Show Transcript
The U.S. Federal Reserve is widely expected to lower interest rates at its next meeting in September. The question for many is how big that cut may be. Scott Colbourne, Managing Director, Head of Active Fixed Income at TD Asset Management, looks at how low rates could go once the cutting cycle begins.
Print Transcript
[AUDIO LOGO]
Markets are expecting the Fed to come off the sidelines in September and deliver a rate cut. The question for many investors is, how big of a cut might we get? Joining us now to discuss-- Scott Colbourne, Managing Director and Head of Active Fixed Income at TD Asset Management. Scott, always great to have you on the program.
Thanks, Greg. It's a pleasure to be back.
All right. So the beauty of the central banks-- when we think about the things they have to weigh and the deliberations they have to make-- they have the same information that we have. We know what inflation looks like-- the labor market, the economy. So as you look through those numbers, what are they telling you?
Yeah, September 18 is the Fed's meeting, and the markets are expecting-- and they've been encouraged by the Fed to think-- that they will cut rates. Then the question that we've been debating is whether it's 25 or 50. When you look what's priced into the market right now, we have basically a full percent cut by the end of the year. And we have three meetings.
So the market is saying one of those meeting has to be 50 at the moment. And so the question is, does the data support 50 basis points at one of these meetings? Do they kick it off? There's certainly a range of expectations on the dealer community and in the market.
On balance right now, what you see is an economy that has been slowing. It's a little bit below trend growth. The forecast now forecasts for US growth around 2%. Inflation has been trending lower. We had a good CPI print, headline just below 3%, core just above 3% The trend is in play. Central bank speak has been encouraging us to think that the trend is in play and in inflation.
I would suggest that-- it's hard for me absent this volatility that we saw briefly in the markets this month-- that we need a 50 basis point cut. So I think on balance, the fundamentals say we are going and moving towards a cut, not an easing cycle, a cut because it's more risk management. And valuation may be just pushed a little too far here.
So right now, we've got maybe one and 1/4 cuts priced into September in the US market, and probably that has to get brought back between now and September 18. So there may be a bit of congestion, choppiness in the Treasury markets, especially in the front end.
Interesting this week when we think about all the information we were looking at, the labor market. Part of the story about why it's taken so long for the Fed to get to the stage has been the resilience of the US economy, the exceptional strength of the US economy.
Then we got the labor market revision. I mean, it's backward looking. We're talking about 12 months through March 2024. But it was a big number, like, 818, I think, around that thing, overcounted positions. The markets, seemed to me, they didn't know what to make of it. Should we be worried, or is this just so far behind us it doesn't matter?
Yeah, I think on balance, when you look where-- I'm going way back-- but in the beginning of, say, May, we've had about a 90 basis point rally in US 10 years. And that's sort of like an icing at the cake here in August that we've seen revisions going back to spring of last year that reduced job growth, the nonfarm payrolls, from over 200,000 to about 171,000, 175,000. So it's definitely saying good growth in the jobs market but maybe not as strong as we had.
And there's been a confluence of data basically nudging us towards this Goldilocks environment-- softer growth, improving inflation, and the Fed speak telling us that we're moving towards that risk management cut and we'll see as we go along. So we get the number yesterday and, in fact, at the end of the day, rates were higher.
And I think on balance, the market was encouraged to be more dovish and expect more. And the volatility this month, the sell-off that we got in the equity market--
On our holiday Monday--
Yeah, of course. And that spike in volatility has left market positioning perhaps a little long in the Treasury market. I don't think it interrupts the big picture in the story. And the story is that the Fed is embarking on a rate cutting process. And we'll see as the data continues to evolve.
Does that job number, the trend-- we had, what, 115 or so, the last number-- does it continue to deteriorate? We had jobless claims numbers this morning that were OK. So between now and September 18, we get three jobless claims numbers. That's a high-frequency indicator on a weekly basis to tell us how the jobs market is doing. We get a CPI and a nonfarm payroll.
So I think it all adds up. I think we really need real messiness in that data, very weak data, to get us to 50. That's how we're thinking about it. But we do think that we'll continue on the trend towards a cutting cycle. And so it's not whether they will. It's just how much. And then, ultimately, where did we move over the course of the cycle?
