Show Transcript
U.S. inflation slowed in May, suggesting the Federal Reserve may have enough room to ease off its aggressive rate hiking cycle. James Dixon, Director of Family Office Solutions at TD Securities, looks at the Fed’s next move and the implications for markets.
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We got Fed officials entering a two-day rate decision meeting. They are armed with a fresh inflation report showing cost of living pressures at their lowest level since early 2021. Does that set us up for a rate pause tomorrow? A lot going on.
Joining us now to discuss, James Dixon, Director of Family Office Solutions at TD Securities. James, great to have you back on the show.
Thanks so much for having me, Greg. It's great to be back.
You've got to imagine everyone walking into that meeting has got that inflation report under their arm. This is going to be the talk of the table. What did we get from the inflation report today? And what does it do to the Fed's mindset?
Well, I think the first thing is you need to look at market pricing going into tomorrow. So the market's clearly pricing a pause and then a hike in July. Our TD Securities house view is a hike tomorrow and then the Fed's done.
Really, a hike tomorrow?
A hike tomorrow.
So not the skip that people are talking about?
Nope, not the skip. So a skip certainly would surprise. On our team, we actually believe the Fed's done. We think they come out with a data dependence narrative, which the market could interpret as hawkish. But I think that's really a mistake.
If we really look at the data we have seen, I mean, the employment numbers-- sure, the headline was strong. It was over 300,000. But if you actually look at the unemployment rate, that moved up from 3.4% to 3.7% while participation was flat. So if you've got more people doing more than one job, that's not really a sign of a strong economy.
You talk about the inflation number. Yeah, headlines come off. Core is sticky. So that becomes a little bit of a bone of contention. And if you look at the PMIs, manufacturing PMIs continue to be in contractionary territory. Services, they've held up. They're still in expansion, but the last print was a little bit lower.
I mean, it's a tough spot for any central banker right now. You've got extremely tight credit conditions, which suggest a loosening of policy, while inflation is sticky, which suggests you need to really hike rates.
When you look at those credit conditions, I think this is quite important, because we're now issuing a point in time where the debt ceiling has been raised. So the Treasury has to rebuild its account, its general account. And the estimation is the size of that T-bill issuance is around $1 trillion.
So this has knock-on effects. It sucks a huge amount of liquidity out of the markets. It pushes the front end yields a bit higher. It squeezes credit spreads higher. It just makes borrowing extremely, extremely difficult.
Bank of America had a piece out saying that that $1 trillion of issuance is the equivalent of a 25 basis point hike. And that really takes me back to what I talked about on our last show in May, where I said there's over $9 trillion of securities that are maturing by the end of next year.
So $1 trillion to fill the kitty back up again, now that they raised the debt ceiling, and then all of this issuance that's going to need to roll over.
That's right. So $1 trillion to fill the kitty back up. And then you've still got maturities of over $9 trillion. So to put that in perspective, if $1 trillion equates to a 25 basis point hike in terms of tightening, $9 trillion is equivalent to 225 basis points from current levels.
Additional from where we are?
Right.
After a year of aggressive policy rate hikes, you would have this additional tightening of financial conditions.
Right. And this is why we believe that the Fed's going to have to step in and start buying these bonds. As we alluded to on the last show, you don't have the same buyers as you had before, right? China is going to be more reluctant. Russia will be more reluctant. The Saudis will be more reluctant. After the US froze dollar denominated assets with the war in Ukraine, anyone who's-- might not be onside with the US, or is afraid of not being on the side of the US, is going to be reluctant to step in and buy those bonds.
So let's talk about the road forward then. You think we get a hike tomorrow and then they have to pause it, for the reasons that you said. Is that setting up a situation where financial conditions will be too tight? Does this bring us to a hard landing? Does this grind the economy to a halt?
Sorry, just to backtrack there, Greg, that's our house view. Our house view is a hike tomorrow and then they're done. Our desk narrative is the Fed is already done.
Oh, they're already done?
They're already done. So we deviate on our team from the house on that one. I mean, we may be wrong. We also deviate from the Street, where the Street thinks there's another hike coming in July.
I think the recession argument's-- it's one that's been kicked around a lot. There was a report out from one of the large US players saying the probability of recession was around 35% now, so lower. The market's certainly not pricing a recession. But other major players like-- I mean, Deutsche had a report out last week saying we'd probably see a recession in first half of next year. Earlier this week, Fidelity and Allianz both had reports out saying there will be a recession.
Most are expecting a soft landing, which is certainly where we land. Guys like Rosenberg are looking for a hard landing. Fueling our soft landing narrative is really like the Fed stepping in when things get nasty and injecting that liquidity through the bond buying program.
It's just too early for that now. Things have to start getting bad. Equities have to sell off. And that hasn't really happened right now. If anything, you pointed out earlier, equities are up. I mean, the real concern there is the concentration.
Yeah, let's talk about this bull market. I mean, technically, you're above 20% from recent lows, the classic definition. But there is a concentration there. What should we think of as investors? This isn't the broad market.
Well, I'd be very nervous because tech has driven that run higher. And those are growth names. So they're long-duration assets. So if you do have a recession and you do have significant tightening or tighter credit conditions, just even on the T-bill issuance, those are the first names to hurt, right? So I certainly do think there's a long-term opportunity for tech. I just don't think it's today.
