkish.
Brendan Murphy: (
The Bank of England today raising rates 50 basis points. So I think you're seeing, what you're seeing is really the market is looking at these central banks and just a real concern about duration exposure and trying to shed duration, however they can. So yeah, so that's what you're seeing today. Personally I think it might be a little bit overdone. You know, I think about where Fed funds is priced for next year in terms of the terminal rate and thinking about our forecasts, we think we're a lot closer to fair value at these levels. We have been generally positioned to be underweight duration, but you know, as we get higher and higher yields, the more attractive it comes to sort of cover that duration.
Gary Siegel: (
What do you think the yield curve is telling us? Is it suggesting recession is coming? Do you believe in the inverted yield curve being a signal?
Brendan Murphy: (
I don't think the yield curve is signaling anything right now. I think it's just reacting, if you will. So in other words, it's reacting to a Fed that has said, Look, we're gonna jack rates as much as we need into restrictive territory to ultimately deliver a solution, a situation where inflation is not a problem anymore. So in some ways I think it shows the level of confidence in the Fed, right? That like if the market didn't believe the Fed, then you'd almost see the curve steepen or not flatten as much, right? Because you'd think, all right, they're gonna try to tackle this inflation problem, but they're not, they're never really gonna get their hands around it. That would put upward pressure on the long end. So the fact that the long end has been more stable, I think reflects a degree of confidence that the Fed will be able to tackle the inflation problem.
Brendan Murphy: (
You look at inflation breakevens, some of the sentiment surveys around inflation, that it's not that bad, right? We're still kind of sub three, maybe a little bit higher than what we've seen, but not outta control, right? So long term inflation expectations, I would say to this point have not become unanchored. And, so that's supportive of the long end, not getting outta control, the front end though, who knows, right? If they need to go four and a half to five or even higher than that ultimately, right? That's gonna, that's what they actually deliver is gonna dictate what you see in the front. So I think that the inverted yield curve is less sort of a sign that we're heading into immediate recession and just more the reality that this inflation problem is not gonna persist forever. But that said, the risks around a recession are pretty high because moving into restrictive territory, bringing inflation down, it's gonna require some sort of hit to growth to accomplish that.
Gary Siegel: (
So let's take a brief detour. Let's talk about inflation for a second. To what extent is the inflation we're seeing a function of the aftershocks of shutting down and restarting the global economy? And how much is it a function of more embedded expectations for future price increases and both goods and labor?
Brendan Murphy: (
Yeah, I think to me it's been more about supply, the constraint supply of, as I said before, first, you know, COVID supply chain disruptions, goods just couldn't get from one place to the other, right? So that was really the start of the problem. We've seen problems on the supply side, on the labor front, just lack of workers is what that morphed into. And then more recently, challenges in terms of energy, food prices, right? Things like that. These are all sort of supply constraints that precipitated I think the inflation environment that we're in. Now, not to say that demand has been bad, I mean demand has been solid, right? But I wouldn't classify demand as sort of outsized, right? This is not, so to me there's an imbalance there and the Fed's trying to address that imbalance by tackling the demand side cuz they can't really do much about the supply side, right?
Brendan Murphy: (
So it's about bringing that demand side more imbalance with the supply side from the demand side, right? You had a lot of pent up demand sort of coming out of COVID with the reopening rate, the fact that the economy was shut down for so long, the fact that generally consumers accumulated cash in their balance sheet during that time period and then when we saw the reopening, right? That had that sort of unleashed that initial period of demand, which was, which was good, but that sort of exacerbated the problem, right? And so, now as I look forward, I think, you know, the hope is as they tackle the demand side, the supply side constraints come more in balance. And then that's how you ultimately wind up with this more softish landing scenario potentially.
Gary Siegel: (
So what, what risks do you see that are the biggest threats to the economy?
Brendan Murphy: (
So I mean, the obvious threat is that the Fed over tightens, they don't know when to stop, they push it too far, and create a problem. I worry more about sort of unintended consequences of the type of policy things and things outside the U.S. even and how that might spill over back into the U.S. So things like the strong dollar, the dollar had been incredibly strong. We just saw the Bank of Japan intervene in the yen overnight because the yen was too weak for their liking. I shouldn't say the Bank of Japan, the Ministry of Finance in Japan intervened because the yen was too weak.
Brendan Murphy: (
All these countries that have borrowed debt denominated in U.S. dollars, right? That debt is more expensive, not only because yields are higher because the dollar is strong and sometimes they're borrowing dollars, it gets more and more expensive. And so I worry that the strength in the dollar at some point creates some unintended consequence outside the US that spills back into the U.S. if you will. So it's all about the dollar is clearly very much tied to the Fed policy, so it's all related. Inflation's high, the Fed tightens, the dollar gets strong, rates go up and the big question mark is how long can the global economy really hold together without breaking with all those negative dynamics going against it? And so that's, you know, ultimately what what the big challenge is.
Gary Siegel: (
You're so right, Everything is connected. So, so what are your clients asking you? What are the biggest concerns?
