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Focusing on what’s ahead in fixed income · UBS Trending

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  Equities are near all time highs.
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  While interest rates haven't
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  fully retraced back to their pre around conflict levels.
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  Meanwhile, a new fed chair is on the horizon,
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  so what does it all mean for fixed income investors.
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  Well we're going to break that all down for you right now
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  on UBS Trending.
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  Hi everybody and welcome to UBS Trending I'm Anthony Pastore.
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  Thanks for joining me today.
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  I'm excited to get into my conversation
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  with my friend and colleague Leslie Falconio,
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  who's back to break down the latest
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  on what's going on with the fed, the economy, fixed income.
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  Leslie, there's a lot to talk about.
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  Every time you come through, I feel like I always start with,
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  there's a lot to talk about. I'm a leading indicator.
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  You should be.
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  The fed should be looking at everything you're talking about.
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  Right. Well, let's talk about that.
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  Because clearly,
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  you know,
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  as our audience knows
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  and as we know, there's been a lot of back
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  and forth with this around conflict.
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  News changes almost multiple times a day.
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  And so it's really hard to kind of determine where we're going,
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  what's going on.
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  Even, you know,
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  some fed presidents and voting members have come out and said
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  the uncertainty,
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  the risks that are involved with this conflict
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  continue to remain elevated.
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  So I mentioned in the intro, equity markets are near or at all
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  time highs, but fixed income markets rates have not really
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  kind of retraced back to their pre Iran conflict levels.
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  Why do you think that is.
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  What's going on with the rate market right now.
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  Well I mean listen,
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  even prior to some of the disturbance that we saw today
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  which was causing interest rates to rise,
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  but let's just say from the end of April.
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  So if you look at when the ceasefire began, let's just say
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  it's around April 7th ish to the end of the month.
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  You know,
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  you had sort of this risk on mentality throughout, right?
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  I mean, Vol
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  came down
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  actually at one point reached a new high spreads compressed.
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  And the only thing that really stayed at these in
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  this was all the pre-crisis levels.
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  The only thing that stayed, as this chart shows, to levels
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  that were higher
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  than, say,
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  what was in the at the end of February were interest rates,
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  and that the main reason to
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  that is the market
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  doesn't believe that the fed is going to cut in 2026.
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  As a matter of fact, you know,
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  you and I were talking earlier as of today,
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  and we know this changes very quickly.
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  It actually had a high priced in
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  for a 30% probability of a high priced in for 2026.
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  But let's just say if we go to the end of the month
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  or some point last week,
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  it was higher for longer mentality that the market had had,
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  you know, without the fed cutting for the end of
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  till the end of 27.
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  And one of the reasons
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  why that is,
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  is that inflation expectations, sort of like the longer
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  this ceasefire goes on,
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  we know that it initially in this chart shows this as well
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  initially that breaking inflation
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  expectations went very high in the short end. Right.
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  Because oil hits it hits consumers in a shorter period of time.
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  You know, gasoline electricity all those types of things.
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  Right.
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  But the longer that you are sort of in a cease fire for it
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  starts to, in fact, impact the back end.
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  And that's really what we're seeing.
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  So we're seeing that back end.
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  The ten year inflation expectations start to rise.
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  In a matter of fact,
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  it got gotten to around 247 248,
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  which is the highest that we've seen since like February 25th.
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  Right.
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  And we know that at the most recent fed meeting, fed chair
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  or chair Powell was last meeting as the fed chair, I should say
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  there were four dissenters against the decision
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  to keep rates unchanged.
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  It's interesting
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  to see as he's transitioning out and possibly Warsh coming in as
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  a new fed chair once he gets,
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  you know, voted on and
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  and takes the chair, which looks like it's going to happen.
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  His stance on monetary policy is slightly different.
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  But again, it's hard to know where we're going, considering that
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  there's so much uncertainty
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  in the markets and in geopolitical news.
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  Yeah, there's no question.
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  I mean, and to your point, I mean, one of the things,
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  you know, when we had this discussion, I mean, you know,
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  Myron who had to cut no big surprise there, right?
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  Some people didn't believe, you know, Kashkari
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  and some didn't
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  believe the language
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  that they had the easing bias that was maintained.
