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Speaker 1: Stephen Major, who's global head of fixed Income Research at HSBC.

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Speaker 1: Great have you on the program this morning, Stephen, given

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Speaker 1: such an important day in terms of data the USCPI today,

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Speaker 1: the youth Kevin versions pasted its first birthday tenure yields

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Speaker 1: have they further to rise? This obviously is the main

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Speaker 1: focus of markets no anymore.

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Speaker 2: The peak for yields was established in October twenty and

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Speaker 2: twenty two, and since then we've had four months with

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Speaker 2: yields down and four months with yields up, and we're

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Speaker 2: back at the top of the range. So you know,

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Speaker 2: everyone's been a winner in this game, if you like.

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Speaker 2: So this is what turning points look like, in that

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Speaker 2: you get a bifurcation of views and again there's no wrong,

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Speaker 2: We're right here. So you've got a hawkish narrative which

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Speaker 2: is part of the forward guidance, and you're part of

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Speaker 2: this because you're discussing it and you're feeding it into

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Speaker 2: valuations and expectations. Central banks want everyone to know that

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Speaker 2: they're on guard against inflation and that they might even

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Speaker 2: hike some more. But the truth is we all know

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Speaker 2: that we're at the end of the cycle more or less,

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Speaker 2: give or take But.

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Speaker 1: Then to my point is that you're actually a little

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Speaker 1: bit bullish on European rates. And again this is the

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Speaker 1: same playbit for the ECB key to emphasize its hawkishness,

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Speaker 1: but that actually can the economy and you do really

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Speaker 1: withstand this and the US economy you know, larger, more powerful.

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Speaker 2: You've read our report then, so so actually we have

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Speaker 2: a bullish which is the maximum for US on five levels,

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Speaker 2: for US and the Eurozone, and for choice, maybe the

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Speaker 2: Eurozone is the better one. And it's about what's priced

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Speaker 2: into the forwards. So if you look into twenty twenty four,

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Speaker 2: market barely discounts the chance of a rate cut. It's

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Speaker 2: a you know, ten bases spots here over there. The

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Speaker 2: US is quite deep easing expectations if you look at

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Speaker 2: where the one year forward is for example. And so

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Speaker 2: if this was a bet, and I'm not allowed to

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Speaker 2: use the word bets in our publications, well I'm going

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Speaker 2: to use it here, right, If it was a bet,

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Speaker 2: you get better value on buying the Eurozone saying Eurozone

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Speaker 2: not UK here right than the US.

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Speaker 3: Right.

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Speaker 2: So, because you know, if if the if there's a recession,

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Speaker 2: the Eurozone isn't pricing it the US is see me.

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Speaker 3: Yeah, well then let's talk UK guilts have been described

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Speaker 3: as a falling knife that no one wants to catch.

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Speaker 2: With that, well, there's some people who will catch them.

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Speaker 2: So if you're rich enough, so if they'll talk about

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Speaker 2: retail investors here, you should be buying some at the

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Speaker 2: front end because you know there's a capital gains tax advange.

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Speaker 2: And I'm not here to give personal financial advice, but

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Speaker 2: the point is who is going to be the marginal

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Speaker 2: buyer of guilt when it's it's it's horrible. You've got

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Speaker 2: the inflation picture. Bank of England's still hiking and they

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Speaker 2: have to be hawkish. It's really horrible. But you know

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Speaker 2: the marginal buyer will come in if the price is right.

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Speaker 2: So when you can get yields above five percent at

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Speaker 2: the front end, there are plenty of individuals and institutions

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Speaker 2: that will be will be will be chomping at the

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Speaker 2: bit to start in the front end of the guilt market.

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Speaker 2: I think you've got good price points. I'm talking about price,

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Speaker 2: not yield here. Right with the price so far below par,

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Speaker 2: there will be those who work out the kind of

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Speaker 2: tax advantages.

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Speaker 1: So then what do you make of this warning from

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Speaker 1: the Bank of England this morning from the financial stress

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Speaker 1: test around increasingly risk averse global investors could raise the

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Speaker 1: cost for funding for UK institutions. I mean that again,

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Speaker 1: it's it's part of the UK narrative, isn't it, the

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Speaker 1: alliance on overseas investors, and that is at risk. The

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Speaker 1: Bank of England again is sort of highlighting.

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Speaker 2: Look, I'm not the first person to say this, but

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Speaker 2: the people are comparing the UK with the non developed

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Speaker 2: market countries and there's articles about everyone's discussing it and

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Speaker 2: use fiscal dominance kind of stories as well. I mean

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Speaker 2: I was looking at the interest bill for the annual

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Speaker 2: interest bill. It's now multiples of what we used to

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Speaker 2: have in guilt issuance. I remember the days. It was

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Speaker 2: only a few years ago that we were issuing fifty

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Speaker 2: billion pounds of guilts a year. Now the interest bill

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Speaker 2: is multiples of that. So it's very, very painful and

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Speaker 2: it's difficult to kind of thread the needle here or

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Speaker 2: to figure out the path because the Bank of England

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Speaker 2: has no choice with the inflation print to be hawkish

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Speaker 2: and to threaten more rate hikes. But we've got a

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Speaker 2: recession coming isn't that baked in the cake?

