Show Transcript
Equity markets are close to returning to the record highs reached in February. But interest rates remain low and could stay there through 2022 and beyond. Kim Parlee speaks with Priya Misra, Head, Global Rates Strategy at TD Securities about the impact of unprecedented stimulus on markets and monetary policy.
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[MUSIC PLAYING]
- Priya, I want to start with both the markets and interest rates. And for someone who's coming in and looking at it today, we have the markets basically back to where they were, at near all time highs at February levels. On the other side we have interest rates, which have remained low, and are going to remain low for years. So which one of these is mispriced, in your opinion?
- Right. So I actually don't think that there is that much of a disconnect between the two markets. What sort of squares the circle is the Fed.
So we have the Fed coming in with a very dovish message over the last couple of months, I think because partly, they are concerned about the virus resurgence. Maybe we have a second wave. Partly, they are extremely concerned about structural damage that may be done. Certainly on the consumer confidence front, it's possible that there has been some of the structural damage, but particularly on the small business front. If a store goes under or you have a pick-up in bankruptcies in restaurants and hotels, they're not hiring those people back.
So I think the Fed is concerned about this longer term risk, and therefore is telling us that they're going to be growing the balance sheet for a long time, which sort of keeps the long end contained. They're going to keep rates here for a very long period of time. So there's this reach-for-yield if investors have savings readily invested, that's why the stock market's doing well. You look at credit spreads, it's done well. So I think the market's essentially telling you we're in this holding pattern right now where the Fed is keeping rates low.
I do worry about risk assets. If the Fed's fears are realized, if we do have a secondary wave, or if this new normal that we are reopening to, if that's a much weaker growth outlook, then I think some of the gains in risk assets may struggle. But it's too early to say that. I wouldn't say that right now is the time to get out of risk assets. But the rate side I think, is just telling you that central banks globally are being very, very accommodative here. I think they just don't want any reason to increase the structural damage by allowing interest rates to rise.
Well, you mentioned it's early to tell. And I know that you spend probably a lot of time watching data. But I'm sure the types of data you're watching are different than the data you used to watch before. So what are you watching?
- Right. That's a fair point. In fact, the market's not reacting to a lot of the economic data that we've looked at.
We have awful data in April. But I think the market said, well, let's look a little bit longer term. That impact of data in April was because of the lockdowns. Now we're seeing much better data.
But again, can you extrapolate from the data going forward? What we've been getting right now, I would say no, because we're seeing the reopening. So instead of the usual economic data-- which I have to say, as a rates person, I do have to look at. But we're looking at things like the virus curve, positivity rates. Is there any sign of the second wave? Or are different countries, different states in the US, are they able to flatten these curves? So we're certainly looking at the virus curve.
And then were looking at things like Google mobility data, Apple mobility data. What we want to understand is, are people heading out just to go to the parks, which is actually what's happening right now? Or are they going out to spend money?
It's still a little early, because parts of the country have not fully re-opened. New York City re-opened, just re-opened. So I think if we start seeing people actually going to restaurants, going to stores-- credit card data, that's another thing we're looking at.
I think we've all had to become more creative in term, because we've never really faced a pandemic like this since the early 1900s. In order to see how does the consumer react, how does the business sector react, I think we'll have to look at this data apart from the usual economic data until we just get a sense of what's the impact on the psyche of the American consumer.
- Are you seeing anything that would lead you to think that we could see inflation pop up its head? I mean, there's so much liquidity in the market. The Fed has done so much. So any concerns there?
- So certainly from the investor side, I am hearing that concern. It's a little bit similar to what I heard in 2009 as well, because the Fed balance sheet grew a lot. We had a very high fiscal deficit, as well. So if you think the fiscal side is providing money to the system, the monetary side is providing money-- if you're a student of economics, more money chasing same goods, it tends to be inflation.
It didn't happen, though, in 2009. In fact, one of the things the Fed has been saying is we had very good growth pre-COVID in the US, and yet inflation didn't even reach their target. So there's something structural going on. I liken-- you know, a lot of people have talked about this pandemic as being like a war or a natural disaster.
I think there's one very big difference between that analogy and COVID. If you look outside the window, the capacity is still there. We're not using the capacity. There's been no destruction of output. So when we go back into the world, there's going to be this excess capacity issues. I think that's going to overwhelm this money chasing assets. I think you can get financial asset inflation.
But for real inflation to show up in the economy, I think we need a boost in aggregate demand. And we just talked about how demand might be getting impacted by the confidence shock. I'm not sure that the fiscal side has done enough to create more demand, demand for real goods and services. So we're less concerned about inflation.
