Bill Housey discusses recent dynamics in the bond market, including why longer-term interest rates have increased since the Fed began cutting rates, where we are in the economic cycle, and implications for fixed income investors.
----------------------------------------------------------------------------------------------
Subscribe Here to the ROI Podcast & other First Trust Market News
Website: First Trust Portfolios
Connect with us on LinkedIn: First Trust LinkedIn
Follow us on X: First Trust on X
Subscribe to the First Trust YouTube Channel
Subscribe to the ROI Podcast YouTube Channel
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Ryan (00:15):
Hi, welcome to this episode of the First Trust ROI
podcast.
I'm Ryan Isakainen, etfstrategist at First Trust.
In today's episode, I'm joinedby Bill Howsey, managing
Director of Fixed Income atFirst Trust.
Bill and I are going to talkabout what has happened with
interest rates since the Fed cutby 50 basis points.
We're going to talk about theeconomy and where we see
(00:35):
opportunity in the bond market.
Thanks for joining us on thisepisode of First Trust ROI
Podcast.
Bill, thanks again for joiningus on the podcast.
I think this is your thirdappearance on the podcast.
You were my second guest ever,so I appreciate you sticking
with us.
A lot going on in the bondmarket Always Great to be back.
So I was thinking as I was onmy way heading into the office
(00:57):
today what would Bill Howsey bedoing if he was not a star bond
manager?
And that's my first questionfor you If somehow you didn't
end up in the financial industryas a bond manager, what would
you be doing?
What would I be doing if?
Bill (01:12):
not managing bonds.
Well, my interests are inbarbecue.
Right, it would be brisket.
It would be really goodbarbecue, authentic barbecue.
You know, that's where I findyou know my sort of labor of
love, if you will.
Ryan (01:29):
Yeah, you'd be a pit master, I'd be a pit master,
nice, there's nothing like agood barbecue, especially like a
brisket, if you get it right.
You know, do you do kind oflike the six-hour thing, the
three-two-one method or what'syour preference?
Bill (01:41):
I have ruined a good number of briskets in my day
right and.
I've rushed them.
I've I've, you know, found lotsof different techniques and
tactics.
My favorite way to do it as anovernight smoke, so you smoke it
overnight while you sleep, yeah, and then you wake up and you
got to get it to the perfecttemperature.
Ryan (02:00):
Okay.
So what I learned making anumber of briskets and getting
some wrong, getting some rightis, when I'm that first stage, I
take some of the fat thedrippings, make tallow with it,
oh yeah.
And then, after you wrap itwith your butcher paper, you put
a little of that on the paperand it keeps it nice and moist
during the rest Perfect.
(02:20):
I don't want to give away allthe tips, but Okay, all right.
So back to business here.
Bill, the Fed is what's in thenews.
Over the last few weeks,finally, after a cycle of
raising, the Fed decided to cutrates by 50 basis points.
I think one of the surprisesfor many people in the market
was that the longer end of theyield curve since then has
(02:42):
actually seen about a 40 basispoint increase at the 10-year.
So I guess that's my firstquestion for you.
Was that a surprise to you thatyou'd see the curve steepen, at
least between the federal fundsrate and the longer end of the
yield curve, in the wake of whatthe Fed did, and what are the
implications of that?
Bill (03:01):
The real driver of what we've seen to shift those
interest rates higher has beenmore about the expected number
of cuts that were in the curve.
We look at the minutes thatcame from that meeting.
It wasn't a one-sided view.
There was clearly some heavydiscussion around that topic.
But what really came after thatwere market expectations that
(03:23):
we were going to see not onlythose 50 base points of cuts
that came through in the middleof September, but as many as
eight more cuts by the end ofnext year.
And our thinking on that wasthat there's just too many cuts
priced into the curve based onwhat we know today with respect
to the economy, the labor market, inflation data, Not to say
that that destination doesn'tmake sense, meaning a terminal
(03:45):
Fed funds rate of around 3% atsome point in the cycle.
