Hello, and welcome to Global Research Unlocked, the interest rate and effects series. This podcast is based on our weekly client conference call where our strategists, along with guests from other parts of BWA Global Research, discuss the most topical and pressing questions faced by our market. I'm Ralf Preusser, head of Global G10 rates and effects strategy.
Good morning, good afternoon, everyone. Thanks so much for joining. Conflict disclosures regarding any securities mentioned can be found on the call invite.
Today is Friday, November 13th. I'm joined today by Aditya Bhave and Mark Cabana, chief economist for the U.S. and co-head of global rates strategy, respectively. Thank you both for making yourselves available.
Aditya, let's start with you. You added a hike to your FED call this morning. What's the view now?
Thanks Ralf, and good morning, good afternoon, everyone. Thanks for joining us. So the simplest way to think about why, so first, what did we do, right?
We added one hike in Jan of 2027, so now we have three consecutive hikes in Dec, Jan, March for a terminal rate of 4.5 to 4.75%. The simplest way to think about why we did that was we have been of the view that the pause in October was a mistake, the FED should be going sequentially. After October CPI, the FED, if anything, looks further behind the curve.
If you listen to FED speak, most of them are expressing a sense of urgency to address the problem, which suggests that they're also thinking, okay, we need to go, we need to move faster going forward. The combination of the data, FED speak, and of course, the move in market pricing suggests that the distribution of risks for the policy path has shifted over to the right. I think that's a, hopefully that's a pretty uncontroversial statement.
We were sitting on a call of two more hikes with risk to the upside. We now feel more comfortable for our base case to be three hikes with balanced risks. Thank you.
You mentioned the inflation trend, which obviously was a big part of the market move that we had this week. How bad was it in your view? It was bad in the sense that not only were the top line numbers quite problematic, but also the details were not great.
What we've seen over the last two months is 0.3%-ish inflation, which annualizes to about 3.7, 3.8, by the way, and without excuses in the sense that it isn't any one component that's really lifting the aggregate and everything else actually looks pretty benign, it's nothing like that. In that sense, it was a pretty bad print, and remember, it comes on the back of a strong jobs report, a hawkish jobs report with even wage inflation, which is still quite tepid, but that's the price to the upside in the last report, and it comes at a time of year where typically you would expect inflation to be a little softer. We know there's residual seasonality in the data.
It tends to lift inflation in the first quarter, but in prior years around this time, you've actually gotten some pretty tepid readings, which have contributed to the rate cuts in 2024 and 2025. Now if you're not even getting that, then as we get to next year and we lap those elevated numbers in the first quarter, we're still not going to be able to bring the year-over-year rate down that much because now we have these higher prints in the last couple of months as well. So in many ways, it was bad.
Thank you. And then obviously the other big part of the price action this week was Waller's comments and the fact that he seemed to be open to moving rates by 50 in December, and clearly you don't think that that is particularly likely. You seem to be on the camp of moving sequentially, but what would have to happen for you to get to 50 in your own mind?
Right. So our view is, as you suggested, that the talk of 50 is a bit overdone from our perspective. If the prior status quo or base case was that they would go at a quarterly pace, then the next step would be to go sequentially.
And then the step after that would be to think about supersized hikes. So it feels a bit premature. It would also look very political, or rather it would make the October move, the decision to not move in October look very political if you're essentially taking that back immediately in December.
So almost the optics, it still won't be great if you start going sequentially after October, but it would be worse if you did a 50 in December. Now what would have to happen to get the 50 over the line? One of the things we said when we changed our call overnight was that PPI would have to push core PC up to potentially 40 basis points or so.
That does not seem to be the case based on the market reaction. It looks like the details were a bit soft, and if anything, core PC estimates might get pushed lower. We were at 32 before the print.
We haven't published our estimates after the PPI print. So that condition has already not been met. The other things we said that would probably have to happen is the markets would need to price more than a 50% chance of 50 basis points.
At this time, markets are pricing only about a 10%-ish chance of 50, and beyond that, you would probably also need to see a very strong jobs report, a very hawkish jobs report. So just based on what's happened in the last hour, I think it's even less likely now that they go 50. But I think what's happening, just let me clarify.
