Ira Jersey on Deciphering Fed Signals, Fiscal Policy Intricacies, and the Mechanics of Market Movement

Discover the underlying currents of monetary policy with Ira Jersey, Bloomberg Intelligence's lead US interest rate strategist, as we explore the Federal Reserve's communication intricacies and the recent dovish signals that have left the markets buzzing. With a seasoned eye, Ira dissects the balancing act the Fed performs while steering the economy, providing an expert's take on how their guidance, or lack thereof, sends ripples through the interest rates and risk assets. Expect a deep dive into the challenges of forecasting in an unpredictable economic landscape and the implications of the Treasury's actions on market stimulation.

Venture with us into the realm of government fiscal policy where the impact on household spending and the economy is as complex as it is profound. Let's scrutinize the role of government transfers, such as Medicare and Medicaid, in supporting household income and debate the sustainability of these programs against the backdrop of swelling deficits. This conversation doesn't shy away from the controversial; we tackle the paradoxical effects of fiscal stimulus on inflation and growth, and even ponder the future of labor in the age of artificial intelligence.

In our concluding segment, we peel back the curtain on the mechanisms of Treasury auctions and the corporate credit landscape. This episode is a treasury of knowledge for those keen to understand the forces that shape our financial world and the hidden levers that move markets. Join us for a journey through the intricate web of economics, policy, and trading that you won't want to miss.

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Transcript

Speaker 1: 0:08

My name is Michael Guy at Publisher of the Lead Laggaport. I'm here for the Rough Hour at Ira Jersey. Ira, you've been around for a while, man. I've been seeing you on Bloomberg for a number of years. But introduce yourself to the audience. Who are you? What's your background, what have you done throughout your career and what are you doing, carly?

Speaker 2: 0:22

So I'm Ira Jersey.

Speaker 2: 0:23

I started my career in finance in 1995 after receiving my master's degree in international relations from a school in the UK, the University of Birmingham, became an Aston Villa supporter in the Premier League when I was over there back in the early 90s.

Speaker 2: 0:37

I first worked at Vanguard and then moved up to New York, worked for a number of different banks, including CIBC, world Markets, morgan Stanley, dean-witter. It's been a bulk of my career with Credit Suisse, ap, and while I was there I started as a credit strategist in the fixed income markets and then worked my way in 2007. So I turned in the credit cycle, decided to move over to the rates area, where I covered Fannie Mae and Freddie Mac in, starting in the summer of 2007. So you can imagine what it was like being in the research side looking at Fannie and Freddie at the time, at the beginning of the global financial crisis. I then went to Oppenheimer Funds where I worked for the taxable fixed income group over there, and then, most recently, I've been working at Bloomberg Intelligence, as right now I'm the team leader for the global rates area and I'm the chief US interest rate strategist. Call it 28 years in the industry and about 25 years in fixed income research.

Speaker 1: 1:33

Do it 28 years in the industry. Would you say that we're in an era where monetary policy is perhaps more unpredictable than it used to be in the past, despite the levels of communication that Powell and other Fed governors put out there.

Speaker 2: 1:48

So I think there's been times and periods during my career when we've been uncertain about the direction of monetary policy. I remember very early in my career in I want to say 1994, like when I had just started I was actually still in grad school, working trading currencies as a part-time gig while I was finishing my graduate work, and we weren't sure hey, is the Fed going to hide 25, 50, 75, 100 basis points and then is that going to be their last one, or are they going to keep going Right? And so I don't think it's unusual for the markets and for ourselves to have this much uncertainty. I think we got complacent when we had the part of the end of the green span era right, when we had the we're going to, when they were rising rates 25 base points every single meeting right and we knew they were going to do that. They highlighted it.

Speaker 2: 2:33

The only question that we had to ask ourselves back then was when are they going to stop? It wasn't so. It was incredibly predictable. But at these tops and bottoms, I think it's always there's always a lot of uncertainty until it gets going. And then, once you get that policy momentum on its trajectory, then it becomes a lot more certain and then so the question that we're having now with when it's going to start. I think it's interesting, I think, that the markets are focused so much on what we're going to start instead of where are we going to end? Right, because presumably the next move by the set is going to be a cut whenever that happens. But are they going to cut to 3.5%, 3%, 2.5%? I think that's a much more relevant question to be asking for both the rates market and indeed risk assets as well, because obviously the farther they're going to cut is also determined in part by how bad the economy gets and how low inflation goes.

Speaker 1: 3:26

Could you argue that what the Treasury and what Powell did had the effect of cutting November, december and maybe over-demulating? You look at credit spreads entering November of last year they were starting to widen out a little bit and then they just got crushed right. They just, you went essentially back to cycle loads, from what I've seen, and that was just done with words and yelling on doing some things as far as the Treasury goes. But is it fair to say that maybe Powell miscalculated how aggressively the market would be what they did November December at being dovish?

