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What could change the Fed’s next move? · UBS Trending

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  With the next
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  Fed meeting just a couple of weeks away, investors are curious
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  as to the factors that will inform the Fed's policy decision.
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  Inflation ticking higher long term interest rates, equity market
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  concentration risk
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  all factors likely on the minds of Fed officials.
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  So where do we go from here
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  and what matters most to the central bank.
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  We will break it all down for you right here on UBS
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  Trending.
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  Hi everyone and welcome to UBS trending.
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  I'm your host Dan Cassidy.
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  Joining me here in the studio.
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  Glad to welcome back
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  from a Apollo partner and chief economist Torsten Slok.
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  Torsten is joining us to share some insight on what's
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  going on with the Fed inflation and yields
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  Torsten is also a member of the UBS Research Advisory Board,
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  which is a group of experienced market leaders
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  and industry
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  experts who collaborate with the UBS Chief Investment Office
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  to explore the key themes
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  driving markets, the economy and long term investing.
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  Their perspectives helped broaden
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  the conversation around today's most important investment topics,
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  and bring valuable insights to UBS clients and advisors.
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  Torsten, first off, great to be with you here in the studio.
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  Welcome back to UBS
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  and congratulations on the appointment to the UBS Research
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  Advisory Board.
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  Thank you. Dan, thanks so much for having me.
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  I look forward to this conversation.
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  So a lot of top of mind for our viewers, including of course
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  inflation.
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  Now just a few months remaining here in 2026.
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  We have a Fed meeting coming up in just a few weeks time.
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  Talk to us
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  a bit about your inflation
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  expectations here in the US through year end,
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  and how might inflation be informing the Fed's policy
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  decision making?
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  Yeah, the inflation
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  backdrop for the next fed meeting is very important
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  because we have three different tailwinds to inflation.
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  That's lifting inflation from current levels.
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  First of all,
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  we still of course
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  have a significant impact on inflation from oil prices.
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  Oil prices have gone up quite a bit over the last 12 months.
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  And as a result when you measure inflation as a 12 month window,
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  that means that the overall level of inflation
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  continues to grind higher.
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  We also have tailwind to inflation coming from delayed effects
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  of tariffs.
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  Businesses
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  in a New York Fed say survey
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  saying that they are still implementing tariffs,
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  which is also a lift on inflation over the next several quarters.
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  And finally,
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  we also have some upward pressure
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  on inflation from immigration restrictions.
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  Meaning if you restrict immigration,
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  that means that not authorized immigrants are seeing wages
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  go up in the sectors where they normally work.
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  That means that if you have less labor in agriculture,
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  construction, hotels and restaurants
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  means that there's also wage inflation.
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  That is also putting upward pressure on inflation.
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  So the challenge for
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  the Fed is inflation today is in round numbers three and a half.
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  The Fed's target is that inflation should be two.
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  And the problem is
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  we have some tailwinds that are lifting inflation going forward.
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  And that is the problem for the Federal Reserve.
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  And that is the reason why financial markets currently a pricing
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  that the Fed will hike rates three times over the next 12 months.
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  So yes, we expect inflation to be higher for longer.
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  And as a result also interest rates to be higher for longer.
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  So quite a range of factors contributing to inflation,
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  a lot of factors contributing to the rise in Treasury yields.
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  The ten year
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  as we're speaking today on Tuesday October 13th, still above 5%.
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  So I'm curious the factors that have driven rates higher ie
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  debt issuance perhaps comes to mind.
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  What may also bring yields lower?
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  Yeah.
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  When you look at the whole yield curve,
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  one thing
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  that becomes very important
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  is that there are several forces
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  putting upward pressure on the yield curve.
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  And that's what you see in the chart
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  that we brought along here today.
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  First you're seeing the front end
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  that there's upward pressure from inflation
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  being higher for longer.
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  As a result
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  the Fed will keep short term interest rates higher for longer.
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  But exactly as you're saying down in the long end,
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  we have some fiscal challenges when fiscal challenges appear.
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  Of course, we need to issue more treasuries.
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  And when there's more issuance of treasuries,
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  that also means that there's
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  also more upward pressure on long term interest rates.
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  And in the belly of the curve,
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  the middle of the chart,
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  you see that hyperscalers are also issuing more debt.
