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The bond market is talking · UBS Trending

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  Everyone is
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  watching stocks, but the bigger story may be happening in bonds.
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  The ten year Treasury is testing 4.8%.
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  The 30 year has climbed above 5.3 and mortgage
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  rates are pushing higher again.
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  So what does this all mean for investors?
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  We're going to discuss that
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  and a whole lot more right now on UBS Trending with Leslie
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  Falconio.
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  Hi, everyone, and thank you for joining me.
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  I'm Anthony Pastore and Leslie Falconio, as I mentioned
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  is here in the studio with me.
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  Leslie, there's so much going on.
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  You know, we're going to be talking today
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  about expectations for the Fed and interest rates.
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  We're looking at the jobs numbers and upcoming inflation
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  reports. There is so much happening on the economic side.
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  And of course we're seeing yields on bonds just continue to rise.
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  I do want to start though, with that payroll
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  report that we saw came in better than expected.
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  Has that
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  report changed your and the CIO's outlook
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  on what we can expect going forward from,
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  especially from the Fed, because we're watching every word
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  that comes out of Walsh's mouth
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  these days to see where we're going.
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  Is he going to be more hawkish or dovish. What's happening.
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  Yeah, absolutely I mean listen there's no question that Friday
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  report was strong and was stronger than expected.
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  And this is after two months of fairly soft labor data.
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  So you had about 161,000 added.
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  Right.
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  But the participation rate went up.
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  And you had what I call recovery, if you will,
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  and things
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  like leisure that had been, you know, fairly negative
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  for the two months prior,
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  but you had the employment
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  rate, the unemployment rate, about 4.1.
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  But we really mean between four
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  one and four three for a very long period of time, right?
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  And more importantly, this just shows
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  that even though interest rates have gone up this year,
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  we know that growth is still very strong.
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  And right now
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  the labor market appears to be at a minimum, stable.
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  So when we think about the outlook of the fed colleague
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  Anthony, as you know, when we
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  when we add in the growth that we're seeing on the labor side.
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  Right. That mandate right.
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  As was pointed out Jackson Hole that is concern about that.
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  You go back to that price stability part.
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  And even though the labor market and nonfarm payrolls are strong
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  and we're not seeing a big spike in wages,
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  and we still have this persistent type of sticky inflation
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  that has remained above that 2% target,
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  which the Fed is very adamant about getting towards fairly quickly.
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  So with that said, our fed forecast actually had moved, you know,
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  it had moved in terms of we do expect to hike in September,
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  we expect a hike in December.
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  But I will say there's a lot of optionality to that.
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  And this market is even though
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  the market's pricing in the expectation
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  of a fed, fed rate hike in September by about 68%.
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  As you
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  as you pointed out,
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  we have some inflation numbers
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  this week, which will definitely dictate.
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  I don't think one number is going to alter necessarily the path,
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  but I think more importantly, it's not really whether the fed
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  hikes in September or not.
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  What really is the, driver.
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  And what you need to follow is what's a destination.
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  How many hikes do you think they're doing.
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  Is this something
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  where it's going to be methodical to say two hikes,
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  maybe three, that the reverse some of the 2025 easing?
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  Or is this going to be something that is exponential to that.
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  And you know, hundred and hundred and 25 basis points of hikes.
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  We think the former. Right.
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  So we think it's one that where the market
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  is already pricing this in.
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  We don't see it as a large heading into the equity market.
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  We don't see it in a large headwind to growth.
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  So again what will they do in September.
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  And that is really not the path or really shouldn't be the focus.
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  It's where that destination of the fed is going to be.
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  And in our opinion right now
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  you're looking at two maybe three hikes okay.
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  And the third hike possibly in early 2027 I would assume.
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  It could be I mean, right now we're not forecasting that.
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  But as you know I mean it's a lot of the fundamentals change.
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  Right.
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  And particularly
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  now that,
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  you know,
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  we have a continuation of this crisis,
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  we have to see how the data comes out.
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  Right?
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  Right now we're two
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  and that's not really going to be material enough to alter
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  the path of growth or what we're seeing in the equity market
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  or more importantly,
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  push yields
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  materially higher in the 10-year to 5.25% or something.