Principally because if we'reback to a 2% inflation target at
some point, a 1% real rate, areal federal funds rate so a
terminal rate at 3%, inflationat 2%, gives you a 1% real rate.
So what's actually occurred?
We had that big labor marketprint beat in non-farm last week
(04:09):
and what's really resulted isthat some of those extra cuts
that were priced into the curvehave now been removed.
So that's what's brought ratesback up.
The only thing that's reallytranspired is we've taken some
of those cuts and we've kickedthem out.
So now, if you were to look atthe expected Fed funds rate over
the next, you know, into theend of December 2025, there's
(04:29):
about six cuts priced in, andwhat we would say is that looks
a lot more reasonable to us.
So that's how I would come backto what's occurred with respect
to rates.
Ryan (04:39):
I want to stay in the economy for a minute, partly
because the yield curvenormalized in light of the Fed's
cutting rates and it's beennormalized now since then, I
believe.
Maybe it went a little bitnegative at one point, but
historically that has oftenpreceded recessions and there's
(05:00):
a lot that's different in thiscycle and we don't have to
review all those differences.
But in your view, is this timedifferent?
Is it not going to precede arecession soon after the yield
curve normalizes, or is thatwhat we would expect to happen
again?
Bill (05:14):
Empirically, as we look back at the you know last
several business cycles, a lotof people tend to look at the
inversion of the curve as awarning sign for the business
cycle.
But in fact, the point thatyou're making is that it's the
un-inversion that's typicallymuch closer to the end of the
business cycle, the data, as wewere just talking about, that we
(05:35):
get in the business cycle andthe economy is incredibly
lagging.
And one of the best anecdotes Ihave for this is you can go
back to you know the financialcrisis and you know the yield
curve inverted in 2006,.
Right, we obviously didn't geta recession until December 2007.
It was a very long periodbetween that inversion and the
(05:58):
ultimate recession.
But the anecdote lies inthen-Chairman Ben Bernanke's
comments, where he had said theFed had engineered a soft
landing and by October 2007, theS&P put in a new high and I'm
sure he was feeling really goodabout the soft landing at that
point.
And, of course, by December2007, we were in a recession.
(06:19):
But it was even better thanthat because it was either
January, february 2008,.
Chairman Ben Bernanke is givinga speech and he's asked does the
Fed foresee a recession?
And his reaction or responsewas no, the Fed does not foresee
a recession.
We were already in therecession and these are really
intelligent people.
So it isn't to say thatintellect has anything to do
(06:41):
with this.
It's just that the data is soincredibly lagging.
And so you know the point about.
Does the un-inversion signal alate cycle indicator?
It has in many cycles.
You know, forecasting arecession is very difficult,
timing a recession practicallyimpossible.
You may as well put the tarotcards on the table and we'll do
our best with that.
Ryan (07:01):
So would you say that there's more of a bias, that the
likelihood or the probabilityof a recession is greater now
that the yield curve has donewhat it's done?
Bill (07:10):
I would say that it's a good late cycle indicator, but
it's one of many.
I do think that it's telling usthat we are later cycle,
because what it really ties backto, in my mind at least, is
that the Fed is reacting.
Let's remember what the Fed'sjob is.
It's a dual mandate.
It's employment and inflationthat they focus on.
(07:31):
Now, for the last couple ofyears it's been a single mandate
.
It's been inflation, inflation,inflation right.
What did the Fed do?
The Fed raised the equivalentof 21 times.
The Fed raised the equivalentof 21 times 21,.
25 basis point hikes wereinjected into the economy.
Now there's a lot of debateabout the transmission mechanism
of that Fed policy.
(07:52):
A lot of people locked in lowmortgage rates and things like
that, so maybe to that extent,the transmission mechanism isn't
as great.
Companies locked in low bondrates during 2020, 2021, when
rates were very low.
But the reality is that 21 ratehikes into the economy will
have some effect at some point.
(08:12):
And so the logic that it has noeffect and perhaps it's
mitigated in this cycle by thelarge fiscal impulse that came
into the business cycle postCOVID, I think we certainly
think about that.
