ESGB - Why Markets Are Pushing Back On A Fed Pivot To Rate Cuts
Summary
- What's next for the bond market after Fed Powell's speech?
- Is the Fed pivot away for higher rates off the table?
- Outlook on inflation in Canada and the U.S.
Stock markets tumbled following Fed Chainman Powell’s hawkish stance on rate rises. Greg Bonnell speaks with Chris Whelan, Senior Canada Rates Strategist at TD Securities, about whether a Fed pivot away from rate hikes is officially off the table, and how bond markets are reacting.
Transcript
Greg Bonnell: Markets are looking to find their footing after a three-day slide following Federal Reserve Chair Jerome Powell's much-anticipated speech at Jackson Hole. Joining us now to discuss whether a Fed pivot away from rate hikes is officially off the table, and what's going on in the bond market -- Chris Whelan is Senior Canada Rates Strategist at TD Securities. Great to have you here. Welcome to the program.
Chris Whelan: Thanks, Greg. Appreciate it.
Greg Bonnell: So let's start with the big question of the summer and the theory of the Fed pivot, which seemed to -- Jerome Powell seemed to go at lengths to sort of just throw cold water all over and say, listen, this is going to be a tough fight. How are the markets anticipating and sort of interpreting it, and specifically the bond market?
Chris Whelan: I think the bond market had the meeting right ahead of time. We kind of lead higher in yields into the meeting. The equity market is still digesting that, I guess, aggressive, hawkish tone that came out of there. I think the bond market is telling us that, whether or not the central banks are going to come out with a strong hawkish footing, which I think is clear now, post-Jackson Hole -- the bond market is telling us that this pain isn't going to last that long or something's going to change in the economy. Because the bond market is -- we're around 3.1% on the US 10-year. The highs are around 3 and 1/2%. We're hanging in there at a -- the bond market has a muted reaction post-Jackson Hole. So I think the bond market is telling you that the pain doesn't have to last for as long as we think, or the economy is going to roll over, or the data is going to soften, inflation is going to soften.
So I think even though the general consumer might be reading into that Jackson Hole as a scary moment, I think we don't know what we're bracing for. But I think that they're not going to be able to maintain that hawkish stance for long, is what the bond market is telling us.
Greg Bonnell: Does that give us enough information to bring the word, pivot, back into the discussion? Or is the word pivot sort of becoming like transitory as well? At some point, it just wasn't useful anymore to a discussion about what was happening in the markets.
Chris Whelan: I think I think the pivot has evolved to when they're done. So the pivot is over now. They're not going to pivot. But now, we're talking about when they're done and what we look like on a forward basis. So does the -- I think the inflation is -- it looks like the bond market is telling us that inflation is going to start softening. And I think we're all sort of hoping for the best scenario on the soft landing. But it's difficult to say whether the bond market is pricing a hard landing and sustained inflation, or what we're pricing in there. But we're definitely -- we're definitely pricing in the -- sorry, the pivot is gone, and it's kind of about more when we end. And I think the bond market is saying that the hiking cycle is ending sooner than later. So it should be ending before the spring next year.
Greg Bonnell: Because the fascinating thing, obviously, about when central banks -- when they take the action on rates, either as they have aggressively to the upside recently, or to the downside at the beginning of the pandemic. We're supposed to have a bit of time before it actually makes its way fully felt. And we've had some super-sized, jumbo-sized -- I don't even know what words to use anymore for, like, jumps of 75 basis points or 100 basis points in this country. That's going to take some time, isn't it? I mean, at some point, though, the central banks take a look and say, let's see how this key continues to flow through the economy.
Chris Whelan: I think we're already starting to see the signs of the impact starting to be felt. I think the built-up inventories -- I think the -- today, we had Canadian GDP -- the flash estimate shows a 0.1% contraction. And in the coming month, I think that the data is starting to soften overall. And I think that that's where the bond market is getting its cue and extrapolating forward -- that these hikes are working. And they are bringing inflation expectations down, and they are contributing to slowing in overall consumer activity, in general.
