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  • JPMorgan's Barry Sees Steeper Yield Curves Ahead

JPMorgan's Barry Sees Steeper Yield Curves Ahead

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Bloomberg Oct 28 22:04 · 9563 Views

Jay Barry, JPMorgan's head of global rates strategy, says the US Treasury is in a good spot.

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  • 00:00 Jay Berry is the Managing Director and Head of Global Rate Strategy over at JP Morgan, and he joins us now to kick us off to the close.
  • 00:06 And Jay, let's focus in a little bit here on the Treasury's borrowing needs.
  • 00:10 I think everyone knows that at some point, those borrowing numbers are going to have to come up significantly.
  • 00:16 It looks like at least for the first quarter, they seem to be guiding in that direction.
  • 00:20 Yeah, I think that's right, Romain.
  • 00:21 And thanks for having me on this afternoon.
  • 00:24 In our baseline
  • 00:25 and the borrowing estimates we got,
  • 00:27 I think for this quarter we're not too far off from our expectations and for the first quarter probably a little bit larger.
  • 00:32 But I think what we know is that for fiscal year 25, which has just begun, the Treasury is probably in a pretty good spot with its long term auction sizes.
  • 00:40 But that the closer we get to August, November next year, as you sort of quoted from MDR Denny,
  • 00:45 there's a strong likelihood that Treasury will have to resume its increases to long term auction sizes, probably in both a magnitude and duration
  • 00:51 that looks just as big as we saw last summer through this spring.
  • 00:54 But in our minds, we think the Treasury is probably in a good spot for the next 9 to 12 months or so,
  • 00:59 even though these announcements for the first quarter were larger than expected.
  • 01:02 This raises a lot of questions though, Jay, about the trajectory of interest rates.
  • 01:06 I mean, if we just take the benchmark 10 year, which of course right now back at that 4243 level
  • 01:12 and in a time where we were expecting that number to come down because of the presumption of additional Fed rate cuts, how is this all going to balance out?
  • 01:19 If the Fed does continue to cut rates, but the Treasury's borrowing needs continues to go up, is that just going to keep us pinned in a tight range on the Treasury notes?
  • 01:27 Yeah.
  • 01:27 So I think a lot of this increase that we've had over the past month or five weeks or so remain has been a function of the action the Fed took last month by delivering an aggressive 50 basis point cut.
  • 01:38 I think it was a sign to markets that the Fed does not want this expansion
  • 01:41 to end prematurely.
  • 01:43 And there's a likelihood of better growth and inflation outcomes down the line,
  • 01:46 meaning less easing.
  • 01:47 And we've seen that because the terminal Fed funds rate priced into markets
  • 01:51 has risen from about 260 to 70 in the middle of September to something like 350 right now.
  • 01:56 So it's certainly reflective
  • 01:58 of few reasons coming down the line.
  • 02:00 But to your question on what it means when we intersect monetary and fiscal,
  • 02:04 in our minds the primary driver of Treasury yields is always going to be the markets medium term monetary policy expectations.
  • 02:11 But away from that, we do think that for a given level of policy rates because of this
  • 02:16 100 plus percent debt to GDP ratio
  • 02:19 and a treasury buyer base which is shifting from price sensitive or price insensitive buyers to price sensitive,
  • 02:25 it's just going to mean long term rates remain more elevated for a given policy rate
  • 02:29 than we've seen over the last 15 to 20 years.
  • 02:31 So in all other
  • 02:33 all else equal, we really think it results in steeper yield curves as well.
  • 02:36 So Jay, when we look at this off in treasuries right now, I mentioned how Treasuries have resumed their sell off from, you know, over the past month.
  • 02:43 Really
  • 02:44 is this actual positioning for an outcome or is there something else muddying the picture like like hedging?
  • 02:49 Yeah.
  • 02:50 So I think, Scarlett, that a lot of this has been fundamental fundamentally driven because of the shift in the Feds reaction function,