Speaker 2: 4:00

Yeah, I think that there's been a communications issue that the Fed's been having, and it's like they don't want to get too dovish, but they also don't want to say that, hey, we're never, ever cutting rates, right, and so they're towing this fine line.

Speaker 2: 4:13

And the problem is that communicating that is incredibly difficult. There's a difference like. My job is to try to determine what the Fed's going to do and then how that's going to affect markets once they do it. And then but on the other side, I get asked these questions all the time is what should they be doing and what should they have done? Or what should they do right, which is different? Right, because that's putting myself in the actual shoes of a policymaker, which is a somewhat different animal, because what I would do might be different than what they do. But I think the issue with the communications policy right now is that they want to keep optionality, but they also need to give the market some directional advice and the problem with that is that if they say, hey, we're not going to, it's not yet time for us to be cutting interest rates, which they've been pretty consistent in saying but as soon as they say, here is the situation in which we're going to cut interest rates because we need to cut interest rates before the CPI or the PC numbers reach our target, because otherwise we're going to be too late. Then the market has to interpret all of the incoming data and say, oh, the Fed's going to be behind the curve or in front of the curve, or they're going to not be able to cut till June because that's when we'll see the data there. So they almost gave too much information in a way right, where the market can almost interpret it. However the market is feeling on that day or when that piece of data comes out. But at some level I do agree that the market certainly took Powell as being dovish in December and they certainly had to walk that back just a little bit in the most recent meeting.

Speaker 2: 5:47

We have a Fed meeting coming up in less than two weeks and I suspect that at that meeting there's going to be a shift in the dot plot. Right? People are trying to tell us not to use the dot plot. Well, if you're telling us not to use it, why don't you just get rid of it? Otherwise we have to use it because it exists.

Speaker 2: 6:03

But I think you'll get a different dispersion of the dots this time right, because I think there's going to be some more members who are thinking that, hey, we can just stay on hold for much longer than we were thinking earlier. We've already heard a couple of speeches in that regard and then a couple of members who are going to continue to think that they're going to cut interest rates three or four times this year. You might have the median dot and bup a little bit where state is saying with the three cuts. Then the question is, will the market believe them or not? And I suspect the market's still whirled, but the economy is running pretty decently. So we have these big disconnects between what the Fed, being as data dependent as they are, means that they themselves have been wishy-washy and probably will continue to be, because they're just going to be following the incoming data as well. Based on every six weeks they're going to have to reevaluate what their stance is, and that creates volatility, that creates uncertainty for sure.

Speaker 1: 6:54

I find this to be fascinating just the idea that there's so much of a deficiency bias in the way they're looking at data that that's affecting their decision making. If you're that data dependent, it seems to me that you're missing the point that there are lags with the data and the Fed should actually ask. I don't recall in monetary policy history the Fed being that short term in terms of what they're looking.

Speaker 2: 7:14

Yeah, that's probably true. They're much shorter term now, but I think one of the reasons for that is that they're worried about making a mistake. So they're worried about me. They're trying to tow this incredibly fine line instead of saying, look, we're looking at five years of history and they have to now say, hey, we're going to start cutting because before we reach 2%, because we have to, because otherwise we'll overshoot, because the economy will be even worse if we don't start cutting early, given how much in tightened policy and the like.

Speaker 2: 7:45

And, quite frankly, I would argue that you could go back to the fact that they're trying to target directly that 2% figure instead of having some kind of average inflation targeting. And you can go back to some of the recent speeches by some members of the Fed, including Powell himself, when talking about 2% being a hard target as opposed to some kind of averaging. Because the problem is that having that 2% target means that the markets, meaning the household sector as well as the financial market, are focused on. Hey, the Fed wants to get back to 2%, like just squarely at 2%, instead of suggesting that, hey, we were at 1.7% on the piecing deflator for seven years, it's OK if we're at 2.3% for a couple of years, even though we had that very high print for about a year. That means that we'll have that 2% average over a decade.

Speaker 2: 8:38

So I think they've lost some flexibility in how they can set policy. So they have to explain. We know what they're going to be doing in a less clear manner just because they are trying to live within the real world while having this very distinct policy framework, which is, by definition, unachievable. They're never going to reach 2% of inflation every single month, right? So more than a couple of months in a row?

Speaker 1: 9:01

I put out a post which is I have a flare for the dramatic on X. I basically said the Fed need the credit event to get to the, to finish that last mile, to get to the 2% right, that they need some kind of something that's maybe exogenous. They're going to force a mini period of disinflation or deflation. That is outside of monetary policy. And others who, I think, have argued that it's going to be hard for the Fed to go from where the inflation number is now to 2% anyway, especially with credit spread tight regardless. Is there any truth to that that we're at this point where it's harder to get to that target with just monetary policy alone?

