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Decoding the Fed with the "real yield" story · UBS Trending

• 0:00
  Sometimes one chart can tell
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  a story that the market isn't really talking about right now.
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  Something unusual is happening in the Treasury markets.
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  Yields are moving higher,
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  but the real driver may surprise investors.
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  We're going to break down
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  what's behind
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  all of these moves,
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  how it connects to the expectations of Fed monetary policy.
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  And what it could mean going forward.
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  Right now on UBS Trending.
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  Hi, everyone, and thanks for joining me.
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  I'm Anthony Pastore.
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  This is UBS Trending for our monthly spot.
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  We've got Leslie Falconio joining us again.
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  And Leslie there's really a lot to unpack here.
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  Good to see you by the way.
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  There's a lot to unpack.
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  We're just coming off of a Fed meeting from last week.
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  Warsh's second meeting lots that he said
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  during more importantly the press conference afterwards.
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  That wasn't
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  even in the much shorter statement than versus what Powell's fed
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  was releasing.
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  I wanted to ask you, when you looked at what came out of
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  not only the statement,
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  but Warsh was saying during the press conference,
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  and then you were watching the action
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  that was happening
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  on the Treasury market side, fixed income side.
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  What did you take away?
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  How did that all come together?
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  And what did you see
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  that the bond market
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  was interpreting versus what Warsh was talking about?
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  Well, I mean, Anthony, it's interesting
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  because when you think about
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  what the probability of a hike
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  was coming into that meeting
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  and as you know, that was not our expectation.
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  We did not expect the Fed to hike,
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  but the market was pricing it over a 50% probability
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  that they would hike, you know, in this July meeting.
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  And we know under the former chairmanship, right,
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  that more than likely wouldn't have occurred either.
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  Something likely to appear in
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  the Wall Street Journal that adjusted the market's expectation.
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  And, you know,
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  that sort of hawkishness,
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  if you will, wouldn't have been
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  as predominantly priced in as it was.
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  So the statement in and of itself,
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  as you mentioned, there really wasn't
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  that much of a surprise there.
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  Obviously with there was three dissenters,
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  which I mean shouldn't be ignored.
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  But frankly, if it just stopped there with, okay, you paused,
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  you didn't hike,
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  and you had these three dissenters
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  know, the market probably would have reacted,
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  okay, you're not going to go today, July,
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  but you're going to go in September.
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  Again, not our call, but the market has reacted that way.
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  It would have been
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  a much more of a calm reaction than what we saw.
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  Instead, it really was, to your point, the,
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  you know, time during the Q&A
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  when the market really started to establish this volatility.
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  And I
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  as I've always said,
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  Anthony, it's
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  not just about the level of rates,
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  but how quickly you get there, that velocity that has the,
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  you know, impact to performance,
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  whether it's equity or fixed income.
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  And as you know, during after that Q&A, yields rose.
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  I mean, month over month
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  you had Treasury yields rise like 27 basis points.
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  The curve, what we call twist steepened meaning
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  that long-end yields went up and the short end yields came down.
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  Right. So you had the steepness.
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  And frankly it was because particularly in that back end
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  because the focus
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  particularly in June was on the price stability mandate.
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  Right.
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  And meaning that,
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  you know,
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  this isn't the Fed that just looks at the demand side anymore.
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  It looks at the supply side that it's not just about,
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  you know, the middle East crisis, but it's about whether or not
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  we hit that 2% target and the focus is on that 2%.
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  You know inflation target by chair Warsh.
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  That what happened
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  was the market took that as okay wait a second.
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  You just said this was really a focus.
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  You didn't hike
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  so that back and said you need to start compensating me now.
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  So what we saw was breaking inflation expectations
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  all of a sudden rise. Right.
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  And as inflation expectations rise that 30 year
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  yield start to rise.
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  So you saw a really large move in the Treasury market.
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  And you also saw a shift in how the market is pricing
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  that Fed policy going forward,
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  meaning that the fixed income market
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  was, you know, pricing several hikes in 2026.
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  Now it's has one hike in 2026 and December again right now
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  that's not sales call. We think they remain on hold.
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  And they have another
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  excuse me another high priced in June of 2027.
