Transcript
Speaker: Welcome to the Macro Brief from HSBC Global Investment Research, our weekly look at the issues driving financial markets across the world. I'm your host, Aline Van Dyne, coming to you from our New York studio.
Speaker: Today we're asking whether US rates are close to a turning point. We're talking about both policy rates, so the interest rates set by the central bank, and bond yields. Both, of course, are crucial to determining how much it costs for people and companies to borrow in the US and globally.
Speaker: And uncertainty has increased in recent weeks. Markets think the Federal Reserve will hike this year, but they're not sure. At the same time, Treasury yields are on the rise as markets weigh a mix of sticky inflation, resilient US growth, firmer energy prices and, of course, a heavy fiscal backdrop.
Speaker: So what to make of it all? I'm delighted to welcome two experts on rates of all shapes and sizes into the studio. Ryan Wang, our U.S. economist. Great to be here, Aline. And Deiraj Narula, our U.S. rate strategist. Good morning.
Speaker: Ryan, let's start with the Fed. At the end of July, Kevin Walsh presided over his second FOMC meeting as chair. What's he signalling about the future of interest rates?
Speaker: Yeah, well, I think you very much summed it up quite well, Dean. There's significant uncertainty. Thank you, Ryan. about whether we might need to see higher rates this year to bring inflation lower. Now, remember that the Fed did deliver rate cuts in each of the past two years, 100 base points of rate cuts in 2024, then 75 base points ah last year. So in a way, if we do get rate hikes this year, you could view it as just reversing some of those rate cuts. But anyway, the primary reason is just five years and counting of above target inflation. And more importantly than that, that inflation has moved higher this year relative to late.
Speaker: Now, in terms of the messaging, Chair Walsh has made clear he's not a fan of afford guidance. So where does that leave us? Is there a vacuum that's being filled with market speculation or or is there guidance? where are we?
Speaker: Well, I think the Fed is very much trying to analyze the drivers of inflation as ah as markets are trying to do as well. And I think that's part of the complication. And you also mentioned some of these in the intro. We have the energy price shock, really, that's related to the conflict in the Middle East. Then you also still have tariffs that have been increased over the past 18 months. That's still feeding through to consumer prices. But then you have this entirely other different element. You could say on the demand side, which is very robust demand for AI-related products, which is also spilling over into consumer goods. Now, the Fed's supposed to control inflation no matter what, right? so But an interpretation and an analysis of these factors is important. The markets are trying to figure this out as well, and this is certainly where Deiraj's views come into play because market rates have already moved up even though the Fed has been on hold all of this year.
Speaker: So, Deiraj, over to you. Yeah, absolutely. So, it's not unusual for bond markets to lead the Fed in terms of pricing and Fed decisions before they happen. But I think one of the things that Chair Warsh has set out to do by his own ah by his own press conference is what he's told us is, as Ryan noted, kind of a reduction in forward guidance. So, we no longer want, from the Fed's perspective, they no longer want to be in environment where the bond market goes into every Fed meeting 100% aware of what the exact decision is going to be. And the rationale for kind of pulling back on that forward guidance is to preserve some policy flexibility. That said, there is a distinction between forward guidance, which is sort of signaling to the market what the actual policy decision is going to be, and a reaction function. So the bond market's understanding of how the Fed interprets incoming economic data and the evolution of the balance of risks. So is that part what's changed? Is that what's causing some of the uncertainty? Not so much the data and the usual interpretation of things, but just exactly how much is being signaled?
Speaker: Yes, so I would say it is a combination of both for sure, because one consequence of reduced forward guidance is that the bond market will then have some additional uncertainty being priced over the outcome of any individual Fed meeting.
Speaker: For example, in the July meeting that we had last week the bond market went in with about a 35% chance of a rate hike being priced. So naturally, the outcome of the decision is either hike or no hike. And when you're priced in between, the market will react one way or another. And so there is a little bit more volatility that you naturally get from not pricing in a decision fully.
Speaker: That said, when you have less of an idea about the overall reaction function and kind of how the Fed's even thinking about the data, there is more uncertainty over the overall trajectory of rates, the overall way in which policymakers are thinking about the economy. And that can have impacts on even longer term rates and the compensation that investors are demanding for having less of a picture of how policymakers see the economy. So let's get into that because short term rates, policy rates are stable, but longer term rates, especially 10 and 30 year US bond yields have been on the rise.