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  Well, let's talk about that
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  because, you know, as we sit here,
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  we're watching yields continue to rise.
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  I'm specifically looking at
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  not only the 10-year and the 30-year,
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  but also the intermediate part of the curve.
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  The 3 to 5 year yields are rising there.
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  What do you attribute to all of this.
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  And like me, bonds are so cheap right now.
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  They are.
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  I mean the longer the market is we would
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  and I agree they are cheaper, you know.
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  But as you know, Anthony,
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  we've been a little bit hesitant
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  about extending further out that Treasury about the yield curve
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  and simply
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  because you're earning a lot of compounding income
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  in that 2 to 5 year,
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  you know,
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  you are not getting over your skis
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  in terms of taking interest rate risk.
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  And to your point, let's talk about, you know,
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  why interest rates are rising.
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  Okay.
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  You know, the first thing we could say well, growth right.
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  We've got 6.5% - 7% nominal growth.
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  Growth was very strong.
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  We know the consumers are resilient.
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  But this year is also been faced by a large correction
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  in sentiment when it comes to the fed path. Right.
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  So when you think about where we were
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  in February in terms of 60 basis points of cuts, now all the way,
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  all the way to these, you know, 50 basis point to hikes in 2026.
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  So that also influences the back end.
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  Then you put on top of that
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  the rise in oil that we continue to see.
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  And although it hasn't spiked,
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  you know
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  beyond the high that we saw
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  two months ago, it remains elevated.
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  And so does the conflict.
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  You know all of that with supply
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  coming out, fiscal uncertainty,
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  all of these kind of variables are keeping that back end.
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  You know, both in tens and 30s and particularly 30s at a
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  more elevated level
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  right now, the question becomes is how the market reacts.
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  If, in fact, the Fed does hike in September, are the inflation
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  vigilantes going to become in that 30-year starts to come down?
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  That's my expectation.
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  But again, we have a lot of numbers till then.
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  And considering that the market
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  has really been pricing in these hikes for not just recently,
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  it's been a few weeks,
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  maybe even a couple of months, like through the summer.
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  It seems like the market has priced in the Fed
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  hiking at some point this fall.
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  And now obviously our forecasts have adjusted that as well.
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  Absolutely.
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  And since Jackson Hole
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  and since the labor report was strong,
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  that probability has just been higher. Right?
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  Yeah.
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  What about, you know, credit spreads are still pretty tight.
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  They're in pretty stable.
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  How do you play within that space,
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  considering that credit spreads
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  haven't really moved all that much.
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  You know, they haven't, and they've been remarkably stable.
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  Right? I have to say.
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  I mean, even, you know, look, when we think about
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  credit in terms of and credit,
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  it could be a good leading indicator.
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  If there are pockets of vulnerability in the future.
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  Right. You always look at the credit markets.
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  But what we talked about earlier is, you know, financial
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  conditions are loose, capital markets remain open.
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  And with all the supply that we've seen in the
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  and say, you know, corporates, it's being priced in
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  and you have a lot of yield buyers, a lot of technical demand
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  that's keeping those spreads sort of intact.
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  This is a hyperscaler related
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  or at least is that a portion of it.
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  Because we talk about IG corporates,
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  and it seems like a lot of these
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  hyperscalers are looking to issue debt.
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  They are.
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  And you have to remember when you're
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  whenever you're at a hyperscaler and your IRR is 15%
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  in a raising interest rates
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  a little bit is not going to do a lot in terms of what you can
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  or they're not.
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  They're not as concerned about the cost of capital right now.
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  Right. Maybe the future will be a little bit different.
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  Obviously the free cash flow might be dwindling a little bit,
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  but given how sort of how strong some of these fundamentals
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  are, both on the household side and the corporate side,
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  you know,
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  the corporate side is seeing,
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  you know, good demand for both IG and high yield.
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  You know what?
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  What do we are starting to see just recently.
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  And we've seen some a little bit of widening in IG spreads.
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  Is that what we call the correlation.
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  Meaning that ten year Treasury yields are rising.
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  And a lot of times when ten year Treasury
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  yields rise it's because of growth. Right.
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  And spreads will have a tendency to come down.
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  Now as Treasury
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  yields rise corporate spreads are starting to widen a little bit.