  • 02:57 but also because the data has proven to be more resilient both on the labor market
  • 03:01 and on the inflation side.
  • 03:02 But that being said, when we look at the move in long term yields adjusted for a sort of their typical fundamental drivers,
  • 03:08 it's been in excess of what we would have expected.
  • 03:11 And while it might be tempting to attribute this to a shift in electoral expectations,
  • 03:15 I think the bigger issue here
  • 03:17 is that we've not quite caught up to where growth expectations have gone.
  • 03:20 And further from that positioning, at least on the duration side, was pretty long heading into the September Fed meeting, and it's been sort of washed out and it's much more neutral right now.
  • 03:29 So everything I've heard from clients
  • 03:31 being on the road the last couple of weeks is that this has been a fair amount of de risking and that clients would rather react to the election rather than proactively position for it given how close it seems like it might be.
  • 03:41 Interesting.
  • 03:42 So that means that we could see a lot of volatility in the days right after the election.
  • 03:45 I'm wondering how you're thinking about the sell off that we're seeing in oil, because lower oil obviously helps to improve the inflation picture in the months ahead.
  • 03:53 Yeah, I think it's certainly indicative of lower
  • 03:56 burn on geopolitical pressures given what happened over the weekend.
  • 04:00 And while I think it might be tempting to think that it is certainly reflective of lower inflation and a better outcome for this consumer.
  • 04:07 It probably means we can go back to kind of thinking about the prospects for growth
  • 04:11 inflation from a sort of more macro fundamental perspective rather than having to think about geopolitics,
  • 04:16 which means that any sort of premium that had been built
  • 04:19 into the rates market from the energy market is probably dissipated.
  • 04:22 And I think as we go forward,
  • 04:24 our colleagues in commodity strategy think that as we head into next year,
  • 04:28 it's likely to be that supply will outweigh demand given ongoing strong
  • 04:32 supply from OPEC Plus, which means that oil prices, if we're in a more stable world or likely bias somewhat lower.
  • 04:38 And obviously, a lot of this is going to hinge on the outcome of the US election, two different candidates with
  • 04:44 some very clear differences in policy.
  • 04:46 And that could have a big impact here
  • 04:48 on Treasury funding as well as just how the market reacts to it.
  • 04:52 I am curious, Jay, just in the short term here, we have an election
  • 04:56 a week from tomorrow.
  • 04:57 Are you going to be up on Tuesday night?
  • 05:00 Watching the results.
  • 05:01 And if so,
  • 05:02 what parts of the market do you think are going to react?
  • 05:04 Are you anticipating are going to react first to the outcome?
  • 05:08 First remain.
  • 05:09 I'm definitely planning to be up late watching the results.
  • 05:11 And I think the parts of the market that I'll be watching
  • 05:14 first, the short end of the inflation curve
  • 05:16 because the work that we've done has indicated that
  • 05:19 if you see a divided government with a Trump victory and that likely means more tariffs globally,
  • 05:24 that's likely to raise the price level by about 1 1/2%.
  • 05:27 And we've seen that through the summer
  • 05:29 as the probability of a
  • 05:32 former President Trump victory has increased, that has meant that short term inflation expectations has risen.
  • 05:36 So I'll be watching that.
  • 05:38 Second, from that, I'll just be broadly watching the slope of the yield curve because you've talked about the fiscal picture
  • 05:42 and we've said that a sweep in either direction is likely to mean meaningfully more borrowing than the baseline that we've heard from the Congressional Budget Authority.
  • 05:51 And that means given the focus on term premium and the shift in demand that we've talked about against the backdrop of what is a pretty strong economy, likely biases the yield curve higher and steeper, but to varying degrees, whether it's a Trump win or Harris win in the event of a sweep.
  • 06:06 So I'll definitely be watching the front end of the inflation curve.
  • 06:08 We'll be watching the slope of the Treasury curve and the outright level of yields as well.