There's no mathematical model.
At least that we have that tiesit all together in a perfect
(08:32):
bowl like that.
But these are considerations wemake.
I just think that it's one ofmany variables we consider.
With respect to that late cycleindicator, I do believe that
the Fed is using lagginginformation because we know
empirically we can look back atthe last 60 years of business
cycles and see that whenunemployment is typically going
(08:53):
higher, you're very late in thebusiness cycle.
When inflation is back to theFed's target, you're typically
very late in the business cyclein or around a recession.
Does that mean we're going totip over in a recession tomorrow
?
Of course not.
It just means that these areall aligning with respect to the
business cycle overall and interms of late cycle indicators.
Ryan (09:14):
Yeah, that makes sense.
So this has been a weird cycletoo.
Right, it's been an unusualcycle, and I think there's been
a lot of surprises foreconomists, for portfolio
managers, for strategists.
As you think about thisparticular cycle, is there
anything that jumps out at youthat has surprised you the most,
either for the good or for thebad?
Bill (09:33):
positive, negative there was certainly no textbook on
investing through a pandemic.
When the government shuts down,the business cycle shuts down,
the economy injects trillions ofdollars.
I mean, there were a number ofunique circumstances that played
through here and I think youknow these are the things that
we have to be thinking aboutwhere we could be wrong.
(09:55):
Could it be that, for example,that large fiscal that's held up
construction employment in thisbusiness cycle far better and
far longer, despite the risingrates?
I mean, certainly, if you justthink about previous cycles,
rising rates would lead toweaker demand for housing, lower
housing prices and loss ofconstruction jobs, but we had
(10:16):
this big fiscal impulse thatsupported construction jobs.
We had a dearth of supplybecause people had such low
mortgages they didn't want tosell homes, so it led to higher
prices.
So when you've been doing thisthrough multiple cycles, you see
that each cycle is unique andwhat we have to do is look at
all the data the best that wecan in an attempt to try to test
our thinking with the dataright.
(10:37):
So we try to avoid justcreating an opinion as opposed
to relying on data.
So we're always looking at themath, we're always looking at
the data to drive the decisions,and I think that that's a
really important thing that wehave to do to test our thinking.
Ryan (10:51):
So all that fiscal spending, all that money that
was passed into laws there'sstill a lot of that that is
authorized to be spent over thenext couple of years and that
has to be having an effect on alot of the economy.
So I mean, does that figureinto your thinking?
(11:11):
Is part one of the question,and part two is that has to be
paid for and we're running hugedeficits and deficits are
projected as far as the eye cansee.
So what does that mean forinterest rates looking forward?
Bill (11:26):
It's a really good question, so let's break it down
.
There are definitely pockets ofthe economy that are feeling
more pressure than others.
I think wealthy consumers feelreally wealthy in their spending
.
I think weaker consumers areunder a lot of pressure right
now, particularly with respectto what's going on with interest
rate policies, and I thinkthat's partially why the Fed is
cutting right.
It's one of the many reasonsthey are looking at the real
rate in the economy as beingpunitive, especially for weaker
(11:50):
consumers.
Right, the real rate Rememberthey raised 21 times for 9%,
inflation for 8%, for 2%, sowe're at whatever 2.4% as of
today.
So you start to think aboutthat.
That's it becomes.
That real rate becomes punitivefor people, and I think that's
what you're seeing now.
As you bridge that then to thedeficits.
With respect to the fiscal, theway I've thought about this is
(12:13):
and Bob Stein, our deputy chiefeconomist, has said it best.
He said it's the most recklessspending in the history of our
country.
Right, we're not at war, we'renot in a recession, and we're
spending as though we are, soit's incredibly reckless.
What I would say, though, isthat the bond market has clearly
coalesced around.
An understanding of this iswhat the deficit is and this is
(12:35):
what bonds will be needed tofund that deficit, and has sort
of said this is the type of bondmarket pricing that's necessary
to clear that deficit as weknow it today.
