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Speaker 1: Bloomberg Audio Studios, podcasts, radio News.

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Speaker 2: Please to welcome back Kathy Jones, chief fixed income strategist

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Speaker 2: for the Shwop Center for Financial Research. Kathy, let me

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Speaker 2: start with you. I want to pick up on that

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Speaker 2: chart that Mike just showed us, that idea that traders

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Speaker 2: have not only priced out rate cuts for it the

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Speaker 2: rest of this year, but they have priced in a

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Speaker 2: rate hike or the odds of a rate hike this

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Speaker 2: year as well. Is this dramatic repricing appropriate or is

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Speaker 2: it overdone?

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Speaker 3: You know, I think it's appropriate because coming into this,

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Speaker 3: the idea was it was going to be a short

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Speaker 3: term event and we were going to pass right through it.

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Speaker 3: Now we're into it the fourth week I think third week, Okay,

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Speaker 3: So we're approaching the fourth week, and that's significantly longer,

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Speaker 3: and it's gotten significantly more escalated than had been anticipated.

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Speaker 3: So we're seeing the energy price shock, and sort of

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Speaker 3: between the rise and energy prices and the slow down

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Speaker 3: in growth that will come from that is the inflation hit.

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Speaker 3: And so I think the market is reflecting that the

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Speaker 3: inflation hit is coming and it needs to deal with that.

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Speaker 3: I'm not sure that it's accurate that the Fed is

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Speaker 3: going to high rates anytime soon, but I think it's

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Speaker 3: more appropriate to go from building in one or two

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Speaker 3: rate cuts to being at least neutral at this stage.

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Speaker 2: George, what do you think?

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Speaker 1: Yeah, I think that the you know, the market has

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Speaker 1: a tendency to overshoot at the very front end of

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Speaker 1: the curve. I mean, just listening to what Mike said

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Speaker 1: and what Kathy said, as well as some of the

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Speaker 1: things Powell said earlier this week, the Fed's kind of

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Speaker 1: on hold, and I think they said that very clearly.

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Speaker 1: They're on hold. They're going to wait and see. They

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Speaker 1: cannot move proactively unless something really really dramatic happens, But

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Speaker 1: as it stands now, they're kind of stuck in neutral. Now.

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Speaker 1: The market's kind of rushed to price rate hikes, which

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Speaker 1: seems a little premature because if we look a little

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Speaker 1: further out the curve, if you look at break even

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Speaker 1: rates for inflation one year out rates, the inflation looks

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Speaker 1: like it's going up over the next twelve months. But

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Speaker 1: if we look further out, say ten years, the market

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Speaker 1: still has inflation pegged it around a little under two

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Speaker 1: point four percent, So long term inflation expectations remain pretty

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Speaker 1: firmly anchored. But it's those front end, you know, kind

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Speaker 1: of worries that are getting the market very anxious. And

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Speaker 1: when we looked at rate cut expectations earlier last year

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Speaker 1: and even the prior year, the market gets very excited,

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Speaker 1: very quickly rushes to price in rapid moves by the Fed,

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Speaker 1: and then the Fed has to slow pedal and kind

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Speaker 1: of move much more slowly with the data as the

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Speaker 1: data unfold, so we don't see them doing anything for

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Speaker 1: at least the next three plus months or maybe even longer.

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Speaker 2: So one of the consensus trades before the war began

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Speaker 2: was the steepning yield curve, and this week we've seen

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Speaker 2: the twos ten spread narrow sharply to around forty two

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Speaker 2: basis points. You would think that the inflation impact of

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Speaker 2: rising oil would lead to curve steepening. What does this

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Speaker 2: rapid flattening, Kathy tell us about what the market sees

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Speaker 2: as a key risks facing the fat.

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Speaker 3: Yeah, I think this is reflecting that rush at the

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Speaker 3: short end to price in a shift in rate expectations

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Speaker 3: and at least take out the rate cuts on the

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Speaker 3: part of the Fed, as George indicated. So I think

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Speaker 3: the long term trend is probably still towards steepening, but

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Speaker 3: there is a chance and one scenario, and there's so

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Speaker 3: many scenarios to play out, but one scenario is this continues,

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Speaker 3: inflation becomes a big concern, the Fed does have to tighten.

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Speaker 3: Growth slows down, So we know that behind the inflation

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Speaker 3: push is probably a growth slow down. So I think

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Speaker 3: the market's starting to reflect that right now, but it

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Speaker 3: will probably play out these scenarios a dozen times before

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Speaker 3: we actually know what the endgame.

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Speaker 2: Is here, George, as we wait for the endgame, what

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Speaker 2: do you want to hold? Where do you want to

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Speaker 2: be on the curve?