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  And again you know, as you know right now our view is
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  they remain on hold
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  until well into 2027 where the next move is a cut, not a hike.
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  Right. Yeah.
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  There was a as you just kind of went through.
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  Leslie, thank you for taking us on that journey
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  because there really was a lot to unpack.
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  You know, we heard Warsh
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  say that the Fed was doing this watchful thinking
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  instead of any urgency to hike.
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  So there you go.
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  That was when the market was kind of like,
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  wait a minute, wait a minute, back it up for a second.
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  That's not what we came out of. The statement.
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  So yes, there really was a lot to unpack.
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  But we did see, just before
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  I walked in here, I was looking at the action
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  in treasuries from the statement
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  all the way through Friday of last week.
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  Well, you know, we're sitting here filming, the, the week after,
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  the 10-year Treasury yield
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  hit a high that we hadn't seen since January of 2025.
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  Since then, it's come back down a little bit.
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  That was related
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  more to the continuing back and forth between Iran and U.S.
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  with the conflict there.
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  So when you're looking at, say, just generally rising real yields
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  and the move that we've seen recently across treasuries,
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  what message is the bond market
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  actually sending about overall economic growth and inflation?
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  And by the way, just to remind our audience,
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  we think here at CIO
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  that we're going to see more disinflation, meaning that we'll see
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  prices rising but maybe at a bit of a slower pace.
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  So given all that,
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  Leslie, what message is the bond market sending.
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  Yeah, absolutely.
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  And Anthony, not only
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  are you seeing
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  10-year
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  Treasury yields
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  the highest since, you know, January 2025,
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  but the 30 year yield at,
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  you know, 5.25% to 5.27% is the highest since 2007.
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  So when you think about like real yields,
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  the way real yields have been acting
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  and that's because real yields
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  are the nominal minus inflation expectation.
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  What really yields were doing is that real yields were rising
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  okay.
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  And real yields were rising more than break even.
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  Inflation expectations.
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  And the caveat
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  and the important part here is it was doing this
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  when oil was going up. Right.
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  Because at that point
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  in time the conflict was actually, you know,
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  starting to re-engage again.
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  So I have oil moving higher
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  but inflation expectations coming down.
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  Why is that?
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  Because the market was expecting the, you know, committee
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  to sort of look through
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  the current crisis is being transitory,
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  if we will, and actually hike because the probability
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  or the expectation was
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  you want to get to that 2% price stability.
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  So in that sense, you saw real yields rise.
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  And part of
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  it was because the terminal rate
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  of the Fed funds was going higher.
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  Growth, as you mentioned, was doing a bit better.
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  But once they didn't okay.
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  And once they actually didn't pull the trigger and hike,
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  the mark was saying, okay, well, maybe this price
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  stability mandate is not necessarily the pure focus.
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  You know, after,
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  you know,
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  he kind of stated vaguely,
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  it'll take so several years to get down to that 2% target.
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  And what happened was inflation
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  expectations moved higher, as did that long end.
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  And now it's been our expectation,
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  you know, that, you know,
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  the second half of the year the curve is going to steepen.
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  But our
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  expectation of the curve steepening
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  because we stayed away from that back end of the curve
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  has also
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  because we really thought that short end
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  was starting to start to come down
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  because as you mentioned,
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  we're looking at it more to disinflationary standpoint.
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  You know, over the next several months
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  we don't think the Fed is going to hike.
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  So that curves of steepening.
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  So the market was caught off guard if I should say a bit.
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  And because of that you saw this large shift in that back end.
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  You know, Leslie, I was reading through your most recent
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  blog from the beginning of, or the end of July,
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  and you were talking about how you, you had this sort of
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  what if scenario if the Fed does hike.
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  Right.
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  And so I know that there's a lot that we still don't think Axios
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  you reiterated that the Fed is going to hike
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  not this year anyway.
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  But given given that the what if scenario, the unknowns
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  that we have ahead of us
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  and the fact that we still believe that
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  high-quality fixed income it has holds a place in any portfolio,
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  where do you see the biggest opportunities
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  right now in fixed income,
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  and what should investors
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  actually be paying the closest attention to?
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  Because there is so much going on between the Fed, the markets,
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  you know, the what's going on in geopolitical conflicts.