And I would highlight that the Fed is telling us they are happy with inflation going above the target. This is actually very different from what they told us in 2015. Actually, the Fed reaction function was the same as it is today. They wouldn't even have hiked 2015. So I think they're happy to let inflation run. But I just, from a fundamental standpoint, just don't see the inflation forces at play.
- Interesting. What about the Fed and, if I could throw in as well, if you take a look at 10 years, what you're seeing, what we've heard from the Fed, they plan on staying low for a while. But you've got your own thesis on how long that could actually be.
- Right. So the Fed has told us through the dot plot that they don't expect to hike until the end of 2021. They don't forecast anything beyond '22. But we do forecast going far out. We actually don't have the Fed hiking 2024, and that's assuming no virus second wave. If we do get a virus second wave, I think the hit to confidence is much more. So then they could be on hold even longer.
But when you talk about the 10-year, I thought I'd just bring up, there's certainly-- the 10-year is impacted by what the Fed does on the front end. But the 10-year is also more impacted by what they do on the balance sheet. They've bought $1.6 trillion of treasuries just since mid-March. So as long as they keep buying-- and our forecast is that they will keep buying at the same pace until the middle of next year. And they'd be buying at a lower pace until the end of next year.
Now the Fed has not made that forecast. But this is our own forecast with our economists. If the Fed is buying so much in treasuries, it actually puts a cap on 10-year, as well.
So I think there's both the force of the balance sheet and what they do on the front end that can keep the 10-year-- I think if we see better data, we can probably get close to 1%. But I struggle to see the 10-year in the US go above 1% all of this year or next year.
- One last quick question, if I could. We have the US election coming up. I mean, that could do all sorts of things. I mean, how does the market price something-- or what do you think is being priced in right now? And what do you expect to see as rhetoric starts to really ramp up and then we get closer to the date?
- Right. Great question. Because normally I would have said if there was no COVID, the market would be pricing in the election right now. I think that there are just so many variables. We're pricing in the economy.
Do we get a second wave during flu season? The election is around flu season. And you know, is this election a referendum on President Trump? So I think the market really doesn't know how to-- and doesn't do like to price in political risk, because they get extremely binary outcomes.
But I do think that the market right now is priced for President Trump reelection, because that just keeps that uncertainty low. Because we know what his policies are going to be. If it looks like-- and certainly in the last month, it looks like Vice President Biden's chances are improving-- I think you could see some pullback in risk sentiment. You know, where you are on the political spectrum, it just increases uncertainty. So I think the market is going to want to take a step back and see what exactly are his policies before that run can continue.
- Priya, great insights. Such a pleasure. Thanks so much for joining us.
- Thank you.
[MUSIC PLAYING]
- Priya, I want to start with both the markets and interest rates. And for someone who's coming in and looking at it today, we have the markets basically back to where they were, at near all time highs at February levels. On the other side we have interest rates, which have remained low, and are going to remain low for years. So which one of these is mispriced, in your opinion?
- Right. So I actually don't think that there is that much of a disconnect between the two markets. What sort of squares the circle is the Fed.
So we have the Fed coming in with a very dovish message over the last couple of months, I think because partly, they are concerned about the virus resurgence. Maybe we have a second wave. Partly, they are extremely concerned about structural damage that may be done. Certainly on the consumer confidence front, it's possible that there has been some of the structural damage, but particularly on the small business front. If a store goes under or you have a pick-up in bankruptcies in restaurants and hotels, they're not hiring those people back.
So I think the Fed is concerned about this longer term risk, and therefore is telling us that they're going to be growing the balance sheet for a long time, which sort of keeps the long end contained. They're going to keep rates here for a very long period of time. So there's this reach-for-yield if investors have savings readily invested, that's why the stock market's doing well. You look at credit spreads, it's done well. So I think the market's essentially telling you we're in this holding pattern right now where the Fed is keeping rates low.
I do worry about risk assets. If the Fed's fears are realized, if we do have a secondary wave, or if this new normal that we are reopening to, if that's a much weaker growth outlook, then I think some of the gains in risk assets may struggle. But it's too early to say that. I wouldn't say that right now is the time to get out of risk assets. But the rate side I think, is just telling you that central banks globally are being very, very accommodative here. I think they just don't want any reason to increase the structural damage by allowing interest rates to rise.
Well, you mentioned it's early to tell. And I know that you spend probably a lot of time watching data. But I'm sure the types of data you're watching are different than the data you used to watch before. So what are you watching?
- Right. That's a fair point. In fact, the market's not reacting to a lot of the economic data that we've looked at.
We have awful data in April. But I think the market said, well, let's look a little bit longer term. That impact of data in April was because of the lockdowns. Now we're seeing much better data.