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Speaker 1: I mean, I suppose the question is about how sharp

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Speaker 1: and how long and how quickly the Bank of England

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Speaker 1: would have to reverse course, and if they do a

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Speaker 1: fifty basis point rate rise, whether that is a policy

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Speaker 1: error At this point.

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Speaker 2: Well, we'll sort of getting to the point where that's

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Speaker 2: what it will look like in a year's time. It's

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Speaker 2: easy for me to sit here saying it. I mean,

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Speaker 2: as policymakers, they've got little choice, right, they are beholden

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Speaker 2: to a mandate that they have to deliver to. Then

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Speaker 2: you've got a bunch of economists and some non economists.

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Speaker 2: You have to make a decision, and it's pretty clear

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Speaker 2: for them. With unacceptable inflation and wage pressure. The UK

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Speaker 2: is a bit unique in the global economy because you're

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Speaker 2: not seeing this in the US. You've seen a complete

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Speaker 2: disinflation pattern on the headline at least K looks very different.

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Speaker 2: Brexit effect, the huge fiscal stimulus of the during the

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Speaker 2: COVID period, all of this is coming home to roost.

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Speaker 3: But you have got, compared to nine months ago, a

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Speaker 3: strong pound. Does that actually show that the UK can

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Speaker 3: withstand higher rates better than now?

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Speaker 2: There's a bit bit of a paradox because if you

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Speaker 2: look at great differentials, that makes the pound look attractive.

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Speaker 2: But that's a short term thing because if you look

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Speaker 2: at the theory interest rate parity theory, if a country

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Speaker 2: is paying more on interest rates compared to another one,

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Speaker 2: then that should say that the character is going down

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Speaker 2: in the future. Right, that's the interest rate parity theory.

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Speaker 2: It's how the forwards work as a free lunch.

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Speaker 3: Right.

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Speaker 2: But the bizarre thing is the flow into the higher

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Speaker 2: yielding guilts and pound assets is holding it up. But

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Speaker 2: that doesn't look good news for next year or for

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Speaker 2: some horizon I don't know, three to six months. You'd

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Speaker 2: be worried about sterling, wouldn't you. Sterling has frequently been

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Speaker 2: a tool of policy in the past. It's one of

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Speaker 2: the levers that the UK has that France doesn't have.

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Speaker 1: Yeah, yeah, anyone who absolutely so? Look then, I mean

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Speaker 1: I said to use on bond vigilante. But are we

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Speaker 1: back to an era now where bond markets absolutely have

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Speaker 1: the upper hand. I mean we've seen it with list

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Speaker 1: trust in the UK, but also with even one could

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Speaker 1: argue with reccept type one also in Nigeria. I read

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Speaker 1: T boot same sort of thing is is that are

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Speaker 1: we now in that era where there is much more attention.

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Speaker 2: Yield yields are above the trusts era, right, so this

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Speaker 2: is this is not supposed to have happened, and I

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Speaker 2: wouldn't go so far to use the emerging market comparison.

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Speaker 2: I think that's inappropriate. The UK has some huge advantages.

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Speaker 2: First of all, very high duration on the debt. The

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Speaker 2: optionality that gives the DMO and therefore the treasury is huge,

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Speaker 2: right in terms of switching on and off different segments

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Speaker 2: of the curve if it's too expensive to issue, right,

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Speaker 2: it's expensive to issue when the yield is high. The

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Speaker 2: Bank of England has good stock of bonds as well,

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Speaker 2: so you know there's there's huge optionality around the policy.

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Speaker 2: Fiscal policy could be used as well, and the whole

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Speaker 2: idea of integrating the monetary and fiscal stance in a

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Speaker 2: more imaginative way.

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Speaker 3: I believe you've just jumped on my hobby horse, the

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Speaker 3: topic we've been raising for weeks now. But it does

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Speaker 3: seem the use of fiscal policy to bring down inflation

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Speaker 3: if it's the government's number one priority to have inflation,

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Speaker 3: and there's this lag in monetary transmission. What would you

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Speaker 3: see as being the way to do it through fiscal policy?