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  But you know, to tell you the truth, Anthony,
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  it really didn't matter
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  because the market's not pricing in anything. Right. Right.
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  So that kind of impact to the marketplace really
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  I mean, except for
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  you haven't had for us since 1992 or something like that.
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  It was a great in terms of headline,
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  but the market wasn't pricing in an easing anyway.
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  So that that actual impact wasn't that great.
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  A particularly the things like spreads. Right.
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  Which by the way, we just talked about reverting
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  to their pre-crisis norms.
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  But you're still in favor of high quality right now.
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  Talk about your conviction on that.
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  Yeah, there's a couple of things.
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  I mean, one of the things that, you know,
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  that there's two things.
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  One is that lower credit
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  quality has actually been the dominant driver.
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  And you know what we're showing in this chart
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  is how some of these spreads have changed for both high quality
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  and those sectors that are more credit embedded.
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  Right.
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  And yet the sectors have really tightened in
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  since like pre-crisis levels.
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  So you don't want to say, well, nothing really happened.
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  But it is quite incredible how resilient
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  these credit spreads have been.
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  And, you know, for the month of April, you know, high
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  yield did incredibly well. Right.
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  Spreads compressed.
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  You know, you've got a lot of in a lot of income.
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  That's one of the top performing sectors.
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  But this concept right now
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  of the potential higher, oil prices,
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  you know, hurting consumer demand
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  doesn't seem to be in the picture right now,
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  which I find surprising,
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  because the longer this goes on for growth is going to slow.
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  Right.
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  And we're
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  and we were just talking about the yield curve
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  before we started as well.
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  And then the long end of the curve right now
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  you're looking at you
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  know, 10s, 20s, 30s are much higher than the shorter end.
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  But that could shift at any time depending on the news
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  coming out of Iran or anything else
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  that's happening in the markets. Right?
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  I mean, so it's it's not like
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  we're going to see
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  this sort of normalized upward sloping curve forever.
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  It could change depending on what happens in the markets.
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  It could listen I don't think the curve listening
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  I don't think the curve inverts.
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  I think the upward sloping yield curve remains right.
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  But to your point, if the markets had continuously priced
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  in high kick cake hike, then you have the potential,
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  you know, six,
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  seven months and now the market pricing an inverted yield curve.
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  I don't put a high probability to that, but it's not impossible.
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  And just CIOs still believe that the fed is going to cut twice
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  this year.
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  That hasn't changed at this point.
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  Now it has.
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  And we still have, you know, two cuts by the end of the year.
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  And as I've said before,
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  the timing of the cut,
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  whether it's September and December, doesn't really matter.
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  That what matters is that it's a cut, not a hike.
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  At the end of the year, which we do believe it will be.
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  And as I mentioned,
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  I mean, the market's
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  just not
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  the market's sort of focused on this and this inflation impact.
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  You know, the fact that the economy is strong.
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  You know 4.3% unemployment rate.
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  Retail sales are strong. Claims are down.
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  But it's not really looking ahead and saying
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  you know what could potentially happen to growth.
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  And you know that had one to consumer demand
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  as they go through their you know tax refunds right.
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  And as we see,
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  you know
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  higher quality total returns are still outperforming cash
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  given where rates are.
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  So what are you advising
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  our investors or clients to do now that we may have a higher
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  for longer fed in place. Yeah.
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  Listen you know cash
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  there's a lot of cash on the sidelines still in the in which
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  when you have uncertainty that has a tendency to happen.
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  So of course I mean you can't fault that.
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  But you know,
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  one of the things that we
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  that we blogged about and one of the charts showed
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  is if you look at the total return, here
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  it is of different fixed income sectors and that with cash.
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  Yes, cash is cash has been, you know, the okay performing sector.
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  It's yielding fine given
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  the fact the fed is not,
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  you know, or the market's perception
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  is the fed doesn't cut right.
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  So you're going to keep those interest rates elevated.
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  But again it's our expectation
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  that in the second half of the year
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  when you go through
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  some of these cushions of tax refunds and you know, consumers
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  start, you know,
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  pulling back a little bit on that discretionary
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  spending you to have growth slow.