And I want to really emphasizethat as we know it today,
meaning if there's a newadministration and they take the
deficits from $2 trillion to $4trillion, well that's clearly
not in the price, right?
(12:56):
I've used this old analogy.
If you're old enough toremember the old Prego pasta
commercials, they'd say it's inthere, right, the ingredients in
the sauce, right.
And so when I look at the bondpricing of those deficits what
we understand them to be today,I would say it's in there, it's
in the price.
And the reason I say that, andthe reason I say that the bond
(13:17):
vigilantes haven't come yet, isbecause the bond market is
trading on what the Fed is doing.
The bond market is trading onthe economic data.
It's not decoupling from that.
The auctions have been clearing.
So if you look at the data, youlook at the evidence, you would
make the case that very clearly, the bond market isn't, the
vigilantes aren't there.
(13:37):
Now, if we get a newadministration or there's a
major policy change and we'regoing to uptier the spend.
Well, clearly that's not inthere and that would be damaging
and you would clearly see thevigilantes coming out in that
environment in our view.
So we're not trading that todaybecause I don't think you can
trade that.
It's very speculative in thatsense.
(13:59):
But that's how we're thinkingabout that?
Ryan (14:01):
Yeah, so that would imply, when you say the bond
vigilantes would come out.
Just for those who don't knowwho these bond vigilantes are,
that would imply higher interestrates, right, because they
would demand that in order toactually have demand for that
debt.
Bill (14:17):
The bond market, investors would say I need to be
compensated for this risk ofheavier funding.
Now, compensated for this riskof heavier funding.
Now you know, if you look atgrowth in the economy 3% a year,
that type of growth, 2% to 3% ayear could the US government
fund a trillion dollar deficit,have a trillion dollar deficit
into perpetuity?
Sure it could, right, Justbased on the size of the economy
(14:39):
.
Does that mean it's responsible?
No, it's irresponsible, right,and we see it clearly that way.
But is it at such a point wherethe bond market is extracting a
pound of flesh for it?
Not yet, but if there is amajor change, I think we would
see that.
Ryan (14:57):
The other thing I wanted to ask about with respect to
inflation you brought upinflation a minute ago is how
tariff policies you think wouldimpact inflation.
You know, of course you put atax on, it's passed along to
somebody and it seems like abipartisan agreement that
(15:19):
tariffs are.
Now, you know, maybe we'regetting a little bit more trade
protectionism in our overallpolicy from both sides.
Maybe we're getting a littlebit more trade protectionism in
our overall policy from bothsides.
It's interesting that none ofthe Trump tariffs on China were
actually rescinded by the Bidenadministration and even more
were put on.
So it's not necessarily apolitical discussion about who
wins the election.
It seems like both are going tohave tariffs.
(15:40):
So my question for you is, as abond manager, as you think
about the impact on inflationand therefore rates, potentially
, how do you think about tariffs?
Bill (15:50):
There's a number of ways to take that conversation, but I
think the best place to startis to go back to 2019, trump's
tariffs come through.
You go back to what occurred in2019.
Former President Trump's amarkets guy, like if he puts a
policy out there and the stockmarket starts to crater.
President Trump I thinkPresident Trump's a markets guy,
like if he puts a policy outthere and the stock market
starts to crater.
President Trump I think he's anegotiator.
He would look at that andlikely say, hey, the market
(16:15):
isn't digesting this the way Ithought it should or would.
But, more importantly, thenarrative around tariffs is that
you push tariffs through,prices go, surge higher and
there's no doubt about it.
We've looked at the data.
We know the data that when youpush tariffs through, it is
inflationary.
But it is a one-timeinflationary thing, right?
You don't.
(16:36):
If you raise, if you put atariff in place and you assume
prices increase to offset thattariff, it happens.
It's, they're recovered and itdoesn't go up every single year,
unless the tariff is changingevery single year, right?
Yeah, the other thing is thatthere's a presumption in most of
what I've seen that's writtenabout tariffs that when you have
a tariff, a company immediatelytakes the price higher and
(16:57):
offsets the tariff through thathigher price.