Speaker: Just tell us what's been happening. Yeah, absolutely. So there's a couple of narratives that have been associated with the rise in long-end bond yields. One of them, as I mentioned just now, is more uncertainty, both in terms of how policymakers are thinking about the economy, but of course, a lot of uncertainty just about the overall global macroeconomy in general does tend to lead to investors demanding more compensation for locking in those longer-term interest rates. So that's definitely one part of the story. But I think some parts of the narrative that have also developed in recent weeks is also just how much the market is remaining anchored to stable inflation expectations. Now, we've seen long-run inflation expectations be very, very well anchored, and they're still relatively well anchored. But I think
Speaker: a little bit more uncertainty and a little less clarity on the Fed's thought process, reaction function, makes investors want a little bit more compensation for that longer run inflation risk. And just give us the context. How much have yields shifted in the last year?
Speaker: Yeah, absolutely. So the long end of the curve, so the 30-year Treasury yield, which is very important for things like the stock market, for mortgage rates, etc., we're seeing those push past 5.2%. So those are levels we have not seen since the global financial crisis back in 2007, 2008. So it is very, very notable just how far we've come in terms of long-end rates, especially with the Fed not actually having hiked front-end rates at all so far.
Speaker: So Ryan, back to the Fed and its decision making, these higher longer term yields are presumably already affecting the economy, creating tighter financial conditions. How does that then lead back to the discussion around policy rates?
Speaker: Yeah, I think it definitely plays a role. and And it's been common for Federal Reserve policymakers for many, many years to pay attention to financial conditions. And of course, that can relate to longer term interest rates, but it can also relate to other factors such as the equity markets or the foreign exchange value of the dollar.
Speaker: But I think for the Fed, for the practical decision, do we raise rates in the second half of this year or not? It still, I think, comes down to the objective, which is to bring inflation lower and lower.
Speaker: That, in our mind, could end up being a very close call. We have core PCE inflation currently running at around 3.3%. It actually did take a small step down in June relative to May, but only by 0.1 percentage points. So that's that's not that's not much comfort. And, of course, 3.3% is well above the Fed's 2% target for PCE inflation.
Speaker: So if inflation even takes us a bit of a more upward movement in the second half of this year, I think that will put even more pressure on the Fed to act. ah But we have been forecasting since its the beginning of the year that the Fed will stay on hold in 2026 and into 2027. And if inflation really has peaked, even though if it takes a long time to get closer to 2%, then maybe the Fed can still adopt a wait-and-see approach and and not need to raise that policy rate.
Speaker: So let's take a quick break. We'll be back with more from Ryan and Deeraj in a moment, including what to expect at Jackson Hole.
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Speaker: Now back to today's episode.
Speaker: So before the break, we were talking about what's been going on in markets, what's been pricing in and whether or not there's a potential turning point in US rates. Let's delve into what to look out for. Ryan, there's quite a lot happening in August from the data perspective, but also Jackson Hole.
Speaker: Tell us why that matters and and what you're expecting. Yeah. So the simple way to put it is that the next f FOMC meeting will be in the middle of September and we will get some economic data before that time. We'll have two more CPI reports, inflation numbers, and we'll have two more jobs reports as well.
Speaker: And one set of each of those numbers will come before and after the Jackson Hole Economic Symposium, which occurs at the end of August. So if you think about that backdrop, and we have basically had it confirmed that Fed Chairman Kevin Warsh will ah speak at the Jackson Hole Symposium.
Speaker: ah But so far, Chairman Warsh has said he hasn't begun preparing for that speech. So it's not totally clear, and it may end up being a mix, whether it will talk about this very near-term question of rate hikes versus no rate hikes this year. Or ah Chairman Warsh also expressed ah some some intention to talk about possibly longer-term issues. This turns us to another topic where the the Fed has already commissioned five external task forces to look at topics like communications and the Fed balance sheet and data measurement, all these complicated issues that are very important to Fed policymaking. And so we may hear a combination of things from Chairman Walsh at the end of August.