Speaker 2: 10:08

Well, I do, and there's a couple of reasons for that, and one is that there are large portions of the economy today that are just not age or straight sensitive, especially when you have wages continue to grow at 4% in many sectors. In particular, you look at a lot of the services sectors and you have inflation that's seeded where you do have a wage price spiral in some portions of the services sector. When you see wages growing at 4%, you're going to have to raise your prices in order to keep up, keep your net, your profitability, at a stable rate. So you're going to have to continue to see a little bit of price increases just about everywhere, just because of the structure of the economy and a lot of those services sector is just not interest rate sensitive the interest rate sensitive sector. So we've already seen significant shifts. Yes, housing prices are still growing up a little bit because there's not a lot of supply and there's a lot of structural reasons for that, but just the fact that these long and variable lags are much, much longer now and they've been getting longer. We made this point look, I made this point when I was at Credit Suisse back in 2005,.

Speaker 2: 11:10

When you just look at the structure of the corporate debt market. For example, when you go back to those 1990s, you had 25, 30% of corporate leverage was in commercial paper, so very short-term interest rates. And then when interest rates went down to 1%, it's been the early 2000s, late 1990s, early 2000s, when the Fed cut after the dot-com bus, just about everyone turned out their debt significantly, and now short-term financing is a significantly smaller part of corporate America. And what that means, when you have those shorter and shorter or less and less short-term debt, that just means that the market and the economy is going to be less interest rate sensitive.

Speaker 2: 11:47

And then, if you look at a place like Canada or England, for example, they have significantly more floating rate debt, even in their mortgage market, so they have resets that are much more frequent. They have a lot more loans that are based on floating rate instruments and because of those things, their economy is sent to react a bit faster than ours to move some interest. There are good things and bad things about that. I think one of the good things is that we could have much longer and not necessarily as dramatic booms and busts when it comes to shifts in monetary policy, but it does mean that in a situation like we have now. You can raise interest rates 500 basis points and it's going to take the market and the financial market and the economy in general more than two years to basically have those interest rates take full effect. It's going to take five, six, seven years potentially for those interest rate increases to take full effect.

Speaker 1: 12:39

I know it's not exactly analogous, but I would assume that, because that's an ever-increasing trend of the way debt happens, with more and more credit card usage, that the makeup of the floating rate dynamic increases over time. Just because more and more consumers are not using cash and I'm just putting on buy and out pay later on credit cards, at one point does that become a dynamic that maybe makes the legs shorter, because at some point behavioral changes, as people realize. Hey, my minimum payments are going up and my interest rate now is 30%.

Speaker 2: 13:08

Well, I think if you're overlevered, you're overlevered regardless of what the actual rate of payment is. And something like credit cards is an interesting example, because what is your propensity to spend when interest rates are 22% versus 26%? It's probably not significantly different If you're already paying a 22% rate. Going up to 26% doesn't necessarily make your payment massively bigger versus what it was going to be before. But, that being said, as you spend more, as credit card balances go up and up and then the payments go up, then it is then a drag on consumer spending and the growth of consumer spending, and that can't go on indefinitely. There is a distributional issue here where we don't know and we can guesstimate, but we can't actually know with certainty if the household sector is only spending on credit cards, and we know that that's not true. And one of the reasons I know it's not true is because we do look at a lot of the quarterly data that is presented by the Federal Reserve, by a number of the banks, and what we can see is that debt as a portion of consumer spending has actually been falling. So, even though credit card balances are going up significantly, it's actually there's other means of income that is helping increase, or I should say, cash in people's bank accounts that's being used for consumption.

Speaker 2: 14:30

The big one that's increasing and this goes to be something we haven't talked about yet and goes directly into my world and that's that, even though households are borrowing money, the government's borrowing money to give money to the household sector.

Speaker 2: 14:44

So there's government transfers. When you look at the monthly personal income numbers and you look at where that money is coming from, yes, wages are growing at 4%-ish more or less, depending on the month, but a lot of the big increases is coming from government transfers, and a lot of those government transfers are from programs like Medicare or Medicaid, so security as well as other income generating programs. So, though, recently, the last six months or so, you've actually seen a significant down tick and unemployment benefits coming from income as a portion of income. So I think that it's a who's borrowing is a big question, and the fact that the government continues to basically be propping up household income that's available, it's probably not sustainable either. It's sustainable for a little while, but it won't be something that can go on forever, and I suspect that if there are members of Congress, for example, that claim that they're going to be fiscally responsible, then certainly some of those growth in some of those programs will need to be capped in order to reduce deficits.

Speaker 1: 15:48

I don't know if there's any way to actually calculate this, but is there a sense of how much those government transfers have delayed the long and variable lags, or at least the tail end of that idea? And I know that the wishy-washy sort of question, right, but do you mean that it must have delayed the delay?

Speaker 2: 16:03

Yes.

Speaker 1: 16:04

No.