Of course, with the market at some point, some participants pushing for the 50 that you don't see a justification for, some pundits talking in that direction-- they're going to be looking to Jackson Hole tomorrow. They're going to be looking to Jerome Powell and say, is he going to give us any hints?
I mean, he's a central banker. You wear your cards pretty close to your chest. At the same time, what kind of words are you listening for?
Yeah, I think we've basically opened the door. It's this notion of risk management that the disinflation trend continues to be in place and is encouraging. We'll look at the totality of the data.
So we had a few Fed speakers today that, on balance, said we continue to look at the data. it's not horrible, but it's definitely moving in the trend. And at the last Fed meeting, the Fed did open the door for September. So I think just it's that continued risk management nudging-- [INTERPOSING VOICES]
--said don't think of the cut in September so much that it's easing as risk management. Is it the concerns about the strength of the labor market, the economy overall?
What I see that is the Fed worried that they are too tight, and so if the trend accelerates here from on the jobs growth. And I think the market and the Fed have pivoted away from inflation concern to more economic or the dual mandate, the labor market side of things.
So do we see an acceleration in the slowdown in the jobs market? And if the Fed thinks right now that they are already in restrictive territory, they don't want to wait and be reactive too much. And so they're viewing this as a preemptive risk management cut. They see the trend. They see both trend on inflation and jobs. So let's start with a cut.
You can go cut or easing cycle. And an easing cycle to me is more like we're concerned about a recession. And I don't believe that the Fed, nor the markets on balance, believe that that's the primary focus right now.
When we put this all together, what does it mean for the bond market? Fixed-income investors have been waiting some time for this.
We've rallied a lot since the spring. But yields, US investment-grade bonds are still close to 5% That's not bad, historically speaking-- a little closer to maybe 4 and 1/4 here in Canada-- not bad, given where we've been here. So you can decide whether you want more duration, go out the yield curve, or you can get very attractive short-term corporate bonds and still lock in some good yields.
So while we've had this big rally in advance of the cutting cycle, we are still encouraged, and I still think that money will continue to flow on balance into fixed income. [AUDIO LOGO]
[MUSIC PLAYING]
Markets are expecting the Fed to come off the sidelines in September and deliver a rate cut. The question for many investors is, how big of a cut might we get? Joining us now to discuss-- Scott Colbourne, Managing Director and Head of Active Fixed Income at TD Asset Management. Scott, always great to have you on the program.
Thanks, Greg. It's a pleasure to be back.
All right. So the beauty of the central banks-- when we think about the things they have to weigh and the deliberations they have to make-- they have the same information that we have. We know what inflation looks like-- the labor market, the economy. So as you look through those numbers, what are they telling you?
Yeah, September 18 is the Fed's meeting, and the markets are expecting-- and they've been encouraged by the Fed to think-- that they will cut rates. Then the question that we've been debating is whether it's 25 or 50. When you look what's priced into the market right now, we have basically a full percent cut by the end of the year. And we have three meetings.
So the market is saying one of those meeting has to be 50 at the moment. And so the question is, does the data support 50 basis points at one of these meetings? Do they kick it off? There's certainly a range of expectations on the dealer community and in the market.
On balance right now, what you see is an economy that has been slowing. It's a little bit below trend growth. The forecast now forecasts for US growth around 2%. Inflation has been trending lower. We had a good CPI print, headline just below 3%, core just above 3% The trend is in play. Central bank speak has been encouraging us to think that the trend is in play and in inflation.
I would suggest that-- it's hard for me absent this volatility that we saw briefly in the markets this month-- that we need a 50 basis point cut. So I think on balance, the fundamentals say we are going and moving towards a cut, not an easing cycle, a cut because it's more risk management. And valuation may be just pushed a little too far here.
So right now, we've got maybe one and 1/4 cuts priced into September in the US market, and probably that has to get brought back between now and September 18. So there may be a bit of congestion, choppiness in the Treasury markets, especially in the front end.