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  A lot to digest there.
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  Yeah.
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  I think, I think that you, you bring up a really important point.
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  And, you know, here's something that we saw from the July FOMC.
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  Right.
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  You know,
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  if you were to label
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  the difference of like the Q and A is dovish.
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  Right.
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  But the dovish lead to a decline in interest rates.
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  It didn't interest rates rising.
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  But I think the question becomes as to whether or not.
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  And again the employment number on Friday to see not only
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  how unemployment rate does
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  but how that wage inflation starts to play out.
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  So we got a big spike in wage inflation.
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  But the point is they did hike it again.
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  That's not our view.
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  Doesn't mean the trend is going to go up.
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  They could come down.
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  And we also have to and I think it's important point.
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  There's two different sort of rules here between
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  you know you know Treasury Secretary Beessent and Chair Warsh.
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  I mean we have the refunding announcement out later today.
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  It's going to talk about the refunding
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  and the Treasury supply over the next quarter.
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  And you know, the deficit is not necessarily falling.
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  So I think you have that sort of push.
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  They call me there also too.
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  I mean, in the longer term
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  we do think that interest rates
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  will come down by the end of the year. Right.
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  But if in fact, we have sort of this continued inflation
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  or acceleration of inflation,
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  then that's going to cause an issue to more of that back end.
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  And because of that back
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  end volatility,
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  we really like staying in that short
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  to intermediate part of the curve. That really hasn't changed.
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  We need to survive in terms of our fixed income allocation
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  for the
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  and things like high yield to attractive you get over 7% yield.
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  It's high quality not a lot of interest rate risk.
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  And we're all about that compounding income right now.
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  And one of the things that we road maps we talked about with this
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  what if scenario is that what's different today in the Levy's
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  other scenarios that we do have a
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  this income that we haven't seen in well over a decade.
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  Right.
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  So the market can withstand higher rates a little bit more.
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  It can send some wider spreads sort of still in historical times.
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  But your total return is really
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  it be driven by this compounding income.
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  So we stay with the higher quality.
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  Mostly securitized product over corporate credit like CMBS
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  and CMBS, which is has done actually much better than we've seen
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  in corporate credit
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  because of the supply investment grade corporates.
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  But we want to stay high quality.
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  We have some high yield
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  to get that sort of that income or that carry, if you will.
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  But we still stay in that short end of the curve
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  because there's a lot of unknowns in that back end,
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  and we simply don't want to
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  or need to take on that kind of volatility. Right.
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  And just so just to kind of round it out duration,
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  you still think duration
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  is attractive compared to, you know, some of the credit sectors.
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  And I've got on the overall equity market. Right.
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  Treasuries
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  listen durations
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  cheap interest rate risk is cheap
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  to both the equity market and the credit market.
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  We just don't want to extend too far out right now.
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  There will be a point in time where we do.
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  But you just have a lot of volatility.
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  So if you want to add interest rate risk,
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  which we think that there's not a problem with doing that,
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  you want to stay with that 2 to 5 year area of the curve.
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  But there's no question
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  that this is due to equity and fixed income.
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  Excellent,Leslie.
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  Thank you. Always a great conversation with you.
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  When we were just kind of joking around about that.
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  This has been quite a busy year for the markets.
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  And we're just about had, you know, past the halfway point.
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  So lots more to go.
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  Look forward to more conversations with you.
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  Thank you Leslie, good to see you.
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  It's a great.
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  And for more information from Leslie
• 11:27
  and the rest of the Chief Investment
• 11:28
  Office, please visit our website at ubs.com/views.
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  Plus, you can follow us on social media.
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  We're on LinkedIn and Facebook.
• 11:36
  Plus the studio has its own Instagram channel.
• 11:39
  You can follow us at @UBStrending
• 11:41
  Lots of content there for you to peruse.
• 11:43
  And if always, if you have any questions
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  about your portfolio or whatever Leslie and I spoke about today,
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  we hope you continue this conversation
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  with your financial advisor. Until next time, I'm Anthony Pastore.
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  We wish you a great rest of your day
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  and remember to keep your eyes on what's trending.
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  See you soon everybody! Thanks.