Greg Bonnell: Now, of course, Jerome Powell's saying that it's going to be a lengthy fight to try to bring inflation back down to where they'd like it to be. And of course, the sweet spot is 2%, and getting within that range. How tough of a fight is that? I've heard other people say, you're probably going to see the inflation print cool significantly over the next little while, but that last mile -- that last mile might be the hardest mile.
Chris Whelan: I think that's the problem -- that we're going to go into an uncomfortable zone where it takes time to get down from. So we expect that inflation has peaked, around 8.6% in the US, 8.1% in Canada. And so we're going to move into the 5s in the first quarter of next year, and then into the three handle in Q2. Q1 next year should feel quite uncomfortable if the bond market is correct. Because we still have inflation at an uncomfortable level for central banks, well above the 2% target, while we should have clear signs of growth deterioration.
So I think Q1 is that uncomfortable moment, where -- that's the difficult moment. And I think that difference of 5% versus 2% is why rates stay at around the 3 and 1/2%, 3.75% level -- 3 and 1/2% in Canada, 3.75% level in the US, if our forecasts hold, into -- through Q1 and Q2. And then, so we think that the cuts come into play in Q3, Q4 next year.
Greg Bonnell: If there still are investors out there holding on to the pivot narrative, that seems to be the moment that will test the resolve of central bankers. When you are looking at, as you said, a slowing economy -- perhaps you start to see the jobless numbers start to rise, the labor markets start to weaken -- can they hold their resolve? Can they look into the face of that and say, we realize we've inflicted pain, but we have to continue to let you feel that pain on this mission to bring down inflation?
Chris Whelan: Yes, unfortunately, I think that pain -- I think it's easier to say pain than feel pain. So we'll see -- [LAUGHTER] --we'll see how that feels in Q1 next year. But I think, to your point, the pivot -- anyone holding on to the notion that the central banks were done hiking, that's gone. And I think in Canada, we have -- I think markets consensus is that we have 75 bps head. It's pretty close to market consensus that they're going to go 50 bps for the next two meetings in the US. So I think in both cases, you have about 100 bps of hikes, kind of, at least in Canada and the US in the coming months.
So I think that pivot notion of them ending soon is over, because 100 bps is not small. Like you said, these are big hikes. So that pivot notion is gone, and we're going to -- we'll talk about what we do 100 bps from now.
Greg Bonnell: Longer-term -- and I know it's so hard to try to predict what's going to happen in the future. But I feel like we've had a decade or more, since the financial crisis, of central banks sort of always being front and center, with monetary policy. Can we ever get to a point where we have a normalized regime of interest rates? Something, though -- do we even know what normal is anymore when it comes to the cost of borrowing?
Chris Whelan: Right. I remember being at university, thinking, wow, we have monetary policy figured out now. We hike a little bit, we cut a little bit, and then we have 2008, and then that certainly wasn't the case. I think, unfortunately, we're very much still stuck in the boom and bust, and the boom-and-bust cycles -- it would be really nice if we got a soft landing this time. But we really hit the pedal full on during COVID, because we saw that 2008 scares of a Great Recession, and then we realized that was a bit too hard. But we didn't know at the time. And now, we have to hike to a degree of interest rates that we haven't seen in a long time when we were just getting used to zero. We all thought zero was the norm. We were just stuck at zero.
Greg Bonnell: I'm never going to pay for money again.
Chris Whelan: I'm never going to pay for money. Money's free. But the -- I think it's hard when we're already -- when we're talking about hikes, the higher you hike, the shorter the distance would be between the time you cut again. So I think, for now, the bond market has been extremely volatile. And that's been a phenomenon we've been dealing with over the last year -- since COVID emerged. And so the bond market volatility is kind of telling you that it might be a ways of time before we understand calm interest rates. So I think we still have to deal with cycles for a good amount of time.
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Why Markets Are Pushing Back On A Fed Pivot To Rate Cuts