Speaker: Yeah, and I think one a couple of the interesting bigger picture themes that we could hear about, both from Chairman Walsh, but also just from the broad swathe of academics and policymakers gathering in Jackson Hole, is kind of thoughts on some of those task force topics that Chair Walsh has brought to the Fed. In particular, I think two of the very interesting themes that we could hear more on is, number one, the broader implications of AI and technology on longer-run productivity, which certainly is an important thing for both monetary policy and where interest rates are priced both in the short term and in the long term. Chair Warsh has, in the past, both as chair and in ah and last year as well, talked about how AI in particular could, in the short run, of course,
Speaker: provide some upwards pressure on inflation through all of this spending, through all of this borrowing activity we're seeing from the hyperscalers. But in the longer run, there could be some disinflationary tailwinds from improved productivity. So that kind of thought process, how that impacts how policymakers are thinking, certainly very important. The other thing that I think will be particularly interesting, and Chair Warsh has alluded to it, is this idea of how the Fed wants to have its presence in the bond market be structured longer term. So the so-called Fed balance sheet question. And that certainly intersects with the thought process of Treasury Secretary Scott Bessent, certainly interacts with how the market anticipates what's the composition of treasuries that we'll eventually have to be absorbing in the future.
Speaker: Of course, Deiraj, you mentioned this. There has been a lot of discussion, there always is, about supply, the amount of Treasury supply. What are your expectations on that and and what are you looking out for on that front? Yeah, so two I would say two big themes on that, especially over just the past one week. So yesterday we had the Treasury's quarterly refunding announcement where they tell us their near-term supply projections and then also a little bit of forward guidance for what's to come. The Treasury held supply of what we called coupons, so anything maturing in more than a year, steady. And that's the 10th consecutive quarter they've held coupon supply steady. So essentially, we are not getting more supply of those 10-year, 30-year Treasury securities. And one of the big reasons that we think they've held this issuance steady is because of where long-dated Treasury yields already are and the prospect of even more supply coming into the market
Speaker: for a same level demand that could push down prices, push up yields, raise those borrowing costs. So there is a lot of incentive to hold off on that for now. And I think the second thing that has been particularly interesting is this idea of um what Treasury Secretary Scott Besson has talked about with respect to the potential sale of treasuries in foreign countries a currency intervention. We've seen that particularly in the case of Japan lately, where there was some discussion about avoiding the need to see lots of treasuries being sold into the market, which can push up rates, um and instead using alternative channels such as tapping into the Fed's balance sheet for near-term support.
Speaker: So as we look ahead beyond August into the last months of 2026, what is your kind of concluding thought in terms of whether we are kind of at a bit of a turning point in terms of U.S. rates?
Speaker: Yeah, well, it ah it remains very tough to tell. I think we are on the cusp, and that's because of what the inflation numbers are actually doing. And to the point that you made, Aline, we will have to look to see what happens in the next one or two months. Actually, the last month of inflation numbers that we saw in the United States were on the low side.
Speaker: And that raises some questions because on the one hand, it might signal some disinflationary trends. But on the other hand, these data are often volatile and can send misleading signals. And we might actually get a reversal higher unexpectedly. And that's the type of development that might cause the Fed to finally deliver some rate hikes.
Speaker: So it's really hard to say, are we at a turning point or not? um For now, we're sticking with our view that the Fed will more likely just adopt a wait and see approach and not end up delivering rate changes. But there's a lot to see even in the remainder of the summer.
Speaker: And in the bond market, in some way or another, this will be a turning point. that We are already seeing some growing pains of the bond market getting used to a new era for the Fed, a new communication style, potentially more uncertainty. And the thing that will be really important to focus on and could be either a risk or a source of ah stability is whether or not the bond market truly remains confident in the Fed's longer run inflation fighting credibility. And if that holds, then we could get through the coming months in a very fairly stable way. But if not, then certainly something investors will be monitoring very closely. Well, thank you both. Certainly not a quiet August here in New York. And we look forward to continue to talk as we as we learn more.
Speaker: Thank you very much, Aline.
Speaker: So that was Ryan Wang and Dheeraj Narula on the outlook for the Federal Reserve and U.S. interest rates and whether or not we're at a turning point. Please like and follow the Macro Brief on your podcast platform. And while you're there, check out our Asia Focus sister podcast, Under the Banyan Tree.
Speaker: Thanks for listening. And we'll be back again next week.