That's not what we saw in 2019,right, what we saw in 2019 was
companies attempting to take theprice higher but unfortunately
unable to take the price tofully offset the tariff, and
profits actually would comeunder pressure.
And many companies look toreact to move production, to
find ways to mitigate the tariff.
(17:18):
And so I don't believe it's aslinear or black and white as the
narrative would have onebelieve.
I think that if you had asignificant or sizable tariff
come into the market, you wouldlikely have profits coming under
pressure.
I mean, we're back into a midtwo and a half type percent
inflation environment.
The idea that the consumer willjust willingly bear the brunt
(17:41):
of a full tariff, I think, is areal stretch in my opinion.
I think that some portion ofthat would be borne by the
companies through profits, lowermargins, if you will.
I think some portion of thatwould be borne by the consumer
over a period of time, but it'sa one-time effect.
Now I do think it still wouldshow up in inflation.
(18:04):
But the question is, you know,is it perpetual inflation?
Because you put implemented thetariff, and my thinking, at
least on this would be it wouldbe temporary, because you would
push it through and it's not anongoing escalation right.
It's a one-time type tariffthat gets implemented and then
exists.
Ryan (18:23):
So it seems like part of the incentive for adding tariffs
would be to maybe have somere-industrialization, some
shifting manufacturing back tothe states or at least back to
some place where there was notariff in place.
And would that be part of yourthinking with that as well?
Bill (18:40):
Absolutely.
I mean that's one of the mainpremises of the, you would
imagine, of the policy right.
Shift production back andcreate jobs domestically.
Those are clearly drivers.
Also create a revenue sourceback to the US from those
tariffs, from the businessesthat are producing elsewhere,
for example.
I think those are all parts ofthe policy discussion.
Ryan (19:06):
Yeah, okay.
So if you're a financialadvisor watching the podcast and
are listening to the podcastand you're thinking about how to
position from a durationperspective, what would you say
to that?
Bill (19:15):
Today, as we sit here around 4%, slightly above 4%,
with a realistic sort ofexpectations for the Fed cutting
cycle that's underway.
When we look at that, we'reback to an environment where
stocks and bonds are notbehaving in a way that they're
(19:36):
correlated anymore.
The old traditional reactionfunction is seemingly back in
place, where bonds are offeringsome protection against stock
volatility.
I think that's a very importantconsideration, and so for us,
ultimately, I don't think thatwe have to be interest rate
strategists anymore.
I think we're in an environmentwhere you can own the bond
(19:57):
market, and when I think aboutthe bond market, the duration of
the bond market, which is yourinterest rate sensitivity, lives
around six years for the bondmarket.
So when we look at theBloomberg Aggregate Index, which
is inclusive of treasuries,corporates, securitized debt,
core, fixed income right, thatduration is around six years.
(20:18):
I don't think investors realizewhat their reinvestment risk
looks like today.
They've ridden these reallyshort-term rates at a very high
level now for a nice period oftime, but I think, as we look
forward over the next 12 monthsand perhaps we are a later cycle
we do believe that the Fed isgoing to continue to cut.
(20:39):
We're expecting as many as sixcuts by the end of 2025.
If you really sit there inultra-short investments, you're
just going to ride that yielddown in most traditional forms.
Of course, there's differentways bond fund managers, active
managers try to mitigate thatrisk, but in the traditional
sense, the way most investorsare sitting in I think the last
(20:59):
number I saw was close to $6.5trillion in money market
accounts they're not positionedin a way that they would be
mitigating some of thatreinvestment risk.
So the way we've thought aboutit is owning a duration where
the bond market is of around sixyears seems like a very
reasonable set of you know sortof investment policy decision to
(21:22):
have today.
Ryan (21:23):
Are there any specific sectors of the bond market that
you think are particularlyattractive?
Bill (21:28):
There's really not an always or never in my mind when
it comes to the bond market.
What we try to do is we lookacross different sectors and we
say where's the value?
