00:00I want to start with the war. You write that it is inflationary. I think we're all seeing that
00:04happen right now, at least when it comes to oil prices and the way that oil flows through to the
00:08rest of the economy. What's the bond market telling us about how inflationary it will be
00:14ultimately? Yeah, you know, what we've seen is the way we look at it, Tim, is through the,
00:20say, the tips break even rates. Now, that isn't necessarily the best measure, but it is one way
00:27the bond market tells us what it's expecting. And those break even rates have moved up,
00:33particularly for shorter term tips. They're, you know, pushing 5% or so for one year. So it's
00:40implying that the market is expecting an inflation rate, at least on a short term basis, to move all
00:46the way up to as high as 5%. The longer term break evens are still pretty well behaved, maybe around
00:52two and a half, but they have come up. So what we've seen is the expectations about inflation
00:59move higher across all tenors, but particularly across the short term tenors. And, you know,
01:05you can look at other measurements in terms of expectations. I think the bond market, though,
01:11is really speaking loudly right now that the big fear is inflation hitting us due to the war.
01:18And in private markets, spreads are widening. How much of that is growth versus just really the
01:23stress in the private credit space? Yeah, there's a combination of things going on here. So
01:29kind of coming into this, we've seen spreads were really compressed, really tight. So anything that
01:35didn't work out perfectly was probably bound to cause them to widen. I think now between the woes in
01:42the private credit area and the expectation that we're going to see some weakness in earnings amongst
01:50various companies that might be caught in this, in the after effects of the war, the downside of what
01:58the war may do, starting to widen those credit spreads. It's also probably just a general risk
02:04aversion taking place as investors just pull back. You know, credit spreads tend to be correlated
02:09somewhat with equities. We're seeing equities come down. I think it's just a risk aversion taking
02:15place. Why, Kathy, do you think that treasuries are not being viewed as a safe haven asset right now?
02:24Yeah, it's got to be somewhat disappointing, I think, to a lot of analysts who thought perhaps we'd
02:32see a run into treasuries. But I think the primary mechanism that we're dealing with here is the
02:37inflation pressure that was already building up coming into the war from, you know, the fiscal
02:44stimulus from the one big beautiful bill and the fact that inflation's been above target, the Fed's
02:50target for, what, five years now. I think that there's not, the market's not as comfortable with
02:58treasuries as a risk off right now because of those factors. And the Fed is not indicating an
03:06aggressive rate cutting cycle because it's not yet a financial market risk. But, you know, I wouldn't
03:15rule it out down the road if financial conditions tighten enough, if there's enough worries about
03:20economic growth down the road that we could see treasuries rally. I do think we're getting
03:25devaluations that discount a lot of negative news. But in terms of flight to safety, the dollars got up,
03:33but we haven't seen a whole lot else in terms of the treasury market.
03:36So talk a little bit, if you could, Kathy, about what it would take for you to see investors flock
03:43to
03:44treasuries as a safe haven. Like what financial conditions would need to tighten? What would need
03:49to change? Well, I think it could go one of a couple ways. So on the one hand, if we
03:57had a severe
03:57enough sell-off in the stock market or in risk assets where we started to see the potential for
04:05the Federal Reserve to come in and provide some sort of support, then I think you'd start to see
04:11treasuries rally. And again, we may not be too far from that because if conditions tighten enough,
04:19then the economy is going to take a hit and that would pull the Fed in. A second way that
04:24it could occur,
04:25though, is that we do start to see the war and these tightening conditions really, really depress
04:35expectations for economic growth. And then we'd start to see people move out on the yield curve
04:42looking for something that would benefit from slower growth. But again, we're just not there yet.
04:48We're seeing a bear flattening in the yield curve. What should investors take away from that signal?