Speaker 2: 16:05

I 100% concur with that sentiment and I don't think there's any way there is absolutely no way to determine exactly how much debt delay is right. Has it delayed the Fed from needing to cut by six months, by a year? It's hard to know. But when we look at the entire economy, one of the questions we do ask ourselves is how long does this fiscal impulse last and when does it start to decline? And once it starts to decline, I think that's when you start to see growth start to roll over much more significantly than we have. And keep in mind growth rolling over doesn't necessarily mean we have a recession. It's very possible we never have a recession. That would not shock me one iota. But you can have this very long slow growth period that feels much like a recession but just isn't. And I suspect that that's something that's going on throughout the country. And you look at some of the consumer sentiment numbers and the different people that feel like where the economy is bad versus the economy is good, and a lot of that has to do with what political party you're in or what income bracket you're in and the like. But I do agree that the fact that there is this continued fiscal impulse when growth is already strong is it's in it.

Speaker 2: 17:20

Government has tended to be reasonably Keynesian, basically since Ronald Reagan, right, or is after Ronald Reagan, basically Bush, clinton, bush 2 and Obama were basically Keynesians. And the Keynes model just the base model says when the economy is good, you're not supposed to be spending a whole lot of money from the government sector, that G in the GDP number should basically be very low, whereas during a recession it should be very high to make up for C. The consumption are going down and we haven't done that right and that's one reason why I think we did have. I think what did contribute to a lot of inflation that we saw in 2021 and 2022 was the fact that we had a massive fiscal stimulus in early 2021 where the household sector was basically given money for free. That was funded by the Federal Reserve and I'm not saying that what and the Federal Reserve did quantitative easing, I think, a bit too longer than they should have, right, and we were critical of them back then for not slowing down quantitative easing. So all of those things I think went into the strength of inflation then and the fact that we still have this $2 trillion deficit period that we're going to have for at least the next few years is certainly going to prop up personal consumption for at least that period of time.

Speaker 2: 18:34

And what makes it go down is has to be that companies start laying off people. They start to have crimped profitability where they try to get a decision, where they have to cut costs in order to maintain profits and even if they don't have any deterioration in top line growth right, top line growth can remain constant. But if their bottom line growth starts to shrink, that's when you start to see the normal cyclical dynamics occur where people start to get laid off. Once people start to get laid off, everyone else is worried about them getting laid off. They start to save more, they start to spend less, and then that's when the economy starts to contract a little bit and we're just, we're not there right now. Could we get there in six months or a year or maybe, but I think it's probably a year or longer before we have that kind of situation.

Speaker 1: 19:16

So play it a thought experiment kind of very long term. So you got to have layoffs One of the narratives around AI going to cause math layoffs across every industry. At some point over time You'll start to see that that's disinflationary. But if you dig that to the logical conclusion, if AI starts replacing people and people can't find new skills, get new jobs, if those AI then replaces those, well then you're going to have universal basic income and the government transfers just keep on increasing. You have the different place share effects of AI against the government transfers. Try to counter it. It seems like we're in this kind of multi year environment where it's going to be really hard to have high conviction either way on inflation being elevated or closer to the disinflation side.

Speaker 2: 19:56

Yeah, I guess there's so many different scenarios of how AI plays out. It's hard to it's hard to know, but there's always been disruptions in the way that people have done business. You go back and I joke around with this One thing that the internet allowed us to do and some computer programs in general, the fact that you have Microsoft Outlook and you can keep your calendar in there. We got rid of administrative assistance and they were like the low hanging fruit. There's not a lot of people in office jobs that have administrative assistance anymore, who aren't in the C-Squad, so it's not obvious to me that people won't be able to have those, that AI will just completely replace people. Yes, there'll need to be some retraining. You also have to train the AIs, right? You have to have someone still think for the AI, right? The AI might be intelligent, but it's not necessarily creative, at least not in its current form, and certainly the way that I think about it and the way that I've been using it. It's more of a tool, or like a new, pretty interesting tool, rather than being able to replace us doing our actual jobs, and it's a shift in the way that we work. It's not completely different from the Industrial Revolution either right and having creative destruction is, in the long term, generally good for economies, or it allows us to have more leisure time. It allows us to do other things, just from an economics perspective. You think about today's world and people want experiences. That's one reason why the service sector has been doing so well is just because people want want to get out and do things, as opposed to. Yes, we always joke around like my kids sit at home a lot, but my kids also want to go out and go do new things. Right, and they, and Having having a 30 hour work week instead of a 40 hour work week could change the whole dynamic of the way that the economy Works and if national income stay the same and your national income for for our, can actually go up, even if national income in total is the same, and that's not necessarily a bad thing, right, it's like I go back to Japan a lot. So I used to when I was at Credit Suisse. I used to visit Japan all the time and I would be talking to clients. I would be talking to people just in the office and they would tell us this narrative that hey, you Americans you fun saying that we have deflation and things must be really bad over here, but we don't see, fine, like I've gotten a pay raise in two years, but it doesn't matter because prices are going down, so what do I care? Right, like, really, incomes are going up. I'm not saying that AI was allowed that to happen, but but that is a potential outcome, right of one potential outcome is we actually have some Disinflation in some sectors and then, having that distance you can have if wages start to fall because of AI, then Real incomes can stay constant and be okay as long as their basic needs are met.