Interesting this week when we think about all the information we were looking at, the labor market. Part of the story about why it's taken so long for the Fed to get to the stage has been the resilience of the US economy, the exceptional strength of the US economy.
Then we got the labor market revision. I mean, it's backward looking. We're talking about 12 months through March 2024. But it was a big number, like, 818, I think, around that thing, overcounted positions. The markets, seemed to me, they didn't know what to make of it. Should we be worried, or is this just so far behind us it doesn't matter?
Yeah, I think on balance, when you look where-- I'm going way back-- but in the beginning of, say, May, we've had about a 90 basis point rally in US 10 years. And that's sort of like an icing at the cake here in August that we've seen revisions going back to spring of last year that reduced job growth, the nonfarm payrolls, from over 200,000 to about 171,000, 175,000. So it's definitely saying good growth in the jobs market but maybe not as strong as we had.
And there's been a confluence of data basically nudging us towards this Goldilocks environment-- softer growth, improving inflation, and the Fed speak telling us that we're moving towards that risk management cut and we'll see as we go along. So we get the number yesterday and, in fact, at the end of the day, rates were higher.
And I think on balance, the market was encouraged to be more dovish and expect more. And the volatility this month, the sell-off that we got in the equity market--
On our holiday Monday--
Yeah, of course. And that spike in volatility has left market positioning perhaps a little long in the Treasury market. I don't think it interrupts the big picture in the story. And the story is that the Fed is embarking on a rate cutting process. And we'll see as the data continues to evolve.
Does that job number, the trend-- we had, what, 115 or so, the last number-- does it continue to deteriorate? We had jobless claims numbers this morning that were OK. So between now and September 18, we get three jobless claims numbers. That's a high-frequency indicator on a weekly basis to tell us how the jobs market is doing. We get a CPI and a nonfarm payroll.
So I think it all adds up. I think we really need real messiness in that data, very weak data, to get us to 50. That's how we're thinking about it. But we do think that we'll continue on the trend towards a cutting cycle. And so it's not whether they will. It's just how much. And then, ultimately, where did we move over the course of the cycle?
Of course, with the market at some point, some participants pushing for the 50 that you don't see a justification for, some pundits talking in that direction-- they're going to be looking to Jackson Hole tomorrow. They're going to be looking to Jerome Powell and say, is he going to give us any hints?
I mean, he's a central banker. You wear your cards pretty close to your chest. At the same time, what kind of words are you listening for?
Yeah, I think we've basically opened the door. It's this notion of risk management that the disinflation trend continues to be in place and is encouraging. We'll look at the totality of the data.
So we had a few Fed speakers today that, on balance, said we continue to look at the data. it's not horrible, but it's definitely moving in the trend. And at the last Fed meeting, the Fed did open the door for September. So I think just it's that continued risk management nudging-- [INTERPOSING VOICES]
--said don't think of the cut in September so much that it's easing as risk management. Is it the concerns about the strength of the labor market, the economy overall?
What I see that is the Fed worried that they are too tight, and so if the trend accelerates here from on the jobs growth. And I think the market and the Fed have pivoted away from inflation concern to more economic or the dual mandate, the labor market side of things.
So do we see an acceleration in the slowdown in the jobs market? And if the Fed thinks right now that they are already in restrictive territory, they don't want to wait and be reactive too much. And so they're viewing this as a preemptive risk management cut. They see the trend. They see both trend on inflation and jobs. So let's start with a cut.
You can go cut or easing cycle. And an easing cycle to me is more like we're concerned about a recession. And I don't believe that the Fed, nor the markets on balance, believe that that's the primary focus right now.
When we put this all together, what does it mean for the bond market? Fixed-income investors have been waiting some time for this.
We've rallied a lot since the spring. But yields, US investment-grade bonds are still close to 5% That's not bad, historically speaking-- a little closer to maybe 4 and 1/4 here in Canada-- not bad, given where we've been here. So you can decide whether you want more duration, go out the yield curve, or you can get very attractive short-term corporate bonds and still lock in some good yields.
So while we've had this big rally in advance of the cutting cycle, we are still encouraged, and I still think that money will continue to flow on balance into fixed income. [AUDIO LOGO]
[MUSIC PLAYING]
