Interest Rates "Sitting" in Place: Tariffs & U.S.-Iran War Keep Fed from Cutting

0:00So let's bring Marley back into the conversation and welcome in Mike Dixon, who's the head of researcher quantitative strategies over at Horizon Mike. I ended up talking about the yields because I feel like the investment narrative has shifted now from the inflation risk to the growth risk and you've seen that playing out in treasuries where originally we had these double digit basis point gains across the yield curve on the thinking that the Fed was going to have to step in maybe cause some demand destruction with the energy shock. Now there's a rethink around the potential growth risk and the fact that we might be pricing in rate cuts once again because the market might be doing its job for it. Talk us through where you think we stand right now with what the Fed should do. Yeah and thanks for having me. I think the Fed isn't a tough place and the markets have definitely responded to this. I mean let's face it we've been well above the kind of inflation target for quite some time. You know frankly the the tariff uncertainty

1:02and that flow through isn't fully solved and now there's this you know oil shock and the longer this goes on the more uncertain it becomes for the Fed and look as a result you've seen a very large repricing on what the Fed is going to do this year from markets. If you look at you know Fed fund futures prior to the the Iran war situation there's as many as you know two and a half to almost three cuts at some point this year priced into the curve and where we sit today there's there's no cuts priced in. Now to be clear the Fed hasn't moved based on their economic projections but the market certainly has you know and for good reason they're they're kind of in a tough spot. And Mike you say they're in a tough spot here the Fed's a little stuck you know we got commentary from Jerome Powell yesterday they completely changed all of the the target rate possibilities for the Fed watch tool they were as high as 20% when I was looking at December before yesterday now they're about 2% for a hike 24% for an ease by the end of the year you know what's your base case does the Fed cut rates at all this year do they hike rates?

2:05Well I mean I think for a one base case we can go look and and see what the the Fed themselves have said and they came into this year with one rig cut kind of pencil then and that's where they left things with their summary economic projections and that that update that we just got a couple weeks back and but look I mean I think the conversation of rate heights is something that has been on the table and the market has gone back and forth and whether that's going to happen I do think it would be a mistake for the Fed to actually hike rates kind of in this environment as you mentioned you know growth concerns we have not quite really seen you know yields fully priced in a big demand shock but it's it's kind of the next thing that we're we're watching for and so what does that mean base case you know probably just kind of sit here uh that's why I really think the Fed is is kind of stuck whether we get one cut no cuts uh I don't think that really moves the needle that much I mean the reality is uh with this inflation shock that the Fed is not going to be able to aggressively cut and that's where that that's where that tug of war is and that's why I kind of

3:05think base case is kind of just sit right around here. Yeah and it was interesting that Paul's comments were taken as dubious yesterday because of the fact that he kind of laid out this scenario where they could sit on their hands at least for now and Mary daily really summed it up quite well in recent weeks about being vague and almost to some extent dissatisfying for the market that giving too much forward guidance in in an uncertain world risks a false sense of certainty and security right now but you've got the schmids of the world you've got the ghoulsbees of the world worried about the fact that inflation was higher even before this energy shock so I'm just wondering if the Fed seems to feel like it's in a good space right now what data point are you looking at that might sort of tip the balance here uh we more worried about the jobs market or inflation because I'm thinking about ISM manufacturing and put prices tomorrow and then of course jobs this Friday. Yes great we get jobs on Friday and the New York Stock Exchange is closed so that's that's going to be interesting um but look one of the things I think the Fed you know

4:09is showed us just with their economic projections this last go round is they actually kind of they increase their longer term expectations on the growth front and you know one of the you know just drivers that it was cited for that is you know potential increased productivity enhancements from the AI side of things and you know I think we need to also look at the starting place prior to this whole Iran conflict we've got a very healthy boom in economy consumers in a very good place you know some question markets around the labor front but a low churn overall and you know a lot of these data points especially if that increased productivity probably points to the the market being able to sustain kind of like that higher uh long-term neutral rate uh and the Fed has told us that through some of their projections so you know a lot of that I think does point to us just kind of sitting here and I think it'd be you know a little too rosy to think we're going to get a lot of aggressive rate cuts in in this environment the data just really doesn't support that and that you know a new incoming chair quite frankly cannot change that you know utterly this is you

5:13know a committee type of scenario and we all know the data they look at and I think that's just the reality where we sit right now just kind of uh you know flat rates on the fed side of things and Mike if we're in this higher for longer world it's indefinitely almost I mean as Sam just highlighted Jerome Powell went almost so far as to say they they just sit on their hands what does that mean for equities and for risk assets this year well I think a boring fed is a good fed that's something we've we've we've said a lot over here at Horizon I think one of the main reasons for that is you know when we do begin to get some you know lower interest rate volatility that flows through to all sorts of asset classes you know unfortunately the last few weeks the complete opposite has happened uh with the uncertainty uh around the inflation front how that's moved uh just uh you know the the short end will really all you know all across the curve quite aggressively you know and as a result we see an interest rate volatility pop up mortgage rates have started to go kind of the other direction as a result so what we want is a boring fed we want a fed that is