These are a lot of relativevalue trades that are taking
place.
So even in pockets of themarket that we may not love, we
still find value in differentcorners of that market.
Pockets of the market that wemay not love, we still find
value in different corners ofthat market.
I would say for most investorstoday, whether it's in taxable
(21:50):
or tax-free, given whereinterest rates are, there's no
reason to chase a lot of riskbecause you can earn a really
attractive level of income inthe bond market that you haven't
had in a very long period oftime, in our country at least
and you can do it withrelatively safe fixed income.
So when we look at core fixedincome things like whether it's
(22:11):
corporates or securitized debtand even Treasuries as a safe
haven, for example I mean youcould really construct a nice
portfolio and even in municipalbonds with tax-free, high
quality, a really nice durableset of bond portfolios that you
can create without taking a lotof excessive risk, and I think
(22:32):
that's really important Now inthe riskier pockets of the bond
market.
Things like high yield, forexample, or even senior loans,
those types of ideas, those canmake sense.
But I think those make moresense today in an equity bucket,
meaning I can de-risk equityexposure by using some of those
opportunities where there'sstill a compelling equity-like
(22:57):
return that's capable of comingout of some of those pockets.
So I think you can reallybifurcate the market into safe
and risk and really use yourbond money for safer fixed
income and look to use thatduration not to swing for the
fences.
I often tell people they say,hey, should I buy this really
long duration?
(23:17):
That's like buying a small capstock.
Right, you're picking a veryspecific point on the yield
curve.
You're hoping for a veryspecific outcome to make money
in that point of the curve.
What we're saying is you canown the bond market today and
you can reduce your reinvestmentrisk by doing that or making
sure you're with a managerthat's working actively to do
that.
Ryan (23:36):
So you're an active manager and you mentioned
considering high yield or someof the below investment grade as
an equity substitute in anasset allocation.
When it comes to those,specifically those parts of the
bond market, but also, I think,probably corporate and the other
the other sectors as well,municipals Managing risk is
really important, right?
(23:57):
So, as an active manager, whatare some of the most important
levers that you pull as you'rethinking about managing risk?
Bill (24:05):
The first thing, particularly if we think about
it through the lens of thecredit side, it's a really deep
understanding of the businessesthat we lend money to.
When we look at these companies, we're really thoughtful about
what could go wrong.
So if I'm buying a stock,there's a lot of embedded hope
and expectations into whatfuture earnings will be, because
I need that stock to go higher,to be driven by something.
I need a catalyst to drive thatstock higher.
(24:25):
Our CIO, Dave McGarrel, talks alot about what's the catalyst
right?
When it comes to the bondmarket, it's more about risk
management.
So we have to be thinking aboutwhat could cause us to lose
money, because our upside islimited typically to earning our
coupon and getting our moneyback.
So we're very thoughtful aboutwhere the volatility could come
from.
So that's where it comes back totaking those hundreds of
(24:48):
earnings calls financialmodeling.
Even through all the workthat's done across all the
various sectors, whether it'ssecuritized sector, municipal
sectors, corporate sectors, allthe way through.
It's that deep understanding ofwhere the risk resides.
And you know we're not.
Our base cases aren't built onhope and dreams.
If you will that really, whenyou see stock multiples expand
(25:11):
that you really need to.
You need those earnings to comethrough to support those stock
multiples.
For us, we're trying to ensurethat when we're buying a bond in
any capacity, that it's adurable investment, that we're
not taking an excessive amountof risk relative to the return
potential in that bond, and thatcomes through an enormous
amount of work that has to bedone upfront to ensure that
(25:32):
we're protected.
Ryan (25:34):
What I'm hearing you say is, in particular, security
selection is really where youcan do that work to know those
businesses and maybe theduration positioning key rates,
something like that, is alsoimportant.
But for the funds that youmanage, would you say that
security selection is really thekey, very important.
Bill (25:53):
We're going to use all the tools that we have.