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We got Fed officials entering a two-day rate decision meeting. They are armed with a fresh inflation report showing cost of living pressures at their lowest level since early 2021. Does that set us up for a rate pause tomorrow? A lot going on.
Joining us now to discuss, James Dixon, Director of Family Office Solutions at TD Securities. James, great to have you back on the show.
Thanks so much for having me, Greg. It's great to be back.
You've got to imagine everyone walking into that meeting has got that inflation report under their arm. This is going to be the talk of the table. What did we get from the inflation report today? And what does it do to the Fed's mindset?
Well, I think the first thing is you need to look at market pricing going into tomorrow. So the market's clearly pricing a pause and then a hike in July. Our TD Securities house view is a hike tomorrow and then the Fed's done.
Really, a hike tomorrow?
A hike tomorrow.
So not the skip that people are talking about?
Nope, not the skip. So a skip certainly would surprise. On our team, we actually believe the Fed's done. We think they come out with a data dependence narrative, which the market could interpret as hawkish. But I think that's really a mistake.
If we really look at the data we have seen, I mean, the employment numbers-- sure, the headline was strong. It was over 300,000. But if you actually look at the unemployment rate, that moved up from 3.4% to 3.7% while participation was flat. So if you've got more people doing more than one job, that's not really a sign of a strong economy.
You talk about the inflation number. Yeah, headlines come off. Core is sticky. So that becomes a little bit of a bone of contention. And if you look at the PMIs, manufacturing PMIs continue to be in contractionary territory. Services, they've held up. They're still in expansion, but the last print was a little bit lower.
I mean, it's a tough spot for any central banker right now. You've got extremely tight credit conditions, which suggest a loosening of policy, while inflation is sticky, which suggests you need to really hike rates.
When you look at those credit conditions, I think this is quite important, because we're now issuing a point in time where the debt ceiling has been raised. So the Treasury has to rebuild its account, its general account. And the estimation is the size of that T-bill issuance is around $1 trillion.
So this has knock-on effects. It sucks a huge amount of liquidity out of the markets. It pushes the front end yields a bit higher. It squeezes credit spreads higher. It just makes borrowing extremely, extremely difficult.
Bank of America had a piece out saying that that $1 trillion of issuance is the equivalent of a 25 basis point hike. And that really takes me back to what I talked about on our last show in May, where I said there's over $9 trillion of securities that are maturing by the end of next year.
So $1 trillion to fill the kitty back up again, now that they raised the debt ceiling, and then all of this issuance that's going to need to roll over.
That's right. So $1 trillion to fill the kitty back up. And then you've still got maturities of over $9 trillion. So to put that in perspective, if $1 trillion equates to a 25 basis point hike in terms of tightening, $9 trillion is equivalent to 225 basis points from current levels.
Additional from where we are?
Right.
After a year of aggressive policy rate hikes, you would have this additional tightening of financial conditions.
Right. And this is why we believe that the Fed's going to have to step in and start buying these bonds. As we alluded to on the last show, you don't have the same buyers as you had before, right? China is going to be more reluctant. Russia will be more reluctant. The Saudis will be more reluctant. After the US froze dollar denominated assets with the war in Ukraine, anyone who's-- might not be onside with the US, or is afraid of not being on the side of the US, is going to be reluctant to step in and buy those bonds.
So let's talk about the road forward then. You think we get a hike tomorrow and then they have to pause it, for the reasons that you said. Is that setting up a situation where financial conditions will be too tight? Does this bring us to a hard landing? Does this grind the economy to a halt?
Sorry, just to backtrack there, Greg, that's our house view. Our house view is a hike tomorrow and then they're done. Our desk narrative is the Fed is already done.
Oh, they're already done?
They're already done. So we deviate on our team from the house on that one. I mean, we may be wrong. We also deviate from the Street, where the Street thinks there's another hike coming in July.
I think the recession argument's-- it's one that's been kicked around a lot. There was a report out from one of the large US players saying the probability of recession was around 35% now, so lower. The market's certainly not pricing a recession. But other major players like-- I mean, Deutsche had a report out last week saying we'd probably see a recession in first half of next year. Earlier this week, Fidelity and Allianz both had reports out saying there will be a recession.
Most are expecting a soft landing, which is certainly where we land. Guys like Rosenberg are looking for a hard landing. Fueling our soft landing narrative is really like the Fed stepping in when things get nasty and injecting that liquidity through the bond buying program.
It's just too early for that now. Things have to start getting bad. Equities have to sell off. And that hasn't really happened right now. If anything, you pointed out earlier, equities are up. I mean, the real concern there is the concentration.
Yeah, let's talk about this bull market. I mean, technically, you're above 20% from recent lows, the classic definition. But there is a concentration there. What should we think of as investors? This isn't the broad market.
Well, I'd be very nervous because tech has driven that run higher. And those are growth names. So they're long-duration assets. So if you do have a recession and you do have significant tightening or tighter credit conditions, just even on the T-bill issuance, those are the first names to hurt, right? So I certainly do think there's a long-term opportunity for tech. I just don't think it's today.
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