I think what's happening here, you listen to Waller talk about 50, you listen to Goolsby this morning starting to talk about wage inflation. He says, I'm not really taking consolation from the fact that wage inflation is low because it could pick up, because I'm concerned the labor market is tightening. This is a risk that the Fed hasn't really been talking about.
And I think what could be happening here is the hawks were perhaps not happy with the way October went down, how preemptive Jefferson and Williams were in getting that price, that hike price out from October. And they're now maybe trying to overdo it a little bit so that you can kind of compromise down to going sequentially, but you don't want the doves to lead the conversation. So that could be part of why he mentioned 50.
Thank you. And then last question for you, what are we actually going to learn between now and the December meeting? Well, that's part of why, yeah, it's a great question.
I mean, it's part of why this 50 seems a bit far-fetched. We're not going to learn a lot. We're going to get PC, but as of this morning, we already have a pretty good sense of where PC is headed.
We're going to get retail sales. That's not really a market mover. And then you'll get one more jobs report, the November jobs report.
The Fed isn't that focused on the employment mandate right now. Typically going into a December meeting, you would get November inflation. The difference this time is that you won't, because the December meeting is early.
It's on the 9th. In the past, it would have been on the 16th. I don't know why they pulled it forward by a week, but that means they have less information going in.
And going into the January meeting, they will then have two inflation numbers rather than one. Thank you, Aditya. Mark, let's come to you.
We were unlucky. We were short into the midterms. We got stopped out.
The market obviously has sold off a lot, but two-year yields are now higher than when we last went short. Your forecast remained above the forwards. What's your take?
Yeah. Thanks, Ralf. It's been a tricky market, if you didn't know that.
I know you do. And you're right, Ralf. The title of the call gives it away.
We had been short twos. I think, if memory serves, we entered at around 470, 475 right after the September FOMC. It worked for a little while, and then it didn't.
And we got stopped out of the paid two-year view in the 5% NASDAQ down day on Thursday last week. Now, at the time, we said that our bias was still to be underweight at the front end, though we didn't have conviction to reset the stop, though in hindsight, we obviously should have. But the reason that we held that bias was due to fundamentals.
And even when the NASDAQ was melting down, and even when it looked like the Fed might not deliver in December, and in the context of the dovish Fed rhetoric that had been out there prior to this week, we still had the view that you got to focus on the fundamentals. And the fundamentals in the U.S. still remain very strong. And that is including what we learned in the midterms, it is including the greater differentiation that we have seen in the equity space, and in particular, in the tech space.
And those fundamentals still suggest that the Fed is behind. And as people probably know, our favorite framework is Taylor and the Taylor Rule. The Taylor Rule says that based upon the unemployment rate of what we have today and core PCE of what we have today, and are probably going to see after we get the final numbers, the federal funds rate should have a five handle on it.
So the Fed is off by at least 100, if not more, according to Taylor. And I would argue that the underlying feedback that we're getting in the real economy tells us that the Fed is very wrong way. So again, we didn't expect the market to reprice this fast, but we are very sympathetic to what the market has done based on those fundamentals.
And it now seems like the center of the Fed is shifting to get caught up. So would we advocate for being received the front end here, knowing that there's a lot that's baked into front end pricing? No, we would not advocate for being received.
Would we advocate for being received December at 27 and a half, as I see it right now? No, we would not advocate for that. Because fundamentals say that the Fed has a lot more work to do.
And it seems like the center is finally starting to take this more seriously after what is now increasingly seeming a mistake in October. So that's where we are on the front end. On the curve, we still like flatteners.
Two thirties is our preferred flattening bias. And that is rooted in the view that the Fed is behind and will get caught up in our forecasts. Well, you know, the market will probably gravitate more to our above forwards front end forecasts.
And the back end will lag on a relative basis. And at some point, the Fed will probably have to get serious enough about inflation such that they need to acknowledge that there's going to be a little softening in the macro economy. The Fed has been so afraid to do that.
But we suspect that they sort of have to, because the Fed is likely learning, as we all know, that you can't just hope that if you wait long enough, inflation is going to come down. That, to me, has been the strategy so far. And as Aditya noted, it seems like that strategy is much less likely to play out.
So, again, our bias is still to be underway at the front end. Thank you very much, Mark. Thank you, Aditya.
Thank you very much for joining us. And we look forward to speaking to you again next week. Thanks for joining us today.
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