Speaker 2: 22:31

Most people aren't completely unhappy. We just we're, we're Americans. We want everything to grow. We want everything to grow, and I do too, right, I'm also involved in a small business on the side, right, that's what I do at night and in. I want that to grow. I want people to be our customers. But but is it a big deal if my costs go down and I can keep my prices the same? That's, that's fine, right? That means my profitability goes up and and my real income goes up and and I'm okay with that, and I think most people. It's not the way we think, right? So it takes a change in psychology and I think I take a generation or two to start thinking that way, but I think that's completely possible.

Speaker 2: 23:06

And to your point on Government intervention and the government paying more, at the end of the day, that's a policy choice that the American, quite frankly, americans are gonna make in November, right? Do we do we want to have more of that or do we want to have less? And do we have candidates that are Going to do one thing or the other with any kind of certainty, or they? Is everyone just lying, and doesn't their American politicians? So I guess that's far for the course these days, but is everyone being really disingenuous about what policy actions they they really want to take in order to propel the economy and help Help the consumer? Have my own opinions about these things. I sometimes think we respect too much of the government and we should just like more of ourselves. But so again, maybe that's my own idealistic.

Speaker 1: 23:45

No, no, amen to that. Amen to that I'm willing. That's a discussion for all another. So big you guys out of market. That's in our inner, in our soul, as a society. Let's transition to Treasury supply because you had these failed auctions that meet a lot of headlines. Nobody ever cared about treasury auctions until Some of these yield spikes start taking place and there was a lot of talk towards the end of last year. I haven't seen much of the around this idea that the in quotes basis trade was causing disruptions Around treasuries and around auctions. I think there was some investigation or something around that. You correct me wrong, but I have the the sort of scheduling of supply. Look, do you suspect there's going to be some of those dynamics that we saw towards the end of last year happening still this year, where the doctors are terrible?

Speaker 2: 24:31

Yeah, so it's been. The auction dynamics have been have been interesting and and we always joke around we looked at every single auction. Since I started here. I one of the things that we did was do a little auction recapped, like right after the, the auctions come out and and auctions no one cares about treasury auctions until they, until they do, until they matter, and the last year or so they really started to matter in terms of pricing because of what you've said.

Speaker 2: 24:53

Where Is there a demand at these auctions for? For the, for all of this government debt that's coming out. So first you asked about let's just talk about generally what's what's been going on. So the treasury department is going to keep on issuing treasury coupons for another month. They're going to, but by the end of April, when you get to the May refunding announcement, they're likely to maintain the current level of gross gross coupon issuance because the just With when deficits come in and then when what the maturity schedule looks like, they won't have to raise them again, probably until 2025. So you'll have basically nine months or so of of auctions at this relatively well, very high level, right? So some of the auctions are at records, some are a little bit below records. But but basically we're at auction levels more or less back to where we were in 2020, when the government was issuing a whole whole bunch of bonds to stimulate the economy after covid.

Speaker 2: 25:46

So I do think that we will have, at different periods, buyer strikes where you won't have particularly good auctions. We're never going to have a failed auction in the us, like we had in Germany and the like, just because the way that the dealer network is set up, we'll always have enough supply. But that doesn't mean that the dealer backbids won't be five or ten basis points above where the market is at the moment that the auction closes. So that's completely possible. That's what we call auction tails when the, when, the, when the rate that the auction comes at is higher than what the market's expecting, at at one o'clock or one thirty, whenever the, whenever the actual auction closes.

Speaker 2: 26:21

So we I think we'll continue to see some tails, particularly given the signs, I think, when you have sell-offs like a day like today. We have a three year auction at in about 20 28 minutes from right now, as we're speaking, that auction will probably be that. There's two ways that that some investors look at it a we're four basis points higher on the day, that means that's bound to cheap, or you could say well, I really don't want to get in front of this falling nice, so I'm going to stay away. And we've really been more in line with that second one, where the market sentiment on the day and what's been going on with the market on the day has Been much, a much better indicator of whether or not the auction gone Well or not. So in a day like today, you'd have to guess that that the auction might not go particularly well Just because recently and the last three or four months, on days when going into the auction, the market's been selling off you.

Speaker 2: 27:12

You tend to have Bad auctions and I think that that will happen more and more, especially as sizes are. So you brought up the basis trade as well. Yes, there, there has been some discussion about the basis trade, certainly. Well, the different market regulators have been looking into the basis trade and I think that I think a lot of the risk that people are Are worried about with the basis trade or I don't think it's as big of a deal as most people think for one thing, oh sorry, just for the audience.

