WEBVTT - Nancy Davis on the Markets (Radio)

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<v Speaker 1>Thank you know, let's get to our guess. Nancy Davis

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<v Speaker 1>is founder and ce IO of Quadratic Capital, joining us

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<v Speaker 1>on the line from Greenwich. So we're saying that two

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<v Speaker 1>year yield in near full percent for the first time

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<v Speaker 1>in fifteen years. Nancy, you say, the last time the

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<v Speaker 1>curve was this inverted, Gorbachev was sitting in the Kremlin.

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<v Speaker 1>What kind of opportunities are there for investors, Well, the

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<v Speaker 1>rates market is definitely expecting the FED to hike more UM.

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<v Speaker 1>The you can see on your Bloomberg terminal, we have

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<v Speaker 1>a hundred and eighty seven basis points of additional hikes

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<v Speaker 1>just this year alone, so in two thousand and twenty two.

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<v Speaker 1>So even if the Fed um you know, there's very

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<v Speaker 1>little expectation about twenty that they're going to hike a

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<v Speaker 1>hundred tomorrow. But even if they hike a hundred, there's

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<v Speaker 1>still another you know, seventy five plus basis points eighty

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<v Speaker 1>seven basis points baked in. And so I think what

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<v Speaker 1>you're seeing right now is a lot of people speculating

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<v Speaker 1>that the number of FED hikes is going to increase

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<v Speaker 1>UM using FED fund futures or treasury options or other

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<v Speaker 1>derivative contracts, and the speculation has actually gotten I think

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<v Speaker 1>a little bit too high um and that has really

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<v Speaker 1>inverted the yield curve. Guield curve is the most inverted

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<v Speaker 1>um over you know, for for for decades um. Currently

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<v Speaker 1>you can see the two year swap rate on your

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<v Speaker 1>Bloomberg terminal is four thirty four, so it's almost four

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<v Speaker 1>thirty five already, and the level of the ten year

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<v Speaker 1>yield is seventy two basis points lower. So it's a

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<v Speaker 1>really odd time for the rates markets because they do

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<v Speaker 1>believe the FET is going to hike. I think the

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<v Speaker 1>question is whether these hike expectations are realistic or whether

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<v Speaker 1>the FET is going to hike seventy five and maybe

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<v Speaker 1>another seventy five this year and then hold um. So,

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<v Speaker 1>so there is a lot baked in, yeah, And how

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<v Speaker 1>much more painful could it get if we continue to

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<v Speaker 1>see the Fed really try to tame the inflation. You

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<v Speaker 1>say inflation potentially could have paked, but even if it

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<v Speaker 1>remains above two percent, we're going to have to continue

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<v Speaker 1>to see these behinds. Well, It's interesting because the five

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<v Speaker 1>year break even, even the Fed Zone calculation of it,

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<v Speaker 1>currently the five year break even is two point one

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<v Speaker 1>one per cent right now. UM, So even though the

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<v Speaker 1>last CPI print was eight point three, the inflation protection

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<v Speaker 1>market is saying inflation is going to fall dramatically. Um

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<v Speaker 1>the two year break even for instances two point three

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<v Speaker 1>right now on your Bloomberg terminal, the ten years two

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<v Speaker 1>point three nine. So there's very little priced in that

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<v Speaker 1>the Fed is going to lose control over the inflation markets.

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<v Speaker 1>In fact, the inflation markets are priced dramatically to have

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<v Speaker 1>falling inflation expectations. And so that's where I think the

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<v Speaker 1>opportunity allies for investors because like all markets, it's um

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<v Speaker 1>it's all about what's priced in, and the market is

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<v Speaker 1>expecting that these rate hikes are going to get the

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<v Speaker 1>job done and inflation is going to fall dramatically. And

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<v Speaker 1>I think taking the other side of that trade, where

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<v Speaker 1>you say, look, does the Fed's rate hikes really impact

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<v Speaker 1>the supply side issues or does it solve the labor

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<v Speaker 1>market crisis, It doesn't really solve any of the bigger issues,

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<v Speaker 1>which are more geopolitical and pandemic related. And I think

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<v Speaker 1>that's an opportunity for investors to add inflation protection in

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<v Speaker 1>the future because it is so cheaply priced relative to

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<v Speaker 1>where it's realizing. What as well, does it mean in

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<v Speaker 1>terms of movement to risk assets, Nancy. When you've got

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<v Speaker 1>the likes of Ray Delio predicting that you could see

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<v Speaker 1>a decline in Stokes and Neural Robani warning that the

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<v Speaker 1>FED could drive the US into a stagflationary dit crisis,

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<v Speaker 1>well we we definitely have a lot of commentarators and

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<v Speaker 1>a lot of positioning that are quite bare as Shaun markets. So,

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<v Speaker 1>I think, you know, as a contrarian, whenever you have

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<v Speaker 1>everyone expecting one outcome, you know the other side is

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<v Speaker 1>usually um, probably right. So I think the FED could

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<v Speaker 1>really avoid, you know, the rate hike tomorrow. I think

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<v Speaker 1>they'll probably hike seventy five. But if they hike and

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<v Speaker 1>then hold to allow the raid hikes to ease their

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<v Speaker 1>way through the economy and also do more with the

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<v Speaker 1>balance sheet reduction, they really haven't been talking a lot,

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<v Speaker 1>even though the caps have doubled in the month of September.

