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Speaker 1: Our next guest is Steve Major, Global head of Fixed

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Speaker 1: Income Research at HSBC. Steve, thanks very much for joining us.

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Speaker 1: Um so jumping out from the notes that you've sent

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Speaker 1: us the year of the claw back three and that

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Speaker 1: investors fixed income investors can make back some of the

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Speaker 1: money they lost last year. So that implies I guess

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Speaker 1: that the bonds move up in the yields moved down

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Speaker 1: so much so that you're predicting the tenure US Treasury

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Speaker 1: yield will be only two and a half percent the

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Speaker 1: end of next year. Does that mean you're expecting recession? Yeah,

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Speaker 1: it's It's a punchy cool, isn't it, Because we're talking

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Speaker 1: about something a hundred basis points below where we trade,

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Speaker 1: and most people are forecasting something more like four to five.

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Speaker 1: I think the point of the forecast is not just

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Speaker 1: to take on board the base case. The base case

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Speaker 1: is what the Feds telling you they're going to do.

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Speaker 1: They're telling you they're going to five. They're also telling

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Speaker 1: you longer run that their equilibrium is between two and

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Speaker 1: three UM. So the base case would probably put the

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Speaker 1: fair value somewhere between three and three and a half

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Speaker 1: on the tenure. So the reason we get two and

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Speaker 1: a half is because we're thinking about the outliers. We're

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Speaker 1: thinking about the tail risk, and this is what they

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Speaker 1: call the left tail risk. So we're talking you mentioned

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Speaker 1: a recession. Just about every man and his dog is

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Speaker 1: talking about recessions. So that's probably going to happen. The

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Speaker 1: question is how severe is it or or is it

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Speaker 1: possible that the FED could even reverse course in the

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Speaker 1: next year or so. So, so you haven't got to

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Speaker 1: forecast rate cuts this year. You've just got to recognize

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Speaker 1: that they reach a peak, say around five, and the

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Speaker 1: next move in two thousand is down. And when markets

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Speaker 1: get that, uh, when they get that sniff or they

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Speaker 1: get that bit between their teeth is what I was thinking,

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Speaker 1: then they're they're going to be looking for more because

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Speaker 1: markets don't expect one rate cut, they expect a whole load.

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Speaker 1: So if markets are implying a fifty betasappoint rate cut,

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Speaker 1: say two, that's a bit like saying a probability of

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Speaker 1: two fifty That that that that that that's what it's saying. Right,

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Speaker 1: Let's let's say you've got to think about it. So

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Speaker 1: I don't think two and a half is wrong. Well,

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Speaker 1: we're not at the end of the year, weren't we

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Speaker 1: in terms of that possibility of easing them. I mean,

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Speaker 1: there was something that was just flagged today on Bloomberg

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Speaker 1: by the farmer. New York Fed chair Bill Dudley says,

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Speaker 1: you know, the Fed can always be easy if the

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Speaker 1: recession gets too deep. So how likely do you see

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Speaker 1: that scenario? Yeah, and here you're talking about one of

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Speaker 1: the guys in the vanguard of the hawkish view. He

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Speaker 1: was early on the hawkish view. He picked up on

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Speaker 1: how the Fed was going to hike. Don't forget the hike.

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Speaker 1: The hikes have been three to four times what the

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Speaker 1: Fed itself was predicting this time one year ago. So

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Speaker 1: so now to be looking across the other side as

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Speaker 1: the hawks are, that's telling you something. But it's also

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Speaker 1: trying to be a bit too cute because in a way, look,

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Speaker 1: we know the economy responds with a lag. So it's

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Speaker 1: twelve to eighteen months um lack so um that the

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Speaker 1: hikes that happened a year ago are are coming through now.

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Speaker 1: So people feel it in their pockets now, they feel

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Speaker 1: it in their mortgages, they feel it with their job

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Speaker 1: prospects or not, as the case might be in a recession.

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Speaker 1: So by the time they get to five percent or higher,

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Speaker 1: you know, it comes down like a sledge sledgehammer. Yeah,

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Speaker 1: it's it's all a bit it's a bit predictable. Um,

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Speaker 1: you know, maybe it's going to be something in between. Um.

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Speaker 1: I mean the idea that you go to five and

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Speaker 1: then at some stage and you also you have to

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Speaker 1: go back down to zero. That seems a bit too binary. Um,

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Speaker 1: it's it's it's possible that they try and hold that

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Speaker 1: five percent level for a while, but it may be

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Speaker 1: that in the event they don't cut that much. But

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Speaker 1: it's what markets do, isn't it. Markets go to far

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Speaker 1: and so in the same way they can go too

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Speaker 1: far on the hawky side, they can go too far

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Speaker 1: on the do wish side. So if you see the

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Speaker 1: ten year potentially heading down to two and a half

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Speaker 1: by the end of three, how about the two year

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Speaker 1: and what does it mean for you Curban version? Yeah, well,

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Speaker 1: the two's are going to be close to five. If

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Speaker 1: the Fed says it's going to go to five and

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Speaker 1: change and stay there, you haven't got to be a

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Speaker 1: mathematician to work it out, because you've got you've got

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Speaker 1: four coupons and a redemption in the space of two years.