But again, can you extrapolate from the data going forward? What we've been getting right now, I would say no, because we're seeing the reopening. So instead of the usual economic data-- which I have to say, as a rates person, I do have to look at. But we're looking at things like the virus curve, positivity rates. Is there any sign of the second wave? Or are different countries, different states in the US, are they able to flatten these curves? So we're certainly looking at the virus curve.
And then were looking at things like Google mobility data, Apple mobility data. What we want to understand is, are people heading out just to go to the parks, which is actually what's happening right now? Or are they going out to spend money?
It's still a little early, because parts of the country have not fully re-opened. New York City re-opened, just re-opened. So I think if we start seeing people actually going to restaurants, going to stores-- credit card data, that's another thing we're looking at.
I think we've all had to become more creative in term, because we've never really faced a pandemic like this since the early 1900s. In order to see how does the consumer react, how does the business sector react, I think we'll have to look at this data apart from the usual economic data until we just get a sense of what's the impact on the psyche of the American consumer.
- Are you seeing anything that would lead you to think that we could see inflation pop up its head? I mean, there's so much liquidity in the market. The Fed has done so much. So any concerns there?
- So certainly from the investor side, I am hearing that concern. It's a little bit similar to what I heard in 2009 as well, because the Fed balance sheet grew a lot. We had a very high fiscal deficit, as well. So if you think the fiscal side is providing money to the system, the monetary side is providing money-- if you're a student of economics, more money chasing same goods, it tends to be inflation.
It didn't happen, though, in 2009. In fact, one of the things the Fed has been saying is we had very good growth pre-COVID in the US, and yet inflation didn't even reach their target. So there's something structural going on. I liken-- you know, a lot of people have talked about this pandemic as being like a war or a natural disaster.
I think there's one very big difference between that analogy and COVID. If you look outside the window, the capacity is still there. We're not using the capacity. There's been no destruction of output. So when we go back into the world, there's going to be this excess capacity issues. I think that's going to overwhelm this money chasing assets. I think you can get financial asset inflation.
But for real inflation to show up in the economy, I think we need a boost in aggregate demand. And we just talked about how demand might be getting impacted by the confidence shock. I'm not sure that the fiscal side has done enough to create more demand, demand for real goods and services. So we're less concerned about inflation.
And I would highlight that the Fed is telling us they are happy with inflation going above the target. This is actually very different from what they told us in 2015. Actually, the Fed reaction function was the same as it is today. They wouldn't even have hiked 2015. So I think they're happy to let inflation run. But I just, from a fundamental standpoint, just don't see the inflation forces at play.
- Interesting. What about the Fed and, if I could throw in as well, if you take a look at 10 years, what you're seeing, what we've heard from the Fed, they plan on staying low for a while. But you've got your own thesis on how long that could actually be.
- Right. So the Fed has told us through the dot plot that they don't expect to hike until the end of 2021. They don't forecast anything beyond '22. But we do forecast going far out. We actually don't have the Fed hiking 2024, and that's assuming no virus second wave. If we do get a virus second wave, I think the hit to confidence is much more. So then they could be on hold even longer.
But when you talk about the 10-year, I thought I'd just bring up, there's certainly-- the 10-year is impacted by what the Fed does on the front end. But the 10-year is also more impacted by what they do on the balance sheet. They've bought $1.6 trillion of treasuries just since mid-March. So as long as they keep buying-- and our forecast is that they will keep buying at the same pace until the middle of next year. And they'd be buying at a lower pace until the end of next year.
Now the Fed has not made that forecast. But this is our own forecast with our economists. If the Fed is buying so much in treasuries, it actually puts a cap on 10-year, as well.
So I think there's both the force of the balance sheet and what they do on the front end that can keep the 10-year-- I think if we see better data, we can probably get close to 1%. But I struggle to see the 10-year in the US go above 1% all of this year or next year.
- One last quick question, if I could. We have the US election coming up. I mean, that could do all sorts of things. I mean, how does the market price something-- or what do you think is being priced in right now? And what do you expect to see as rhetoric starts to really ramp up and then we get closer to the date?
- Right. Great question. Because normally I would have said if there was no COVID, the market would be pricing in the election right now. I think that there are just so many variables. We're pricing in the economy.
Do we get a second wave during flu season? The election is around flu season. And you know, is this election a referendum on President Trump? So I think the market really doesn't know how to-- and doesn't do like to price in political risk, because they get extremely binary outcomes.
But I do think that the market right now is priced for President Trump reelection, because that just keeps that uncertainty low. Because we know what his policies are going to be. If it looks like-- and certainly in the last month, it looks like Vice President Biden's chances are improving-- I think you could see some pullback in risk sentiment. You know, where you are on the political spectrum, it just increases uncertainty. So I think the market is going to want to take a step back and see what exactly are his policies before that run can continue.
- Priya, great insights. Such a pleasure. Thanks so much for joining us.
- Thank you.
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