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Speaker 1: Let's get to our guests. Stephen Major joins us to

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Speaker 1: take a closer look at what's going on in the

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Speaker 1: fixed income space ahead of the speech tomorrow from fed Share. J. Powell.

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Speaker 1: Stephen is Global head of Fixed Income Research at HSBC.

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Speaker 1: He joins us from our studios in Hong Kong. Thanks

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Speaker 1: for being with us. Let's begin with the U S

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Speaker 1: yield curve. I mean, we're seeing a greater inversion right now,

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Speaker 1: and I'm wondering how you're reading this. The conventional wisdom

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Speaker 1: is that it's talking about recession, but I think the

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Speaker 1: timing of when one unfolds and the magnitude of a

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Speaker 1: recession is up for a little bit of debate right now.

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Speaker 1: I'm curious to get your view. What do you think? Yeah, well,

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Speaker 1: some measures of the yield curve have predicted about nine

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Speaker 1: of the last three recessions, So it tells you all

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Speaker 1: you need to know the the the curve measure that

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Speaker 1: Mr Powell looks out. I'm sure you're aware of the

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Speaker 1: near term forward. It tipped into negative territory two or

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Speaker 1: three weeks ago. So the near term forward is looking

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Speaker 1: at the eighteen month forward, three month rade months or

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Speaker 1: three month rate that's a that's a measure that he

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Speaker 1: had had constructed on his behalf during the last cycle,

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Speaker 1: and he has said that this is a more reliable

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Speaker 1: indicator office session, so it has actually led other measures.

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Speaker 1: So let's just say it's probably a base case now

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Speaker 1: that we're going to have a move towards over session.

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Speaker 1: And I mean, they don't seem to be troubled by this,

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Speaker 1: and the FAT is not alone. The RB and ZE

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Speaker 1: to think is taking a similar position. Is this playing

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Speaker 1: with fire so to speak? I mean, could they inadvertently

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Speaker 1: because they have been so aggressive in front loading rate hikes,

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Speaker 1: could they inadvertently create something that is deep and lasting.

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Speaker 1: It wouldn't be the first time there's been a policy mistake.

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Speaker 1: And that in the interaction between the unemployment data GDP

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Speaker 1: data and the and the inflation data is wages. So

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Speaker 1: so what I'm saying is they they know that this

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Speaker 1: has to happen for them to get near their target

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Speaker 1: with the next couple of years. So wages are the

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Speaker 1: important part of inflation. Much of the other stuff is

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Speaker 1: going to wash through over time. If there's any risk

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Speaker 1: that wages are going into an upward spiral, then then

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Speaker 1: that's a problem, So so it has it sort of

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Speaker 1: has to happen. It's a bit harsh, but that's the reality.

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Speaker 1: So how tolerant would they be of much weaker growth?

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Speaker 1: I mean, if inflation is still not near their target,

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Speaker 1: do you think that this could be a prolonged exercise

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Speaker 1: where rates do remain elevated for for some time. Well

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Speaker 1: that that that's what they want us to think. But

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Speaker 1: the market and our view is different. So we're looking

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Speaker 1: through to the other side already, and and and that

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Speaker 1: isn't wrong, by the way. I'm just looking at the numbers.

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Speaker 1: So so in all probability, they'll they'll hit a peak

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Speaker 1: in the next few months and the market will start

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Speaker 1: to price a turn. It's already doing that. Um, just

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Speaker 1: just looking at the data the last seventy years that

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Speaker 1: do you know what the median number of months between

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Speaker 1: the last hike and the first cut is? Well, I'll

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Speaker 1: tell you it's four months, and the mean is eight

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Speaker 1: because of the two thousand and six two thousand eight period.

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Speaker 1: Guess what the median core PC is when the when

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Speaker 1: the first cut has come. It's three point nine, So

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Speaker 1: let's called it four. It just seems to me that

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Speaker 1: it's not out of the question that we get to

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Speaker 1: four core pc next year and they're looking over the

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Speaker 1: other side. I'm wondering, though, whether it's safe to apply

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Speaker 1: historical data when you're dealing with a situation that is

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Speaker 1: so unique. Is the one that we're dealing with now,

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Speaker 1: emerging right from the pandemic, where we're also unwinding a

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Speaker 1: balance sheet in a massive way. That certainly throws some

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Speaker 1: complication into the picture, doesn't it. Yeah, you're quite right,

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Speaker 1: and I normally um set up my presentation of data

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Speaker 1: like that, saying Okay, this is data mining, I get it,

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Speaker 1: but I want the number us and UM. It doesn't

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Speaker 1: mean to say it has to happen, but it it

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Speaker 1: strikes me that the FED is going to have to

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Speaker 1: switch to both sides of the mandate at some point

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Speaker 1: that that they're laser focused, as they say, on inflation.

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Speaker 1: They want us to think that's the only thing that

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Speaker 1: they're focused on, and they want us to think that

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Speaker 1: they're going to go to five or more and just

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Speaker 1: stay there and stay there for as long as it takes.

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Speaker 1: That's that's the message. If they stay there forever, then

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Speaker 1: bonds should be yielding five. That's a simple maths calculation.

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Speaker 1: But today we're trying to factor in the probability that

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Speaker 1: there isn't what's going to happen and in the next

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Speaker 1: it doesn't have to be in the next three six months.

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Speaker 1: I'm talking about within the next year. If we're moving

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Speaker 1: into an easing cycle, the market won't price one cut,

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Speaker 1: it will price the whole load. And that's why when

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Speaker 1: you look at the weighted average of the short rates

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Speaker 1: to derive what the yield should be, it's not wrong

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Speaker 1: that we have a three handle right now, and that

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Speaker 1: we could even have a two handle. So when your

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Speaker 1: research reaches the desk of bond trading desk at HSPC,

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Speaker 1: give me the strategy that you're recommending. Well, our forecast

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Speaker 1: is two point zero for the end of next year. Um,

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Speaker 1: you could say that forecast is wrong, but by definition,

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Speaker 1: the forecast isn't wrong until you hit the horizon date.

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Speaker 1: To me, yields will be lower, not higher. We want

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Speaker 1: to receive duration here, and I think if if you're

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Speaker 1: talking about the wider fixed income, it's credit i g.

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Speaker 1: Credit that would be favored. And I think real money

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Speaker 1: investors recognize that if you're trading credit, you can't just

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Speaker 1: buy everything you need in one day. It takes months

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Speaker 1: to build a position. Same thing you would you would

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Speaker 1: favor duration at this point in time, even in the

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Speaker 1: I G space. Yeah, yeah, well, I think definitely in

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Speaker 1: the i G space because if you if you're a

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Speaker 1: credit investor, and most real money investors are invested in credit,

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Speaker 1: you can't get the bonds you need in one day.

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Speaker 1: I could probably get all the duration I need in

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Speaker 1: treasuries and futures and swaps quite quickly, right, but in

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Speaker 1: in credit a text ages. Last question, Stephen, thirty seconds

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Speaker 1: when you look at the price section in the equity market,

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Speaker 1: do you scratch your head and say, why don't they

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Speaker 1: understand where we're going? I do, That's the short answer.

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Speaker 1: I look at again, looking at the the log normalized

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Speaker 1: accumulated accumulative returns for bonds versus equities. Bonds look cheap

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Speaker 1: compared to equities, so at some stage that has to

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Speaker 1: sort itself out. Thank you so much for taking so

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Speaker 1: much time to speak with us. Stephen Major is Global

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Speaker 1: head of Fixed Income Research at HSBC