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Speaker 1: So if if you're if you're at five and you

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Speaker 1: step up five, your yield is around five. Now, if

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Speaker 1: you build in the probability that they're going to be

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Speaker 1: cutting in two four, then you need to start thinking

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Speaker 1: about a much lower yield. If the FED is an

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Speaker 1: easy mode, the twos will scream that, the yield will

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Speaker 1: scream lower and the curve will disinvert. The one thing

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Speaker 1: I don't understand is given your view, and I think

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Speaker 1: the view has a lot of appeal because the FED

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Speaker 1: is promising you that it's not going to air on

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Speaker 1: stamping too earlier, eas in too early. They want to

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Speaker 1: go the whole mile. Uh. Then I don't understand why

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Speaker 1: you say that default risk is not so bad this

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Speaker 1: year and that you like some investment grade in Europe. Yeah,

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Speaker 1: good point. Now, investment grade credit to some extent, especially

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Speaker 1: in Europe, is discounting of recession. So we can figure

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Speaker 1: out what the default probabilities are implied in today's yield.

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Speaker 1: And bearing in mind you've got so much spread, you've

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Speaker 1: got this protection. So if you bought a hundred bonds

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Speaker 1: and three of them failed, you still got ninety seven

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Speaker 1: that that works. So that the point is in terms

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Speaker 1: of this is where clawback comes in. If if if,

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Speaker 1: if I can get somewhere between five and seven percent

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Speaker 1: yield on investment grade credit, depends where you are. Really,

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Speaker 1: I reckon that's a good deal, and I'll be happy

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Speaker 1: with that in a year's time. I can cope with

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Speaker 1: a few defaults. I think. I think recession risk is

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Speaker 1: implied in Europe. You've you've got the e c B

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Speaker 1: as well, UM with its huge balance sheet, um that

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Speaker 1: that has provided some protection. That's going to start going

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Speaker 1: into reverse more for the sovereign side, but on the

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Speaker 1: on the corporates, I'm not I'm not so worried. So

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Speaker 1: that The point about clawback is you're going to clawback

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Speaker 1: some of the losses of two thousand twenty two through

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Speaker 1: the coupon, not just through the price gain. It's right,

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Speaker 1: and it's gonna take you a few years to get

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Speaker 1: all that back. If you've lost fifteen, it might take

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Speaker 1: you two or three years to get it all back.

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Speaker 1: But that's why it's a claw isn't it. Yeah, that's

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Speaker 1: that's not a bad that's not a bad comparison. It's

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Speaker 1: a bit like that it is. I think that's probably

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Speaker 1: a good way to go. Um, you have to be

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Speaker 1: patient and the gain, the gains are going to come

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Speaker 1: from a cruel less so than through capital gain. But

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Speaker 1: with clawback. I'm thinking about my fingernails and scraping them

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Speaker 1: against the table. Another nice analogy. All Right says they

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Speaker 1: were talked a little about Europe, how about how about

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Speaker 1: emerging markets? Well, a few of the big sovereigns have

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Speaker 1: become uninvestable over the years, and that that actually plays

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Speaker 1: into the hands of those that are more investable. That

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Speaker 1: when I asked questions about emerging markets, I often take

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Speaker 1: a pause and thinking what do we actually mean by

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Speaker 1: emerging markets? I mean, for example, is China in emerging market?

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Speaker 1: That the sovereign bomb market certainly doesn't trade like one.

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Speaker 1: It's it's stuck in a range. It yields you know,

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Speaker 1: two and a half to three that it's one of

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Speaker 1: the safest, most stable of all of the global sovereigns.

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Speaker 1: So I don't know how how much of an emerging

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Speaker 1: market is. I suppose when you start to look at

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Speaker 1: property stocks, you're really an emerging market territory in emerging

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Speaker 1: in China, So so to to me, Latin has been

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Speaker 1: the sweet spot and it probably continues to be. So

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Speaker 1: you've got but in Brazil you've got through some of

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Speaker 1: that political uncertainty, got huge real yields in these in

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Speaker 1: these countries, and and and potential that policy is moving

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Speaker 1: over to the other side into easing mode. We've we've

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Speaker 1: liked Mexico as well for a while, so so that's

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Speaker 1: where the real sweet spot is. Um I'm always looking

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Speaker 1: for the opportunity to buy India, and I guess at

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Speaker 1: some stage we're going to become more positive. We're not

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Speaker 1: really there yet, but if the commodity um story is changing,

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Speaker 1: and if if prices are coming off, which has been

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Speaker 1: the recent the recent sign, then that then that would

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Speaker 1: play into the hands of the big energy importing type

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Speaker 1: of countries. So I should like Mexico and Indonesia. In Indonesia,

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Speaker 1: I think you're right. Indo were quite like and you

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Speaker 1: can get duration as well in Indonesia, and it's one

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Speaker 1: of those bell weather names. Um if if if you

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Speaker 1: like em and I think I think that there are

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Speaker 1: arguments with a weaker dollar, a more benign rates environment,

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Speaker 1: maybe there's a recession, but a shallow recession might actually

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Speaker 1: play into the hands of some of these high yielding

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Speaker 1: e M countries. Just give you thirty seconds or so.

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Speaker 1: You seemed like you were hinting at this that the

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Speaker 1: ECB might crack a little sooner than the FED in

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Speaker 1: terms of support. Yeah, the ECB talk stuff. But the proximity,

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Speaker 1: the geographical proximity to Ukraine, the proximity to recession they're

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Speaker 1: in it really um uh, the the fragility that comes

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Speaker 1: from running a multi sovereign project that has one single currency.

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Speaker 1: I think the odds are that they do crack. Yeah, alright, Steve,

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Speaker 1: thanks very much. Very sexy stuff there for sure, And

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Speaker 1: for listeners who came in maybe mid stream there. You

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Speaker 1: can always find this a Bloomberg Radio dot com or

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Speaker 1: if you have access to the terminal, just go to Adeo.

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Speaker 1: Steve Major, Global head of fixed income Research at HSBC