So each one of these thingswhether it's duration management
, credit selection,diversification, liquidity each
one is a lever that we can pullas an active manager to try to
drive value through thestrategies that we manage.
Great.
Ryan (26:10):
Well, time's flown by once again, Bill.
Last time you were on, by theway, you mentioned this book
about Teddy Roosevelt, River ofDoubt, and I read that book
Really fascinating story.
Put you on the spot again,Because I'm always looking for
something to read.
What would you recommend myselfand the listeners to the
(26:32):
podcast?
What should we check out next?
Bill (26:34):
One book that I would definitely recommend is David
Horowitz's A Radical Son, aGenerational Odyssey, and it's a
great book about his journey asa 1960s revolutionary to a
conservative thinker.
So is that an autobiography?
Ryan (26:50):
Yes, it's an autobiography .
Okay, fascinating.
We will add that to the ROIpodcast reading list.
Bill, thanks for that bookrecommendation.
Thanks again for coming on thepodcast.
Hopefully you can come backagain.
Thank you, ryan, great to bewith you again, and thanks to
all of you for joining us onthis episode of the First Trust
ROI podcast.
We'll see you next time.
Hi, welcome to this episode of the First Trust ROI
podcast.
I'm Ryan Isakainen, etfstrategist at First Trust.
In today's episode, I'm joinedby Bill Howsey, managing
Director of Fixed Income atFirst Trust.
Bill and I are going to talkabout what has happened with
interest rates since the Fed cutby 50 basis points.
We're going to talk about theeconomy and where we see
(00:35):
opportunity in the bond market.
Thanks for joining us on thisepisode of First Trust ROI
Podcast.
Bill, thanks again for joiningus on the podcast.
I think this is your thirdappearance on the podcast.
You were my second guest ever,so I appreciate you sticking
with us.
A lot going on in the bondmarket Always Great to be back.
So I was thinking as I was onmy way heading into the office
(00:57):
today what would Bill Howsey bedoing if he was not a star bond
manager?
And that's my first questionfor you If somehow you didn't
end up in the financial industryas a bond manager, what would
you be doing?
What would I be doing if?
Bill (01:12):
not managing bonds.
Well, my interests are inbarbecue.
Right, it would be brisket.
It would be really goodbarbecue, authentic barbecue.
You know, that's where I findyou know my sort of labor of
love, if you will.
Ryan (01:29):
Yeah, you'd be a pit master, I'd be a pit master,
nice, there's nothing like agood barbecue, especially like a
brisket, if you get it right.
You know, do you do kind oflike the six-hour thing, the
three-two-one method or what'syour preference?
Bill (01:41):
I have ruined a good number of briskets in my day
right and.
I've rushed them.
I've I've, you know, found lotsof different techniques and
tactics.
My favorite way to do it as anovernight smoke, so you smoke it
overnight while you sleep, yeah, and then you wake up and you
got to get it to the perfecttemperature.
Ryan (02:00):
Okay.
So what I learned making anumber of briskets and getting
some wrong, getting some rightis, when I'm that first stage, I
take some of the fat thedrippings, make tallow with it,
oh yeah.
And then, after you wrap itwith your butcher paper, you put
a little of that on the paperand it keeps it nice and moist
during the rest Perfect.
(02:20):
I don't want to give away allthe tips, but Okay, all right.
So back to business here.
Bill, the Fed is what's in thenews.
Over the last few weeks,finally, after a cycle of
raising, the Fed decided to cutrates by 50 basis points.
I think one of the surprisesfor many people in the market
was that the longer end of theyield curve since then has
(02:42):
actually seen about a 40 basispoint increase at the 10-year.
So I guess that's my firstquestion for you.
Was that a surprise to you thatyou'd see the curve steepen, at
least between the federal fundsrate and the longer end of the
yield curve, in the wake of whatthe Fed did, and what are the
implications of that?
Bill (03:01):
The real driver of what we've seen to shift those
interest rates higher has beenmore about the expected number
of cuts that were in the curve.
We look at the minutes thatcame from that meeting.