Speaker 1: 27:38

Explain, explain what the basis trade is, the mechanics right.

Speaker 2: 27:40

So what a basis trade is is that people will say that they'll go out and buy a treasury, treasury security, on margin, basically with repo right. So it's not margin like equity margin, it's. You can actually lever that trades more or less 50 to 1, depending on what the haircut is. Sometimes it's 30 to 1, sometimes it's 50 to 1, but let's say it's 50 to 1 just to make the math easy. And then on the other side of that you, you then sell treasury futures and then you basically make the difference in between what the treasury future is implying is the repo rate and what the actual repo rate is, and that's effectively what. So, as well, we call it the basis trade, but it's technically the repo basis is is the the formal name of it. So if you go back to the 1980s and 90s, they're. These were also reasonably big trades back in those days because they're essentially Market neutral. Because if you look, if you're buying a treasury loan, you're selling a future against it. You're not taking the whole lot of interest rate risk. And the risk that you're taking is this half a basis point, one basis point, two basis points difference between the implied repo rates and what. What? What happens is that because they're riskless on a lot of different risk models, they tend to be very large right, so they can get very, very large.

Speaker 2: 28:46

I think the big risk with the basis trade and the fear, though, that Some regulators the Federal Reserve, treasury Department have is that that it sucks up a lot of the leverage that can be used elsewhere in the market. So there's only a finite amount of financing that you have for treasury trades, and if, if, a significant portion of that is being used in basis trades and that just makes other trades more volatile because you don't have the financing available for everyday Plumbing of the of the financial market and I think that that's a little bit of the the bigger, the bigger issues. Is it a systemic issue? I wouldn't argue that it's absolutely systemic. If the basis trade blows up, you're going to get volatility for more than one day.

Speaker 2: 29:30

But it's I and I don't know why it would blow up. Like the only reason it would really blow up is if there was some Some change in how much financing activity someone can do. But again, like it would be the kind of thing where treasury futures sell off a point and Treasuries themselves only sell off half a point. Right, that's that. That's the kind of trade that you get, where we'd have a dislocation between those two instruments. Just looking at the Bloomberg screen for on the run treasury securities, you barely notice that anything was really going.

Speaker 1: 30:01

At what point are we going to see some tails on corporate credit? I keep going back to this point. I don't think anybody had on their bingo card that all the fastest rate high cycle on the credit threads would be basically a cycle lobes at this point and I've been waiting it's because of me for some widening, some volatility fear, and you haven't seen any default risk getting rewrites, at least not yet. What's going to take for that side? Sorry, I have some tails.

Speaker 2: 30:23

Yeah, thanks. So actually, if you want to follow me for financials, it's IRAFJersey on X. If you follow IRAJersey you'll get a lot of my soccer stuff. It's not financial. So corporate credit it's just where spreads are very tight. At some point you're probably going to get a bit of a pullback, but probably not until you start to see corporate profitability start to roll over Again, because a lot of corporations are not really net leverage is not going to up a whole heck of a lot in the investment grade space and there's a lot of demand. Right, there's still a lot of demand for corporate credit. When you're talking about a 5% handle on total coupons, it fits a lot of benchmarks and a lot of bogies. So when you think about insurance companies, for example, and what book yield they need to bring in in order to fulfill their mandates or certain annuity, these and pension plans and 5% fits them really well. So as long as you have corporate bonds that you can buy close to 5%, you're probably going to continue to, or even north of 5%. How are we still going to see decent demand?

Speaker 2: 31:30

Ironically, when we actually saw some of the weakness in spread product, it was when treasuries were selling off and treasuries became an alternative to corporate credit. So you go back to last September, october, and when you had treasuries of 5%, people could say oh look, I can reach my 5% benchmark by buying a treasury strip, which is a zero coupon treasury, or I can just buy a 5% 30-year treasury instead of buying a corporate. And then, lo and behold, corporate spreads wide at 15, 20 basis points during that period of time because there was an alternative asset that those managers could buy. So I think as long as we stay north of 4% in terms of 10 and 30 years, then corporate spreads would probably be pretty well. I think that the more interesting thing will be what happens if we do rally. What if the Fed Reserve does cut interest rates later this year? 10-year treasuries say get to 3.5% or something. Then do you see people try to avoid credit because they'll think that there's going to be a credit cycle, or do people even pile into it more? Do you even get significantly tighter spreads because people are worried that this basically fear of missing out. They really want to get into this market now because otherwise I'm going to miss out on these higher coupons.

Speaker 2: 32:48

I remember a time I was a credit share, just when there was no credit spread right when you had spreads of like 8 basis points on the corporate index. We didn't think there was any value in corporates back then. But at the same time we were also saying and I think that that might be something true now is that? Yeah, but what spreads can stay here for the next two, three years?