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<v Speaker 1>They initially started in June with the quantitative tightening. I

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<v Speaker 1>think they could be doing a lot more with the

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<v Speaker 1>balance sheet to ease off hiking rates. Um. So I

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<v Speaker 1>do think, yeah, go ahead. I was just gonna say

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<v Speaker 1>I've asked you this before, and I'm just curious to

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<v Speaker 1>get your thoughts, considering things have changeds we last book.

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<v Speaker 1>But but the sixty forty portfolio is that now? Is

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<v Speaker 1>that now a dead way of looking at investing? You

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<v Speaker 1>know a lot of people still have it, so it's

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<v Speaker 1>not dead because it's definitely alive and well, and in

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<v Speaker 1>most institutional as well as retail portfolios have something that

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<v Speaker 1>looked like a sixty forty portfolio. I do think it's

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<v Speaker 1>time for investors to really be looking at the fort

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<v Speaker 1>in bonds because a lot of the passive indusseries don't

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<v Speaker 1>have any inflation protected bonds in it, and that's because

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<v Speaker 1>they were created before these The Treasury even invented the

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<v Speaker 1>inflation protected bond market in so I think the challenges

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<v Speaker 1>is a lot of people in this very high realized

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<v Speaker 1>inflationary environment have been looking at things that worked in

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<v Speaker 1>the seventies and the rates market, even the inflation protected

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<v Speaker 1>bond market didn't exist before the late nineties. So I

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<v Speaker 1>think it's really a time to just be adding inflation

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<v Speaker 1>protection into your portfolio on the fixed income side, because

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<v Speaker 1>so much of the benchmarking in the indusseries has moved

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<v Speaker 1>to nominal treasuries or mortgages, and it's a really dangerous

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<v Speaker 1>time to be just owning that traditional sixty forty for sure.

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<v Speaker 1>So let's tokyobok a little bit. How how is the

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<v Speaker 1>a t F going amidst the recent scenarios that we

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<v Speaker 1>are facing in the global economy? Well, are are depends

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<v Speaker 1>which et F are. Deflation in ETF has been doing

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<v Speaker 1>quite well. UM deflation is really being priced in. A

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<v Speaker 1>lot of people think the Fed hiking rates is going to,

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<v Speaker 1>you know, cause a slowdown in growth and a slowdown

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<v Speaker 1>in economy. Our inflation to e t F UM i've

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<v Speaker 1>all which is the larger and older e t F

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<v Speaker 1>is UM definitely UM not been performing very well because

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<v Speaker 1>the yield curve is massively inverted. So before Jackson Hole,

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<v Speaker 1>we had about ninety two basis points of additional hikes

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<v Speaker 1>priced in before the end of the year. After Pal's

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<v Speaker 1>eight minutes, you know, mega, you know, screaming match about inflation,

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<v Speaker 1>the rates market, the hikes went up. They more than doubled,

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<v Speaker 1>and we have over you know, hundred and eighty seven

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<v Speaker 1>basis points of hikes priceton, even though we still haven't

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<v Speaker 1>had actual FED meeting, So I do think the inverted

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<v Speaker 1>yield curve is not a normal environment. UM investors are

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<v Speaker 1>not being very rational, in my opinion, when you can own,

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<v Speaker 1>you know, the two year swap is four thirty four,

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<v Speaker 1>why would you go by uh, you know, a ten

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<v Speaker 1>year bond for instance, seventy basis points you know, lower

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<v Speaker 1>what meaning less yield and more risks. So inflation expectations

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<v Speaker 1>have been falling dramatically, and that is a lot of

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<v Speaker 1>confidence that the Fed hiking policy rates is going to

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<v Speaker 1>really kill inflation. But like all markets, they move off

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<v Speaker 1>of expectations. So I do think it's a good opportunity

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<v Speaker 1>for investors to buy future inflation expectations because they are

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<v Speaker 1>so cheaply priced. Um the five year break even you

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<v Speaker 1>can see it on your Bloomberg terminal, it's two and

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<v Speaker 1>a half right now, the ten years to thirty nine,

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<v Speaker 1>even the two year is to thirty three. So UM

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<v Speaker 1>inflation is very much on sale alright now, So we're

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<v Speaker 1>gonna have to leave it there, unfortunately. Always a pleasure

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<v Speaker 1>of Nancy Davis is found in ce io of Quadrantic

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<v Speaker 1>Capital on the line from Greenwach Forest