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  When we see building of a lot of data send us
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  a lot of debt needs to be issued that money, which this year
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  would be roughly around $700
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  billion, needs to come from somewhere.
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  And a lot of that money
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  now is coming from other investment
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  grade assets, such as treasuries.
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  So as a result, money is being substituted out of treasuries,
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  which is investment grade,
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  into another investment grade assets, which is hyperscaler debt.
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  And that is now also putting upward pressure on the yield curve.
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  So the whole yield curve, it's at risk of being higher for longer
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  because we have this unique combination of both inflation
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  being higher fiscal problems
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  and the data center buildout putting upward
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  pressure across the entire yield curve,
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  leading to the conclusion that rates will be higher for longer.
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  Now, higher for longer rates.
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  I have to imagine
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  that has some serious implications to the rate of defaults
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  and delinquencies. Absolutely.
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  So that's why if you look at default rates,
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  this also becomes very important,
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  especially to default rates for lower rated credits.
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  The chart here we're looking at at
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  the moment looks at default rates for high yield.
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  And the default rate for loans.
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  And as you can see, when the fit began to rates as trace in 2022,
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  you began to see default rates.
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  The red line and the yellow line begin to go up
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  because the cost of capital went up.
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  In other words, for companies,
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  when it becomes more expensive
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  to borrow,
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  that means, of course,
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  the companies have a harder time paying their bills.
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  And when interest rates on debt payments begin to go up,
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  that's not surprising. Therefore, that default rates move higher.
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  But the good news in this chart here is that default
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  rates have actually started to go down.
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  You could see in the red line here at default,
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  rates for loans have been trending lower over the last year.
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  And that's an important conclusion
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  because when we talk about credit in particular private credit,
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  that's often a discussion around
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  what's going on I think is good, I think is bad.
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  And this chart actually tells you that things are getting better,
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  which is not surprising when the economy is better.
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  You should also have that companies are better.
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  So that's the reason why default rates
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  have started to grind lower.
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  Because we have an economy that's good.
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  That means that the corporate sector is also good.
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  So some encouraging takeaways.
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  There may be.
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  Let's turn focus to equity markets for a few moments.
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  We have seen some notable equity market concentration
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  delivered in part
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  by substantial foreign investment
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  should that foreign investment begin to dry up.
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  What happens?
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  This is very important because the equity market concentration,
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  especially in the eye trade, continues
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  to be very, very substantial.
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  At the moment,
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  the ten biggest stocks they make up 40% of the S&P 500.
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  So that means that in equities,
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  if I think about my 6040 portfolio,
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  there is a significant factor in AI that's driving returns.
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  If I now think about the 40 part of my portfolio.
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  So fixed income.
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  Well there you are also seeing that 49% of issuance in investment
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  grade is also I, 38% of issuance in high yield is also AI.
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  And if I also had venture
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  capital, 87% of venture capital today is also AI.
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  So now I wake up with AI everywhere in my portfolio.
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  And that's also what's important
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  when it comes to this chart for foreigners,
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  because foreigners have also been piling a lot of money
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  into the AI trade.
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  This chart shows you over the last many decades,
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  you could see foreigners didn't really buy US equities.
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  That changed a lot in the last few years
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  because foreigners also wanted to have exposure to the AI trade.
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  And that's what foreigners
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  are getting at the moment,
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  namely through significant equity purchases.
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  At the moment,
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  the chart shows you the 12 month sum of foreign purchases
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  is about $1 trillion in purchases by foreigners of U.S.
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  equities.
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  So that's a different way of saying it's not only in GDP.
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  AI is very important.
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  It's not only in my 6040
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  asset allocation model that AI is important,
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  but it's actually also very important for foreigners
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  because foreigners also have significant exposure to the AI trade
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  through the purchases of public equities.
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  Well, Torsten, very helpful clarity on a range of topics,
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  top of mind for our viewers.
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  Absolute pleasure having you here at the table today.
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  Thank you again for dropping by UBS Studios.
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  Thank you Dan, thanks for having me. Of course.
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  For more information, visit
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  ubs.com/views UBS trending is on social media.
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  that you won't find anywhere else.
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  and for more on Twitter.
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  And as always, if you have any questions about your portfolio,
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  please be sure to speak with your UBS Financial Advisor.
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  Until next time, I'm Dan Cassidy.
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  Have a great day
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  and remember to keep your eyes on what's trending.