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  And that's simply
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  because the inflation component is in the forefront.
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  We don't think that this is something that, you know, lasts
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  for a long period of time.
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  And the income that you're earning
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  creates a tremendous amount of cushion.
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  So we still like high quality.
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  But as you know, we've stayed more in the mortgage agency
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  mortgage backed securities side.
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  Which you've.
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  Securitized.
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  You've liked for a while and don't like them at this level.
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  I do.
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  Obviously, you know,
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  you and I have sat here
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  and talked about mortgage rates and correlation
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  to agency mortgage
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  backed securities,
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  and it's not always a direct correlation,
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  but we have seen mortgage rates go up,
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  you know, being sort of stable at around 6.8% or so.
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  Is that impacting the way you think about agency
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  mortgage backed securities moving forward from here
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  and with the fed expectations of raising rates? Absolutely.
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  You know, that's a great question because what's interesting,
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  similar to the IG
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  corporate market, what we're seeing in agency MBS.
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  Yeah, spreads are very contained.
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  So they're almost decoupling if you will, from that rise
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  in ten year Treasury yields, which normally we wouldn't see.
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  So we've got
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  and if this was what this chart shows
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  you see this decoupling that
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  agency MBS spreads are staying very stable.
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  While 10-year interest rate 10-year olds are rising.
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  Now, you know,
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  as we know since 2022, the effective mortgage rates
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  moved from a 3.3 to now it's about, say, a 4.2%.
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  That's still 200
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  basis points below the current mortgage rate, right.
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  Because we still had this lock in effect intact.
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  The housing market is obviously face
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  some headwinds in terms of these rising rates,
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  not enough to completely, you know, be a large headwind to
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  say, the economy or the consumer.
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  But it is something we consider.
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  But the agent MBS side is like the high quality, very liquid
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  and doesn't have that supply concern
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  that we're seeing in the IG market.
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  And the 570 yield.
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  You know,
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  we happen to think we happen to like that sector quite a bit.
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  And obviously
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  with continuing geopolitical risks that are going on
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  and this movement in yields
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  and of course
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  the expectation for the fed and economic data recommendations
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  not to dump too much into one single part of the asset class.
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  It's more of a diversified portfolio. Absolutely.
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  I know that sounds very 101, but it's true, right?
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  I mean, what we're doing
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  is we're taking some of the high quality rate that we have
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  and that sort of our interest rate component,
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  which is not really any more than a five-and-a-half, six-year.
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  Yeah.
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  And then that compounding income that we look for that credit,
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  we're taking on the high yield side.
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  Right. Very short interest rate risk.
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  Very getting much higher quality in terms of
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  will have been of great performer this year.
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  And we think that's going to continue particularly
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  given our expectation of returns on the S&P.
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  So you know that kind of combination has worked very well.
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  But I will say Anthony, we do remain
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  buyers and we will extend interest rates,
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  you know, on dips
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  and where that dip is maybe around that 485 level.
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  We'll start to consider it. Yeah.
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  But I think being in that that short that 2 to 5 year
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  where we've worked out very well for.
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  Yeah, that intermediate part of the belly of the curve,
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  which has been really nice to be in for a while.
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  Absolutely.
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  Did you think when we sat here
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  in January at the beginning of this year,
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  did you think we'd be here today
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  looking at the way we expect markets and the fed to go?
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  You know what an interesting couple of months it's been?
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  I mean we're in September. Absolutely.
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  And with all those curveballs that have been thrown at us,
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  you know, you have to say the US growth is really resilient.
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  Resilient. That's the word I was thinking of too.
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  Great. Leslie, thank you very much. Always a pleasure.
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  Thanks. My friend.
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  Thank you all for joining us.
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  There's a lot more information coming out of the CIO,
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  including all the content that Leslie and her team
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  are writing about, blogging about, and of course, doing podcast
• 11:15
  and videos with us 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.
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  You can also check out the studio's dedicated Instagram channel.
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  Follow us at @UBStrending.
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  Lots of content there for you to peruse.
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  And as always,
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  if you do have any questions about what
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  Leslie and I spoke about today,
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  make sure that you are continuing this conversation
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  with your financial advisor.
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  Until next time,
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  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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  We'll see you soon. Everybody.