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Speaker 2: Since you raised that, well, they've got to consider taxation

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Speaker 2: and it's going to be selective. Of course. Paradox again

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Speaker 2: is that you put certain taxes up and you only

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Speaker 2: boost the inflation rate. But as a as a break

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Speaker 2: on the economy, they're going to have to be thinking

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Speaker 2: about that. And there's other aspects that we could we

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Speaker 2: could think about. I mean, it is true that this

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Speaker 2: inflation is actually quite unique. It's Brexit related, pandemic related.

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Speaker 2: It needs a much more integrative response and I'm surprised

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Speaker 2: we haven't heard more. So if you've been talking about

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Speaker 2: that's good. It needs to be discussed week.

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Speaker 1: But for example, Prime Minister, is you see again you know,

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Speaker 1: talking about how the it doesn't the government doesn't seem

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Speaker 1: to be at that place. They are still talking about

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Speaker 1: how inflation in the UK it's very similar to Europe

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Speaker 1: and it is a result of the well in Ukraine

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Speaker 1: it's section. I mean, those are the lines, right.

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Speaker 2: I don't want to be too speculative, but there must

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Speaker 2: be discussions on this, right. So obviously the mandates are

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Speaker 2: such that the Prime Minister and the Chancellor shouldn't be

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Speaker 2: stepping on the toes of the bank, and the bank

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Speaker 2: shouldn't be stepping on the toes of the chances. But

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Speaker 2: of course they're talking about I mean, I'll be surprised if.

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Speaker 3: They're not, indeed, and the wider conversation globally is about

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Speaker 3: military and fiscal policy working in tandem. But Stephen, you

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Speaker 3: weren't so cruel as to describe the UK as an

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Speaker 3: emerging market. But I will ask you which emerging markets

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Speaker 3: are you keen on? What's true?

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Speaker 2: You don't think we're anywhere near emerging market centers in

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Speaker 2: the UK. I think it's just lazy, by the way,

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Speaker 2: to say that the UK has finan finance ability in

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Speaker 2: a huge scale. But the markets we like are led

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Speaker 2: by Mexico and Brazil. In fact, all the usual suspects, Indonesia, Career,

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Speaker 2: Czech Republic. And what happens is we have a scorecard

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Speaker 2: and it ends up looking for certain criteria and one

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Speaker 2: of them is the real rate of interest and some

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Speaker 2: fiscal credibility. And in fact India is creeping towards that

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Speaker 2: that group as well. So we don't like China because

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Speaker 2: we think there's little policy move and also it's a

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Speaker 2: relative value thing. Investors have got so much else they

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Speaker 2: can buy. And again, fiscal policy will probably be used

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Speaker 2: in a looser sense in China, not a tightening sense.

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Speaker 1: But I suppose how long can that trade lost? I mean,

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Speaker 1: that's that's the issue about the strength of the returns,

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Speaker 1: because they have been strong.

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Speaker 2: Done well this year. Yeah, so it's the the top

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Speaker 2: performers at em the worst performer of funny enough is

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Speaker 2: goods in yield terms, but you also had currency gains

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Speaker 2: as well in some of those em and investors like

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Speaker 2: that because if you're going to invest in something, whether

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Speaker 2: you're going it's private or institutional, you do like a

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Speaker 2: following wind. So it looks like the right thing to do.

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Speaker 2: And in fact, you could even argue that countries like

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Speaker 2: Mexico have quite some fiscal and monetary credibility, and it's

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Speaker 2: supposed to be an emerging market, and so in fact

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Speaker 2: you are getting your risk reward. You are being rewarded

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Speaker 2: for the amount of risk you're taking.

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Speaker 1: Just in terms. Though I mentioned this when I was

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Speaker 1: looking at the markets, there's been obviously this spike in rates, volatility,

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Speaker 1: equities much calmer jocks are basically held up relatively well

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Speaker 1: also for a lot of this year. Why and does

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Speaker 1: that change swiftly in the second half of the year.

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Speaker 2: Well, the equity analysts have the luxury of taking the

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Speaker 2: bomb market as an input to their process. I don't

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Speaker 2: have much from them that news in my work. I'm serious,

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Speaker 2: I don't know what input I get from equities so

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Speaker 2: on the assumption that the rates are coming down next year,

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Speaker 2: that boys the expectations about future earning. So nothing I

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Speaker 2: can tell you don't already know. It seems to me

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Speaker 2: that's the best explanation of it. But there are a

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Speaker 2: few people now starting to go a bit more risk off.

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Speaker 2: I've noticed our multi asset team is not at the moment,

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Speaker 2: but I think that we could be. You know, if

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Speaker 2: I'm right on the bomb market, that we're on the

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Speaker 2: top of the range for the yields and that by

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Speaker 2: Q four US shields are coming down. If I'm right,

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Speaker 2: then presumably it's more of a risk off kind.

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Speaker 3: Of backdrop, all right, Always a pleasure. Stephen Major, Global

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Speaker 3: head of fixed Income Research at HSBC