Speaker 2: 33:10

Because unless you get a significant uptick in corporate defaults and much more volatility in earnings and then just the rate market in general, there's no reason to think that you have to get significantly wider credit spreads, and I suspect that that might be a period where we could be going into now. Of course, all that gets thrown out the window if we go into recession and there's companies that are getting downgraded left to right and things like that. But our base case probably has credit spread staying relatively tight at least to the end of this year and then beyond that. It really depends on how aggressive the Fed is in cutting and if they can avoid a recession. If you have a recession and you start to get top line and bottom line growth, both being bad, that's a scenario where you're going to get some pretty meaningful spread widening Sure.

Speaker 1: 33:58

You had sent me a DM saying a lot of people seem to gravitate towards these two models that you have the NLP Fed Sentment Model and the Silver Options Distribution Model and models are expected to start the conversation. Modeling predictability maybe becomes questionable in terms of not just education issues, like you mentioned before, but also the market. Then limitation of that Explained what the NLP Fed Sentment Model is on your land. Why are people asking about it?

Speaker 2: 34:27

So the Fed Sentiment Model is the use of AI, so we actually use a large language model. We went back to 1993 and we looked at all of the Fed Minutes from 1993 to present. We scored every single sentence within the relevant part of the minutes to try to determine whether or not the Fed Reserve was getting more hawkish or more dovish. Were there more hawker sentences, were there more dovish sentences and the like. And then we created then a score, an indicator, to determine what was it more hawkish or dovish? And then, once we did that, we iterated it and went from there to the opening remarks that the chair started to make in 2011. I remember I was on CNBC the very first time that Bernanke talked on did his post-mitting press conference. That was a fun time. So we then look at that because that's obviously more real-time data, whereas the minutes you get after you get a couple of weeks after you get the actual meeting. So therefore, we have a more or less real-time indicator now of whether or not the Fed model is actually showing whether or not they were more hawkish or dovish. And sometimes the near test doesn't seem that way. Sometimes the near test might say, oh, he sounded pretty hawkish to me he sounded pretty like they were going to raise interest rates. And then you look at the model and it actually showed that. Well, actually they were more neutral or maybe even a little more dovish than they were at the time before, because we score every single sentence.

Speaker 2: 35:53

So these are interesting models, not so much because you can trade on them directly, but because they give you a less, much more objective view of what was actually said. Instead of being subjective, do you miss sometimes nuance and intonation and the like. Yes, you do miss some of that. But another advantage of it too is that, look, there's multiple Fed shares that have done press conferences now and each will have a different tone of voice and a different intonation. So by just looking at what they say and the actual words, I think you take out some of the subjectivity to it. You might miss a little tiny bit of nuance, but I suspect that it's been a very good indicator of is the Fed ready to cut or hike right now? And the changes in it have been pretty substantial.

Speaker 1: 37:11

How was that? In November, december, was there a big difference between the way people heard it and then what the AI said was with the actual intended message?

Speaker 2: 37:18

Yeah. So people in December heard from the opening statement I think people heard Sherpao as being pretty dovish and when you look at what our model said, our model said, yeah, he got a little bit more dovish, but not much more dovish. Now our model also suggested that he was already. They were already very little bit dovish, but still in the neutral territory. So what happens is with our model is basically, if it's in between a certain range like negative three to positive three, it means that the Fed's on hold and there's little tiny blips up and down from in there. And that's where we've been actually since they started to the last hike.

Speaker 2: 37:55

So they got to neutral territory in June, june 15th, under our opening statement sentiment indicator and then since then they have been mostly neutral. They got a little tiny bit hawkish in January but they're still very much in neutral territory. So they're not ready to cut quite yet and I think that that's important because I suspect that we will see at least one meeting before they cut out much more dovish sentiment from this indicator. It would be very surprising if they cut without seeing that unless something breaks right Like obviously if you have a systemically important bank or something that looks like it's going to go under and then they're cut to just save the financial world. But I think that's very unlikely given the Basel III rules basically will not make that chance zero but make that chance exceptionally well.

Speaker 1: 38:45

I can't wait for the day when the Fed then uses AI to try to prevent your AI from determining what's being said, hey would not surprise me if that's happening or not. Yeah, I assume. So right, you got to assume that there's nothing terribly unique on it, meaning not in terms of your model, but in terms of what the Fed then responds to models like that. What about the silver option distribution model? Silver is a big deal. Not many people understand what silver is. Maybe level set a little bit on that first.

Speaker 2: 39:10

Yeah, so so far is secured overnight financing rate? It's. It's a rate based on, on repo. Not only it is the replacement of live or, which was the, the malaligned interest rate of choice from the midnight Canadians until until it went away just a couple of years ago. So so far is now what what the rate market uses for short-term interest rate moves, hedging trading and Options on so for futures are among the most liquid in the financial world. So when people want to make directional bets or they want to hedge some some kind of risk, they will often use options on so for. So the secured overnight financing rate options, or SFR, is the is the ticker.

