CasPhotography
Recent U.S. inflation data has been fueling market speculation on when the U.S. Federal Reserve may begin cutting interest rates. Alexandra Gorewicz, Vice President and Director for Active Fixed Income Portfolio Management at TD Asset Management, says the results move the needle in the right direction but that the Fed is unlikely to be swayed just yet.
Transcript
Greg Bonnell – The latest US inflation report suggests price pressures may be easing after proving stubbornly high so far this year. So does that change the market’s view on when the US Federal Reserve may begin cutting interest rates? Joining us now to discuss, Alex Gorewicz, VP and Director for Active Fixed Income Portfolio Management at TD Asset Management. Alex, always good to have you on the program.
Alexandra Gorewicz – Thanks, Greg. Great to be here.
Greg Bonnell – All right, so this seems to be one of those reports where at least we’re not moving in the wrong direction. What’s your read on it?
Alexandra Gorewicz – I think you summarized it perfectly. So maybe just a quick recap– whether we’re looking at the headline month-over-month or core month-over-month, it was 0.3%. Year-on-year numbers, 3.4% and 3.6%, respectively, for headline and core. These numbers were basically in line with expectations.
In fact, month-over-month headline was a slight miss. So obviously, the market liked that. All markets liked that– bond markets, equity markets. And probably the reason why is a psychological development. This is the first time that you’re probably sitting opposite someone in many months talking about US inflation meeting or missing expectations.
Greg Bonnell – Using that word “easing.”
Alexandra Gorewicz – Right? Right. And I think that’s extremely important. Now, the devil is in the details, to some extent. Because when we look at, let’s say, super core inflation, which is core services, excluding any shelter-related components, if we look at the last three months, including the latest print, if we look at the last six months, if we average those numbers and then annualize them, we’re still looking at figures that are over 6%.
That doesn’t actually give the Fed a lot of confidence. However, similar to some of the other numbers that I mentioned, the good part about it is not that it comes in line with expectations, the good part is that the rate of change is slowing. We saw stickiness along all these sort of inflation measures in the last several months. And now, we’re starting to see that momentum wane, which is probably the positive outcome of today’s print.
Greg Bonnell – As you said, bond markets, equity markets liking this news. At the same time, I imagine it’s the first of what the Fed is going to need to see through several reports across the different metrics to tell them that, indeed, they’re on the right track.
Alexandra Gorewicz – Correct. And that’s why I said, you have to look at the details, and you have to realize that the numbers are still not compatible with the Fed returning to that 2% target in the medium term, 2% inflation target, in the medium term. So, we have to take this with a grain of salt. It’s maybe a step in the right direction, but by no means giving the Fed the green light to, let’s say, lower its policy rate at its next meeting.
Greg Bonnell – Now, somewhat overshadowing, being overshadowed, by the CPI headline print is the fact that we got US retail sales today. I didn’t go too deep into it other than to see that they were flat. And so this seems to be another indication that, perhaps, the US consumer is starting to say, wow, life’s expensive. The cost of money is expensive. Maybe I need to slow down.
Alexandra Gorewicz – That’s an excellent point because I think when we look at today’s fall in interest rates across the yield curve, it seems to have been more of a reaction to those soft retail sales. Again, psychologically, the fact that inflation was not a beat, that it didn’t come in firmer than expected actually helped to pave the way for that.
But today’s retail sales, similar to some of the mixed data we saw yesterday in PPI, similar to, let’s say, a couple of weeks ago when we had nonfarm for March, you’re starting to see now a string of data in the US that is missing expectations. And, as we know, when we think about market reactions, it really is about, what’s been priced in? What’s expected by investors versus what’s delivered?
And the last several weeks have delivered weaker-than-expected data in the US from a total macro point of view. And I think that, more than anything else, is what is going to enable the bond market to say, well, maybe now we’ve priced out too many Fed rate cuts for this year, and maybe it’s time we start pricing some back in.
Greg Bonnell – All right. So this could create a situation where you have the market’s expectations pushing back against what the Fed is telling us. It’s been a push and pull for a while, right? At some points, it feels like the market is saying, no, no, no, we think you’re going to do this much.
And Jerome Powell is like, take it easy, be patient. He’s been talking about patience for a while now, and the market’s seemed to fall in line with that. So you think there’s maybe a disconnect, as they say, be patient. Let the interest rates do their work, and the market will say, no, no, no, we think you’re going to go sooner rather than later.
Alexandra Gorewicz – Well, now that narrative seems to be, we think you’re going to go, as in cut, sooner rather than later. But just a couple of weeks ago, there was a growing chorus of investors suggesting that the Fed needs to hike again. And in hindsight, I think Powell and the Fed did the right thing by saying, let’s stay the course.
Let’s cut off that tail risk, we’ll say, for more rate hikes and just prolong our current policy stance. We’ll delay when we start rate cuts, but the next move is more likely a cut. And again, the string of data we’ve seen in the last couple of weeks in a number of different indicators suggesting that the Fed is right to, again, try to transition more towards easing.
Greg Bonnell – When we finally do get the easing, when we finally do get the rate cuts, how robust will they be? How aggressive will they be on the other side? Or is this a case of, we’re going to stay higher for longer, and then when we finally do start cutting, we’re going to take it slow?
Alexandra Gorewicz – The key here, and it’s hard to say at this time, the key will be labor market data. What the Fed did by saying, effectively, we just need to hold the current stance longer– and then all of the data that came after that effectively suggested rates didn’t need to move higher– what that all did is to say, well, actually, the Fed’s position and the Fed’s current policy stance could be restrictive enough.
But the key will be labor data. And on days, whether it was claims last week, initial claims that surprised to the upside, whether it was the nonfarm data from a couple of weeks ago, it suggested that perhaps, yes, the Fed’s policy stance is restrictive enough. So you’ve actually seen the response in markets be skewed towards sort of an asymmetric outcome, which is, well, then maybe rates don’t move higher. You have them move meaningfully lower, and then all other asset classes really like that.
Greg Bonnell – Well, let’s talk about the wait. And we’ve been waiting longer as investors than we, perhaps, thought we would be for the Federal Reserve to deliver a rate cut. What is the sentiment like among fixed income investors as they wait this out?
Alexandra Gorewicz – They don’t like waiting. The hard part here is that everything that I’ve just mentioned has actually whipsawed the market around quite a bit. You’re really super data-dependent, which, in some ways, is boring, but in other ways is also very volatile from economic data release to economic data release.
And I think for a long time, bond investors were conditioned to just expect capital returns, whether it was positive or negative, because yields, generally, were so low for the last 10, 15 years up until a couple of years ago.
And because of that, they didn’t have the experience of having to wait for their income return or their yield return to compound over time. And so I feel like bond investors are still very much caught in that psyche where it’s like, OK, I want my returns now.
Like, OK, the Fed needs to cut interest rates, or the Bank of Canada will cut interest rates, and let’s go positive returns. That hasn’t happened, right? We are data-dependent, and that data has been volatile.
But when you take a step back, what you realize is your yields are actually helping to offset a lot of that volatility. But it takes time to compound those yields. It takes time to realize those yields. And I think that waiting and being patient part is something that needs to return to bond investors.
Original Post
Credit: Source link