Brendan Murphy: (
Pretty much the biggest question is when's it gonna stop? In other words, we've seen a massive drawdown in terms of fixed income returns. So I manage global fixed income portfolios, but whether it's a U.S. aggregate portfolio, global AG portfolio, how you pick it, right? Pick any sort of asset class within fixed income, massive negative returns, right? Purely, mostly a function of, I mean, we've seen some credit spread widening, but mostly a function of interest rates moving higher. So the first question is typically always like, okay, have we seen the worst? Are we behind, have we seen the worst in terms of drawdowns? When do you think it's gonna stop? And I think we're a lot closer. I don't want to call the bottom necessarily, but I do think, you know, we're much more appropriately priced as we look forward prospectively you think about fixed income, we always say the two things you want out of fixed income are income and ballast.
Brendan Murphy: (
You want income yield, obviously you got that, you know, at levels we haven't seen in quite some time. And the ballast part is interesting because typically you want fixed income to be the sort of diversifier in your portfolio. What's interesting about the last, about this year really has been the correlation of bonds and equities has actually been more positive than you would've thought historically. And that's because the Fed is raising rates and the Fed is driving it and rates are driving the equity markets. So, I think personally going forward you could see that relationship flip and you could see the correlations move back to more typical sort of negative relationship primarily because as inflation gets more under control or less of a hot button issue, you're gonna be talking more about the growth environment. And so that could be really a really attractive environment for fixed income.
Brendan Murphy: (
And that's, you know, one where the Fed is pretty much done in terms of the hiking cycle. You have really high yields and then you have that balance component if there's some spillover after effects of tighter policy on risk assets. But clearly that everyone's looking for when's the bottom? Like, just tell me, tell me when the bottom is, you know, to find the bottom. I think you gotta know when the Fed is gonna see the peak and that's what we just spent the last 45 minutes or so talking about, is what is the peak, when are they gonna stop? We're close. I'm not sure we're quite there, but we're getting closer.
Gary Siegel: (
All right, I'm gonna take some questions from the audience. One person asks, Chair Powell mentioned that one metric they're aiming for before they're thinking about pausing is seeing positive real yields across the yield curve. Has he ever mentioned this before?
Brendan Murphy: (
So yeah, I don't know how much real yields have been mentioned before. I tend to think of it as I said before. So the real yields would be one metric in terms of financial conditions. I do think the Fed looks at financial conditions and is acutely aware of financial conditions. Real yields would be one input into that equity prices credit spreads, right? There's other other metrics you can use. And as I said before, the challenge with the real yields is just knowing, knowing exactly what it is, right? Cause real yields by definition is just the difference between inflation expectations and the nominal yield. But you gotta know what that inflation number is. And because it's been so volatile, I think it's really hard to know exactly what the real, the sort of x anti real yield is that you should be using. I'm not sure that it's been addressed before, but I think the more probably appropriate metric to use would be broader financial conditions in terms of evaluating how tight policy gets.
Gary Siegel: (
Next question we have is, what are your thoughts on government spending and how that figures in the equation?
Brendan Murphy: (
Yeah, I don't think in the U.S. it's a big part of the equation right now, but I do think in the UK and Europe it is in the sense that with the problems with the energy market there and the subsidization that's gonna have to happen both, you know, either on the consumer side or the corporate side to help alleviate some of the pressure from the supply shocks. You're gonna see a lot more government spending out of Europe and the UK. And so ultimately that's gonna lead to, that's gonna put more inflation pressure right on some level, right? That more stimulus, could be higher yields. So that's gonna have some effect on the overall yield environment, the bond market environment. I don't expect too much out of the US although clearly, if you look back, the fiscal stimulus that we got a couple years ago is certainly part of the reason we're in the situation that we're in now, right? You had aggressive easy monetary policy, you had aggressive fiscal stimulus, and that's part of the reason that we are where we are. Going forward though, I don't think it's gonna be a big impulse.
Gary Siegel: (
Next question. It seems counterintuitive to increase prices under the guise of assisting the price pressures for the populace. The other issue is the wage pressures, will they increase unemployment? It doesn't add up.
Brendan Murphy: (
Yeah. So let me think about this one, think about the question. I think part of the challenge with the unemployment picture too is just the participation rate. And so I think you can make the case that you can sort of, if you can get more people to come back into the workforce, right? That could be a scenario where the employer rate doesn't as much as you think all else equal. Um, so yeah, I understand the question a little bit that it's counterintuitive, but I don't have a great response, I guess is what I'd say.
Gary Siegel: (
All right, last question because we're running out of time. What is your thought on 60/40 portfolios during times like this?
Brendan Murphy: (
Yeah, so this has not been a good environment for that mainly because of that correlation part I talked about before. So the correlation's been pretty positive. So you've had equity selloff, you've had fixed income selloff, so that hasn't worked well and I think it hasn't worked well because what you've seen is an inflation problem and a central bank response function to address that, which has negatively impacted both asset classes. So going forward I would say I'm much more positive about the idea of a 60/40 portfolio because I see those correlations moving more back to normal. That's certainly a big question mark, but I think as the narrative shifts from concerns about inflation to growth, I'd expect the negative correlation to kick back in the fact that the starting yield is so much higher in fixed income than it was, you know, last year or over the last few years is another huge positive. So I think you could see an environment where the 60/40 portfolio behaves more like you'd expect it to. In other words, where equities come under pressure and fixed income acts as the balance ballast for that. I think the environment is right for that going forward, but certainly not what we've seen over the last six to 12 months.
Gary Siegel: (
Well, Brendan, thank you for joining us. Thanks to the audience again, Brendan Murphy, head of Global Fixed Income North America at Insight Investment. And thank you all for joining us today.
Brendan Murphy: (
Great, thank you.
