See Gradual Drop in Inflation, Says Schwab's Jones

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Bloomberg Jul 1 08:16 · 6113 Views

Charles Schwab Chief Fixed Income Strategist Kathy Jones says she sees a gradual deceleration in inflation unless the US economy hits a 'pothole'. She says that at the moment, due to an inverted yield curve in the Treasury market, that it's difficult to extend duration -- adding that she is looking beyond USTs for duration, including to mortgage backed securities. She spoke with Manus Cranny and Dani Burger on Bloomberg Brief.

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Transcript

  • 00:00 We will circle back to the politics in just a moment, but can you give us your view
  • 00:05 of the cadence of the deceleration
  • 00:08 in inflation?
  • 00:09 We're counting down to jobs and jolts this week.
  • 00:11 We had a fairly muted
  • 00:13 PCE on Friday.
  • 00:14 Cathy,
  • 00:14 do we accelerate the disinflation from here forward to the end of the year or is it steady as she goes?
  • 00:22 Well, I, I would guess it's more steady as she goes than accelerating.
  • 00:26 On the downside, we don't have a, that much weakness in the economy, although it's softening and consumer spending in particular is softening.
  • 00:35 But it seems more like a a gradual deceleration or
  • 00:39 really the glide path is if you get .2% on core PCE, you know you continue this kind of year over year slow decline.
  • 00:49 And if we get better numbers like we've seen recently 0.1, you know flat,
  • 00:55 then you actually get, you know very close to the 2% target in the next six months or so.
  • 01:01 So the path ahead seems to be lower on that year over year rate.
  • 01:05 I think it's more of a gradual deceleration unless we had a real pothole in the economy, particularly if we see unemployment rise.
  • 01:13 So Kathy, you like bonds, but we're on this curve because it's a front end that's had fits and starts of being scared of the Fed, and it's a long end that's been scared of the economy and potential deficits.
  • 01:22 So where do you want to position?
  • 01:25 Yeah, the well, so the Treasury curve's inverted.
  • 01:27 It's been inverted forever it seems like
  • 01:30 and so it makes it difficult to extend duration because you're giving up some yield when you move out from the short end.
  • 01:38 We like either barbelling
  • 01:40 in the treasury market or looking beyond the treasury market to extend duration.
  • 01:45 So when we look at the curve and say investment grade corporate bonds,
  • 01:49 it's flat to upward sloping.
  • 01:51 We can capture, you know, five, 5 1/4% yield than agency mortgage-backed securities with six or seven-year duration.
  • 02:00 So there are ways to
  • 02:02 add some duration, hold on to that 5% yield for five to 10 years if you want to without just using Treasuries to do it.
  • 02:11 Well, it's going to be a bumpy Rd.
  • 02:12 isn't it,
  • 02:13 politically and, and, and, and in terms of volatility between now
  • 02:18 and January of next year and now in November.
  • 02:19 I mean, who knows where we go post post the actual election date.
  • 02:22 But there's a lot of notes out there this morning.
  • 02:24 Morgan Stanley is probably the most prominent one on the terminal this morning.
  • 02:27 They say
  • 02:28 a sharp shift in the probabilities in favour of President Trump
  • 02:32 may now be a unique catalyst for curve steepness to become attractive.
  • 02:37 I, I mean,
  • 02:38 is it too early for you to sort of embrace curve Stevens?
  • 02:41 You talk about a barbell approach.
  • 02:43 So
  • 02:43 your first take on the possibility, probability of a a
  • 02:47 Trump in the White House with his tariffs, as Danny says, and, and immigration policies?
  • 02:53 Yeah, I think that a, a shift in the narrative about what policy will be after the election is probably the biggest risk to the Treasury market.
  • 03:02 We
  • 03:02 already have high and rising fiscal deficits.
  • 03:05 So that's something to be concerned about with the long end.
  • 03:08 I don't think it's a critical factor right now,
  • 03:11 but if we were to get, you know, really big tariffs, limits on immigration, which has helped,
  • 03:16 you know, boost the labor market in terms of participation,
  • 03:21 if we get limits on that or a shift in that that's really a major focus, then, yeah, you could see the curve steepen.
  • 03:28 I just think it's too early.
  • 03:29 And remember,
  • 03:31 you know, presidential candidates can say a lot of things on the campaign trail, but they have to get those things through Congress.
  • 03:38 So not only are we waiting for the
  • 03:40 presidential election, but we're really focused also on what's the composition of Congress after we get past November.
  • 03:47 Now, it's such a great point, Kathy, because there's so many outcomes.
  • 03:50 And you could even say even if you could bet on what the outcome is, you don't really know how this market reacts because we are so torn.
  • 03:56 But the thing that seems to be the constant is the deficit that it's going to continue to rise regardless
  • 04:01 of who the candidate is.
  • 04:02 Someone like Steven Major, who I spoke to recently at HSBC, said, look, it's already priced in.
  • 04:07 This is a known quantity.
  • 04:08 So there's no reason for bonds to sell off because of that in duration.
  • 04:13 Does it change anything for you when it comes to duration, Kathy?
  • 04:16 Does it put a cap on things or is there still demand in this era of inflation coming down that outstrips any concerns about the deficit?
  • 04:24 Yeah, we're not putting the deficit per Southeast high on the list of concerns for the Treasury market because
  • 04:31 a, there's no,
  • 04:33 there's no correlation between Treasury yields and deficits over time.
  • 04:38 And that I know it's counterintuitive, but the numbers tell us that there's been no correlation for decades.
  • 04:44 But secondly, you know there are this that there is this range of outcomes
  • 04:50 so that
  • 04:51 you can't really predict,
  • 04:53 you know what the deficits going to be versus relative growth etcetera
  • 04:58 and we don't end up with.
  • 05:00 The a sort of conclusive, numerical, you know,
  • 05:04 even
  • 05:05 semi precise estimate of what it means in terms of basis points.
  • 05:10 So it's really better to look at the things that really drive the Treasury market and that is inflation,
  • 05:16 FED policy and economic growth.
  • 05:18 And when we look at those three things, you know, we see a positive outcome for the Treasury market.
  • 05:23 Kathy, we're debating political regime changes and what that means for the world, not just here in the United States of America, in France as as as we've discussed, India, South Africa and a number of other
  • 05:33 nations.
  • 05:34 From an investment, from a bond investor point of view, you've just about clawed back your losses
  • 05:40 this year.
  • 05:40 You're almost backed apart.
  • 05:42 But are you preparing for a regime, a new regime
  • 05:47 of higher inflation and higher rates
  • 05:50 over the medium term?
  • 05:54 Not really.
  • 05:55 I mean, there's a lot of talk about this happening, this new regime,
  • 06:00 but I haven't really seen any
  • 06:03 demonstration that central banks are embracing higher inflation targets or that they're giving up their independence.
  • 06:09 Now,
  • 06:10 the big fear would be if you lose the independence of the central bank to counter inflation,
  • 06:15 but we don't see that happening.
  • 06:17 And so, you know, whatever,
  • 06:20 whatever the politics are,
  • 06:22 you know, redistribution of income doesn't necessarily mean it's going to be inflationary.
  • 06:28 Tariffs are inflationary, and that is certainly a concern.
  • 06:31 They're also, though, negative for economic growth.
  • 06:34 So you have those two things playing off of each other.
  • 06:37 But I don't embrace the new regime theory as being inflationary
  • 06:43 until we see some loss of the central bank independence to counter inflation pressures.