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Speaker 1: Yeah, as we pointed out earlier, you know, kind of

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Speaker 1: the big move in the front end is is where

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Speaker 1: really where the action's at, and the value is starting

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Speaker 1: to emerge, you know, both in the short to intermediate

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Speaker 1: part of the curve. The three really the two to

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Speaker 1: five year part of the curve is starting to look

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Speaker 1: fairly attractive. As the market gets excited and starts to

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Speaker 1: price and rate cuts I'm sorry, rate hikes, and you know,

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Speaker 1: as Kathy said, as the as the long end comes down,

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Speaker 1: the higher rates and higher oil prices do ultimately become

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Speaker 1: a tax on growth, and the long end is starting

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Speaker 1: to sniff that out, but we're not quite there yet.

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Speaker 1: And so you know, right now, short to intermediate duration

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Speaker 1: looks pretty attractive, you know, kind of grab the yield,

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Speaker 1: play the carry, wait for the trade. Once we see

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Speaker 1: maybe a little bit of economic slowdown, that's when you

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Speaker 1: extend out the curve.

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Speaker 2: When investors spread about oil and inflation, the comparison is

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Speaker 2: always the nineteen seventies. That's kind of where they go to.

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Speaker 2: And when they fear credit blow ups, the comparison is

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Speaker 2: two thousand and eight, Kathy. Not everything is so extreme, though,

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Speaker 2: I mean those are pretty extreme example. What kind of

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Speaker 2: risk does that create, that tendency to go to the

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Speaker 2: most extreme example.

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Speaker 3: Well, it creates risk of overshooting, but also creates some

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Speaker 3: opportunity right when the market's overshoot, that's when you get

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Speaker 3: some good valuations to to s to grab onto. But

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Speaker 3: I do think it particularly when it comes to something

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Speaker 3: like this, because it's a war and it's politically driven,

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Speaker 3: there's so much uncertainty about how it turns out. Right,

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Speaker 3: this isn't something that we can kind of model out easily.

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Speaker 3: We're modeling many scenarios now, and so yeah, markets are

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Speaker 3: going to overshoot in all directions. But I think the

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Speaker 3: the end of it for me is that I'm focusing

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Speaker 3: now on what's the opportunity given the likelihood of a

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Speaker 3: growth slowed down. You know, higher energy prices mean capital

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Speaker 3: investment will slow down, probably hiring will slow down. GDP

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Speaker 3: growth comes down, and eventually that does mean lower rates

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Speaker 3: and lower inflation. It's just how we get there, that's

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Speaker 3: the question.

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Speaker 2: Mark, George, do you think it's a oporate to talk about

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Speaker 2: stacklation light?

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Speaker 1: Well, I think there's risks that stackflation risks have clearly

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Speaker 1: gone up. You know, inflation pressures are mounting, and there's

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Speaker 1: some concern about growth. And what we think is sort

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Speaker 1: of the starting point of where the bond market sits

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Speaker 1: today is really important. And so when we look at

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Speaker 1: kind of the opportunity set that bond investors face as

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Speaker 1: yields move up, that provides a lot of cushion to

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Speaker 1: weather this volatility. And then when we look at the

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Speaker 1: underlying fundamentals, the investment grade corporate bond market is still

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Speaker 1: in pretty good shape, the securitized part of markets are

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Speaker 1: in pretty good shape, and most importantly, municipal bonds are

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Speaker 1: also in very good shape. So there's a lot of

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Speaker 1: safety harbors in the market where you can harbor risk,

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Speaker 1: weather the storm and kind of clip your coupond as

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Speaker 1: you kind of work your way through this.

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Speaker 2: Kathy, final question to you, because this is your last

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Speaker 2: appearance on Real Yield on television before you retire after

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Speaker 2: fifty years in the market, initially as a runner at

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Speaker 2: the Chicago board of Creede. What is the single most

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Speaker 2: relevant lesson that you've learned the hard way about investing.

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Speaker 3: Wow, Managing risk is the most important thing you can

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Speaker 3: do in investing. Always know or try to game out

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Speaker 3: at least the risk you're taking before you enter that investment.

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Speaker 3: Whether it's liquidity, whether it's volatility, whatever it is, manage

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Speaker 3: the risk and the resk can take care of itself.

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Speaker 2: And that's exactly what's happening right now. In March of

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Speaker 2: twenty twenty six, Kathy, thank you so much. Kathy Jones Auschwab,

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Speaker 2: congratulations to you, thank you calling your illustrious career. And

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Speaker 2: George Boy of Offspring really appreciate both of you joining