ACTV - Latest U.S. CPI Reading Suggests Fed May Be Done Creating Possible Tailwind For Markets

2023-11-16 06:30:00 ET

Summary

• Markets up on CPI report.
• Is the Fed done hiking rates?
• Why Moody's is downgrading U.S. debt outlook.

U.S. Consumer Prices were little changed in October suggesting the U.S. Federal Reserve may be done hiking rates. Scott Colbourne, Managing Director and Head of Active Fixed Income at TD Asset Management, says the results suggest the economy is entering a 'goldilocks' period and that might bode well for markets.

Transcript

Greg Bonnell: Only a few weeks ago the US 10-year treasury yield was cracking the 5% level. But it currently sits well below that, the latest inflation report out of the United States showing that consumer prices in the states stayed flat in October in a cooler-than-expected showing. So how does that set us up in the bond market going forward?

Joining us now to discuss, Scott Colbourne, Managing Director and Head of Active Fixed Income at TD Asset Management. Scott, it's always great to have you on the program. This feels like one of those inflation reports, one of those kind of days we've been waiting for for some time now as investors.

Scott Colbourne: It's a good news day for all investors, whether it's fixed income or equities, it's a bit of a reinforcing of a Goldilocks sort of scenario, modest growth, and good inflation. So yeah, a big sigh of relief. The market was expecting a little bit more. Actually, you know, they were expecting a 3/10 to 4/10 of a sort of month-over-month inflation, got 0.2.

And so that relief has fed through into a huge rally, as you know, today across the board. And I think from an inflation story, that takes the burden off any imminent hike from the Fed. So we'll see how growth plays out through the next quarter or so. But for the near term, this is a big tailwind for the asset market.

Greg Bonnell: Now sometimes, when we take a look at a piece of economic data and an inflation report, they'll say, beneath the headline, here's what I didn't like, or here's what we need to pay attention to. Beneath the headline numbers here, and the flat reading month-over-month, was there anything to give you pause or concern? Or do the rate hikes seem to be doing their work to bring inflation gradually down?

Scott Colbourne: I think what you're going to see is a bit of a push-back ultimately by central bankers, right? This is a good news story. For the most part, the details are very good. Even you know, the shelter which popped up last month, has come back down. You know, maybe super core inflation, you know, you can really slice and dice inflation here, is a little bit higher than expected, which is sort of the focus on the labor market. And both Bank of Canada and the Fed have sort of said they want to see further evidence of cooling on the -- on the wage front and the labor market.

So I think they're going to a bit of -- you know, there'll be a natural push-back a little bit by central bankers here. They're not interested in hiking, in my personal opinion. They're going to be patient and let the data come to them. As the Fed chair did say, look, we're prepared to over tighten, or just stay on the tightening side more so than accommodating a change in the market.

So you know, it'll be you know, a dilemma, how much do you price in in terms of cuts in the market? Do you start in the second quarter of next year? Or do you move it more to the second half of the year? And right now, we're starting to price it in the second quarter. So maybe that's where the tension will show up between the market and the central bankers.

But I do think we're done. And you know, right now, it's a Goldilocks story, because it's an inflation that's come down, and growth is OK here. But if we see growth go down and inflation continue to go down, that's going to be a little bit more concerning for asset markets.

Greg Bonnell: As the Fed's dilemma, or maybe even the Bank of Canada's dilemma going forward, not so much what they're seeing in the data, but how we react to it as investors, how consumers react to it thinking -- I just think back to the spring when the bank of Canada said, oh, we're not going to go this time, and everyone said, game on, and the housing market wrecked. And they said, wait a minute, we're back in the game again. Is that what they're more worried about now, how we behave in the next couple of months?

Scott Colbourne: Absolutely. There's you know, an element of expectations here. And we've had inflation expectations that came out last week that were you know, at least from the Michigan Survey, were a little higher than the markets expected. So there's that managing the expectations, right? Let the labor market cool off. We've had one nonfarm payroll that's been soft.

And you know, we need probably a string of that. We need this to feed through and continue the softening on the labor side. We've seen continuous claims creep up. So there's evidence of increasing labor supply, but not really maybe real softness on the labor market. So yeah, be prepared to let central bankers wait here, and the market is going to have to deal with that little sort of push me, pull me attitude from the central bankers here.

Greg Bonnell: I wanted to ask you too about an interesting headline I saw in the past little while, something about a bond auction in the States. There had been some concern I guess about issuance earlier in the year. And they had a bit of a messy one recently.

Scott Colbourne: The supply is sort of a bit of a hair on the bond market. And what we've seen is the big inversion of the yield curve, right, short-term rates are higher than longer-term rates. And that's consistent with the Fed tightening. Now, as we move towards the Fed on hold, and ultimately, pricing in cutting, you know, you're going to get a dis-inversion, and supporting that sort of higher rate staying above longer-term rates is this supply.

And yes, last week we had three auctions. We had a 3-year, a 10-year, and a 30-year. The first two went well. The 30-year was a big dud. It led to a big sell-off in rates. And so I think that's going to weigh on the longer end and it's going to contribute to the steepening of the yield curve.

That being said, I think rates in the long end can still come down, but it's that headwind, lots of supply that's going to impact the bond market. And you know, fiscal spending isn't going away anytime soon. So they need to issue a lot of debt.

Greg Bonnell: OK, speaking of fiscal spending not going away any time soon, we saw some of the rating agencies not pleased in the last several months about what's happening on Capitol Hill. Moody's was the latest to come out with, I think it was a downgrade of the debt outlook.

Scott Colbourne: They put out a -- you know, a downgrade on the outlook, but they didn't-- yeah, it's not a ratings change. But it is just another warning sign. And the markets are doing a bit of that work too, right, putting in more of a term premium and putting more of a premium on buying the longer end because of the excess supply.

So yeah, that is -- that is a huge issue that, I don't think this -- I think this is not going to go away. I think politicians now are comfortable post-COVID spending. I mean, they may rein it in a bit, but I don't think this is going away. And this is going to contribute to a stickiness or an upward bias in the longer end relative to the short end.

Greg Bonnell: So we put it all together, what does it mean for fixed-income investors? Because it was a tough 2022. It hasn't been the 2023 that many of us thought it would have. Have we turned a corner?

Scott Colbourne: I believe we've turned a corner, but I'm measured in my enthusiasm. I think that we can see long-term rates, 10-year rates in the US maybe converge to four -- four and a quarter. I don't think we're going to see short-term policy rates get back quickly to the zero to 2% range that maybe we were comfortable with in the pre-COVID era. So it's more of a measured enthusiasm, but I think that we've nipped the inflation challenge.

It's going to take a little bit of time to wring out the expectations in the labor market on wages. But there are crosswinds at play, deglobalization, aging demographics, excess spending. So it's going to measure or limit how much we can see a rally. And so I'm enthused for the moment. And I think you're going to get a nice risk rally into the end of the year with lower bond yields and probably good returns on risk assets as well. And we'll see how 2024 plays out.

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