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  And so the reinvestment risk
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  we think is going to be there on the cash side.
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  So we like that higher higher quality sector.
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  We like keeping it in our interest rate exposure
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  more in the short end of the yield curve.
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  We're not willing to go back,
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  you know, back end yet simply because there's too much unknown
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  in terms of deficit, in terms of inflation impact or like the
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  the ceasefire. Right.
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  I do want to go back to to potentially future fed chair.
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  What Kevin Warsh, as he is expected to be confirmed and that his
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  tenure is supposed to start mid-May.
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  But of course, we know that Powell has announced
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  that he's going to stick around after he leaves the chair
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  to be still on the board.
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  So he's still have some influence in the room.
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  But do you expect any kind of market volatility
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  as Warsh kind of takes over and starts to implement
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  more of his monetary policy stance and beliefs to the FOMC?
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  You know, there's always there's always volatility
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  when the fed chair comes on
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  simply because they have a different communication style.
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  Right.
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  We saw with Bernanke and Yellen and Powell
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  when they first started those few first few fed meetings.
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  You know they have a tendency to
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  you know make a few communication.
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  You know errors with the market likes to respond to.
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  But everyone has a different communication style
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  and the market needs to get used to that.
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  So it's just going to be volatile
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  or volatility is going to increase just through that.
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  Now do I think that, you know, the recommendations
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  that he has put on the table
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  without a tremendous amount of depth, I might add,
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  comes through
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  not for the first several months, not for the first sentence.
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  And even those
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  those that he's recommended,
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  whether it's balance sheet or even just simply altering
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  which inflation measure you look at,
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  this takes a long period of time.
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  And again, as you mentioned, Powell is still going to be,
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  you know, on the board,
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  maybe not until 2028,
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  but he's going to stay for a while and it is by committee.
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  So I expect the volatility just to just to come naturally.
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  Just just because he has a communication style that's different.
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  He doesn't need to change anything to get that volatility right.
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  It's a pleasure coming from a very low level. That's right.
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  And it took all of us
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  a little time
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  to get adjusted to Powell sort of style of communication
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  every time every time.
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  And I remember
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  there were a lot of headlines
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  about Powell and his communication style.
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  So and now we're used to the way he communicates.
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  So obviously yes we'll have to
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  although with with Warsh you might get,
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  you know, the Q&A quarterly and not monthly
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  because he doesn't want a lot of forward guidance. Okay.
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  But even that one thing being that quarterly one he's got a
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  he everyone has their own style.
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  Right. Exactly.
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  And last, last question, Leslie,
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  because it's always fun to ask you this.
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  The opportunity right now for fixed income investors are we
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  where are we sticking with.
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  You know, we're still in the short end of the yield curve.
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  You know it's it's that that 2 to 5 year area.
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  It's a great place to compound that income.
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  Keep all of the keep that capital preservation high quality.
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  There's no reason to go out further.
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  Yet in terms of interest rate risk.
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  I believe there will be at some point.
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  And probably it could be in the near future
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  the way that things are developing right now.
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  But right now we're going to stay with that 2 to 5 year.
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  We're going to stay that high quality.
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  And you know that compounding income
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  is going to be the challenge of total return.
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  Because I don't see a lot of spread compression from here
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  given how well things did and recovered in April.
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  Great. And Leslie, thank you very much.
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  Always good to have you join us.
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  Leslie Falcone
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  from the Chief Investment Office,
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  and thank you for joining us today for this episode of
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  UBS Trending.
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  There's lots more information
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  coming out of our chief investment office,
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  including everything that Leslie's discussing at ubs.com/views.
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  That's our insights website.
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  Plus you can follow us on social media.
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  We're on LinkedIn and Facebook.
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  Plus you can follow UBS Studios on our dedicated Instagram
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  channel at @UBSTrending.
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  Lots of content there for you. So give us a follow.
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  And as always,
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  if you have any questions
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  about what
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  Leslie and I spoke about today, please continue this conversation
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  with your financial advisor.
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  Until next time I'm Anthony Pastore
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  You have a great rest of your day
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  and remember to keep your eyes on what's trending.
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  We'll see you soon, everybody. Thank you.