6:14sitting on their hands we want a fed that is not is not going to be making knee jerk reactions one way or the other and most importantly we don't need externalities uh you know out there like this iron conflict clouding the environment so a boring fed is a good fed I think it's perfectly fine if we have rates kind of sit right here but what's not going to be helpful is uh you know when we have a massively data dependent fed with this you know external you know inflation shock that that that that could have rate hikes back on the table that's going to be the kind of difficult environment because you're going to see that volatility flow into riskier assets and they're going to fill the brun of it a lot more you know as a result of that higher interest rate volatility some would argue right now Mike that the fed can stay and hold as well because the economy looks in pretty good shape and you know I know that power in recent meetings has even made a bit of an upgrade to the economy as well but some would say it's resilient some would argue in fact it's on shaky ground particularly because Q4 GDP was cut in half and that was before what we saw

7:17this quarter so I'm just wondering as you look at the economy would you say it's in good shape or not right now shaky ground or or looking okay I would say it is definitely on on strong ground and you know the you're right the second revision for GDP did for Q4 did see a downgrade but a lot of that is really through kind of the the government channel the core consumption the real you know real personal consumption component you know is very stable and very strong a lot of that volatility like I mentioned on the GDP front is not is not from that core consumption component and you know when we look at the the benefit puts out a GDP now projection on kind of incoming data where they see this current quarters GDP projections and again on that consumption component also sitting you know around that 2% level quite strong and look we came off a string of really solid GDP prints you know in the second quarter and third quarter of last year as well and so that's

8:20that that's the base case the starting place is very healthy the consumer has very solid positive real wage growth and is sitting on you know solid nest eggs from a lot of the strong equity markets we've seen over the last couple of years cash flush so yeah I think the economy is in great shape for now and I think that's a lot of reason why you haven't seen the you know the rates market react to this being you know a demand shock at this point has been purely inflation driven but you know again the longer this kind of conflict goes on the more uncertainty there is going to be to that component that's what got to keep a close eye on and Mike let's talk globally here you know just this month we've seen some of the global central banks take a more hawkish lean here does that impact fed policy does it limit flexibility how much influence is there in terms of global rate dynamics as it pertains to the Fed well you're right I mean just just a couple weeks ago we had you know the big week with you know Bank of England ECB B O J and the Fed you know

9:22generally speaking you could summarize all of their comments as somewhat hawkish and you saw kind of rates moving up you know globally as a result and you know really it's going to be the the currents dynamics that are going to kind of tie all of those together and and so you know that that's going to be the that's going to be the link between just the movement of these central banks overall you know but but you know I think for the most part when it relates to all this you know a potential divergent policy the Fed you know is going to be making their decisions based on the health of the U.S. economy the U.S. labor market and you know the inflation picture here in the U.S. and I think that they're going to be data dependent relative to that and that is going to be the main driver you know so at this point I think you know we we may see some divergent policies and that's perfectly fine you know but that may have a flow through into potential movements with the dollar and that may impact positioning and so that's something to certainly be aware of yeah and it's been interesting obviously with that higher dollar what that's done for

10:25some of those regional currencies the FT out with an interesting piece about how some economies have actually been ditching U.S. treasuries to sort of try to fend off the weakness in their local currencies as well I'm just wondering from the standpoint of the U.S. economy which you say is looking pretty strong right now in the face of everything what do your recession checks tell you right now Mike and I don't mean like a broad recession I'm talking about some of the rolling recessions that we've already started to see at any form of sort of demand destruction that you're keeping an eye on well the demand destruction is definitely the big one that we need to look for and you know like I mentioned before I think there's a couple really key data points to watch I mean one of the one of the ones that I'll be watching quite acutely is going to be you know the 10 year real yield so you know just kind of stripping out that inflation component when you're in an environment here where you know like I stated earlier I feel like the Fed is kind of stocks you're probably not going to see a significant adjustment to Fed policy and then that means when you're

11:31looking at that 10 year real yield that can be a really kind of pure proxy for the markets view of you know where that kind of economic growth is and it's it's at very healthy levels now but if we see that pullback significantly along with weakness in equity markets combined with a widening credit spreads that would be something that would be a big warning that things might be getting a little rocky we're not seeing that right now but that is it those that kind of you can't just look at one market you're going to need to look at and see confirmation from several different areas but those are you know three three markets that I would look to to see the first sign of real concerns on the demand front you know being real yields credit spreads and equity market weakness and for now that is not being priced in but that's what to look for at this point okay and the US 10 year right now has dip below that 4.3 mark so it's done a few sort of short turn around trips in recent months it's been very interesting to watch Mike thanks so much for

12:32joining us today really appreciate the chat Mike Dixon there from Horizon