04:54Yeah. And again, this is kind of a not great signal for treasury investors right now, the bear
05:01flattening. We've been in a steepening, which was, I think, generally, we have been talking about the
05:09steepening for about a year or so as the expectations were for the Fed to cut rates, but inflation to
05:15remain
05:15sticky. And that was keeping the curve steepening. Add in the rising debt levels, deficits, financing,
05:26that's happened. Now we get a little bit of a bear flattening now. I think that's more driven by
05:33all the focus on the short end and seeing those yields move up to compensate for inflation expectations.
05:42So the Fed and where the Fed goes from here, there are a lot of questions about what the actual
05:47next
05:48move at the Federal Reserve will be, higher or lower. What do you think it'll be?
05:53Well, I think they'll try to stay on hold as long as possible. So I think they're trying to
05:59navigate this by doing very little and saying, well, you know, we're positioned okay for now.
06:05This thing could go one way or another. We don't want to make a mistake. And again, if the work
06:12continues and we continue to see upward pressure on prices, oil prices in particular, then barring a big
06:23decline in the economy or rise in unemployment, the Fed may actually have to pivot towards hiking rates.
06:28I don't think that's the most likely outcome, but it is now on the agenda, I would say, because of
06:37the
06:37inflation pressure and the rise in inflation expectations. So a lot's going to depend on the
06:43labor market, but I would say no change in policy for the rest of this year, barring a big surprise.
06:51And maybe we're building in the potential for a rate hike somewhere, you know, late in the year if
06:57things continue. But it's such a highly volatile environment, both from a policy perspective and
07:04a market perspective. I think for the Fed to try to make a call now, let alone, you know, us
07:10spectators
07:11is really difficult.
07:13It does seem like the Fed is relatively calm about long-term inflation. Do you think that the market,
07:18though, is underestimating that risk?
07:22Yeah, I think the Fed, you know, Fed Chair Powell has frequently pointed to those break-evens in the
07:29tips market as an indication that inflation expectations are well anchored. And, you know, I take a little bit
07:37of issue with that because as you, particularly you go out in the tips market, you know, that liquidity
07:45isn't great and it's easy to latch on to an indicator that, you know, maybe provides some
07:53confirmation bias for you. There has been a divergence. If we look at survey-based, say,
08:00University of Michigan survey inflation expectations, since short-run, you know, inflation expectations
08:07rise very sharply. And then the longer-run rise, but not as sharply. That may be a better reflection,
08:14right now, of where inflation expectations are than the break-even rates. Again, the Fed is taking
08:22comfort in those break-evens. I would say I would look to the survey-based right now because the longer
08:29inflation stays up and goes higher, the more those expectations get built in and the longer it's going
08:37to take to unwind them. So I think the Fed may be latching on to something that may not be
08:45as strong
08:46an indicator as they would like.
08:47Hey, Kathy, before we let you go, I just want to take a moment to recognize the incredible career
08:51that you've had. You're stepping down or retiring, I should say, from Charles Schwab and from the industry
08:57at the end of this month. And we're going to talk a little bit about that. But before we do,
09:02this moment in the context of your career, it's a really complicated one. And you're sort of, you
09:08know, I think it's fair to say, at least when it comes to the news cycle, you're going out on
09:11top.
09:11But how do you view this moment in the context of your career?
09:17It's one of the most complicated situations I've experienced. And I've been around a while.
09:24So I've experienced a lot, you know, all the way from the commodity markets of the late 70s,
09:30early 80s. And, you know, that was crazy. The, you know, the flash crashes, the big crashes in
09:38markets, the Asian currency crisis. I mean, you name it, certainly the great financial crisis. I've
09:44seen a lot. This is not as severe as some of them, because I think the economy was in decent
09:52shape
09:52coming into this. But I think from a policy driven perspective, it's one of the most complicated
09:59because it really wasn't signaled very much in advance that we were doing this. We were at a
10:05kind of pivot point in terms of trying to get inflation down. The global economy is feeling a
10:13lot of inflation pressure and was coming into this. So we've had a combination of policy issues that are
10:21hard to unwind along with market issues that are hard to unwind. And I would say this is one of
10:27the
10:27trickier that I've seen in my career.
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