Speaker 2: 39:51

If you, if you have a Bloomberg terminal, you do SFRA, commodity Ct and you'll see the whole contract table of the the spot so for futures, and then on that there's an options on those which are, like I said, are very liquid. A lot of people use them in Size in order, in order to hedge, and our our model there is that's something a little bit different. That's a risk-neutral distribution model where we look at what is being priced in terms of what is being priced in terms of the, the whole distribution of rate outcomes. So a lot of people just look at Fed funds, futures. So they'll look at so for futures and say, oh, the market's pricing for 80% chance of a of a cut in June, right, or something like that. But then you, if you look at the options market, what I'll tell you is okay, yes, there's an 80% chance of a cut in June, but the thing is there's also like a 10% chance of a height, right. So there's an entire probability distribution based around that, where those Individual, what we call what I call linear instruments will give you basically the weighted average of all of the potential outcomes. And Something important that the, that the model has shown and what, what is being priced into the options market right now is there was when we went back, go back to January, there was a zero chance being priced in that there would be any kind of interest rate hikes this year.

Speaker 2: 41:11

Now we're priced for about a 10% chance of interest rate hikes by the end of the year. So there are some people tail hedging. There are some people who were saying, oh, maybe the economy is gonna run so hot that the Fed, actually the next move may be another interest rate increase instead of instead of a cut. Again, it's a minority of people, it's not a big chance. But just the fact you have some people, some people hedging that that risk I think is is telling it important, because as long as there's people pricing for the chance of a hike, the the chance of six interest rate cuts seems probably much, much lower now. Once that, if that shifts, then Then I suspect that the market will be seeing something much more dovish from the set any, any insights on how other central banks might maybe throw Monkey wrenches in terms of what the Fed does.

Speaker 1: 41:53

Next up, japan is the more obvious kind of short-term possible catalyst. I keep going back. I happen to think there's a risk of reverse carry tree that could spark broader volatility. But you know how well, how isolated, if at all, is the Fed to other central bank actions at the point of cycle.

Speaker 2: 42:08

Yes. So I would argue that it's the other way around, that Japan is the one that's kind of isolated and taking a different path. We actually talked about this in our global rates outlook for this year, where, where we thought that Japan was generally about 18 months or so behind the rest of the world and that they'll Potentially see not well, they already have non-negative interest rates on their government curve, but they could actually see policy rates that might be positive later this year. For the first time in decades. I think the US and Europe are probably going to be much more closely aligned in their large markets. They they, financially speaking, any way there there are someone interconnected that they're both countries that are very, very susceptible to shocks and of energy prices with with oil trading at $78 a barrel, that's fine. They're probably not gonna not gonna change path any, but but certainly Europe, europe and the US are gonna Probably be more closely aligned than Japan will be to anyone else. Do we will?

Speaker 2: 43:03

Will Fed policy change because of them? Probably not the US still, for all of the talk about all of the imported goods and the like that we have is we still are a very domestic based economy. Right, services, by definition, are mostly domestically based and that that is has is and has been the driver of Economic resilience over the last couple of years, as well as what's been driving inflation right. So unless, unless that were to change significantly, I don't necessarily see Fed policy changing because B happens to cut before us or Japan happens to raise rates in the near future. Wouldn't be surprising. Now, said, all of Japan raised rates of not a lot, but a couple of times this year. And remember, they move in much smaller increments. Right, they move in 10 basis point increments, we move in 25. So when I say, when I say that they might hike twice you're talking about, you're not 30, watch 50 base points You're doing about 20 today.

Speaker 1: 43:54

You had mentioned your handle for the soccer enthusiasts and then your handle for your more Budgsmiles as well. Can people find some of your work?

Speaker 2: 44:01

Yes, on the Bloomberg terminal FBI rate, and that's bi space RATN. You can also you can follow me on LinkedIn as well post the same stuff there as I do on X, except with a little more detail Thanks to the character count shoots on LinkedIn for sure. And we do have. We do have a podcast called the thick focus podcast, which encourage you to listen to that. We, we have our professionals here at Bloomberg intelligence, which is the research arm of Bloomberg. We, we give our views as well as bring in outside guests, so customers of ours, both investors as well as as well as sell side Traders in the lake. So I just recently add on Greg for a nello from a Maribeth securities. He he's a rich trader, so he was talking about his view of the market, what kind of flows able seeing, and then we also talk about just our views as well. So sometimes I'll just come on and ask myself questions and give everyone the highlights of how we're doing. Shift it over the prior couple.

Speaker 1: 44:53

Everybody. Please make sure you check out. I was great work and analysis. I have another space that bleeds Thursday, so stay tuned for that and hopefully I'll see you all then thank you, I appreciate it.

Speaker 2: 45:02

Hey, great to be here, michael, thanks for having me on cheers everybody.