It wasn't a one-sided view.
There was clearly some heavydiscussion around that topic.
But what really came after thatwere market expectations that
(03:23):
we were going to see not onlythose 50 base points of cuts
that came through in the middleof September, but as many as
eight more cuts by the end ofnext year.
And our thinking on that wasthat there's just too many cuts
priced into the curve based onwhat we know today with respect
to the economy, the labor market, inflation data, Not to say
that that destination doesn'tmake sense, meaning a terminal
(03:45):
Fed funds rate of around 3% atsome point in the cycle.
Principally because if we'reback to a 2% inflation target at
some point, a 1% real rate, areal federal funds rate so a
terminal rate at 3%, inflationat 2%, gives you a 1% real rate.
So what's actually occurred?
We had that big labor marketprint beat in non-farm last week
(04:09):
and what's really resulted isthat some of those extra cuts
that were priced into the curvehave now been removed.
So that's what's brought ratesback up.
The only thing that's reallytranspired is we've taken some
of those cuts and we've kickedthem out.
So now, if you were to look atthe expected Fed funds rate over
the next, you know, into theend of December 2025, there's
(04:29):
about six cuts priced in, andwhat we would say is that looks
a lot more reasonable to us.
So that's how I would come backto what's occurred with respect
to rates.
Ryan (04:39):
I want to stay in the economy for a minute, partly
because the yield curvenormalized in light of the Fed's
cutting rates and it's beennormalized now since then, I
believe.
Maybe it went a little bitnegative at one point, but
historically that has oftenpreceded recessions and there's
(05:00):
a lot that's different in thiscycle and we don't have to
review all those differences.
But in your view, is this timedifferent?
Is it not going to precede arecession soon after the yield
curve normalizes, or is thatwhat we would expect to happen
again?
Bill (05:14):
Empirically, as we look back at the you know last
several business cycles, a lotof people tend to look at the
inversion of the curve as awarning sign for the business
cycle.
But in fact, the point thatyou're making is that it's the
un-inversion that's typicallymuch closer to the end of the
business cycle, the data, as wewere just talking about, that we
(05:35):
get in the business cycle andthe economy is incredibly
lagging.
And one of the best anecdotes Ihave for this is you can go
back to you know the financialcrisis and you know the yield
curve inverted in 2006,.
Right, we obviously didn't geta recession until December 2007.
It was a very long periodbetween that inversion and the
(05:58):
ultimate recession.
But the anecdote lies inthen-Chairman Ben Bernanke's
comments, where he had said theFed had engineered a soft
landing and by October 2007, theS&P put in a new high and I'm
sure he was feeling really goodabout the soft landing at that
point.
And, of course, by December2007, we were in a recession.
(06:19):
But it was even better thanthat because it was either
January, february 2008,.
Chairman Ben Bernanke is givinga speech and he's asked does the
Fed foresee a recession?
And his reaction or responsewas no, the Fed does not foresee
a recession.
We were already in therecession and these are really
intelligent people.
So it isn't to say thatintellect has anything to do
(06:41):
with this.
It's just that the data is soincredibly lagging.
And so you know the point about.
Does the un-inversion signal alate cycle indicator?
It has in many cycles.
You know, forecasting arecession is very difficult,
timing a recession practicallyimpossible.
You may as well put the tarotcards on the table and we'll do
our best with that.
Ryan (07:01):
So would you say that there's more of a bias, that the
likelihood or the probabilityof a recession is greater now
that the yield curve has donewhat it's done?
Bill (07:10):
I would say that it's a good late cycle indicator, but
it's one of many.
I do think that it's telling usthat we are later cycle,
because what it really ties backto, in my mind at least, is
that the Fed is reacting.
Let's remember what the Fed'sjob is.
It's a dual mandate.
It's employment and inflationthat they focus on.
(07:31):
Now, for the last couple ofyears it's been a single mandate
.
It's been inflation, inflation,inflation right.
What did the Fed do?
The Fed raised the equivalentof 21 times.
The Fed raised the equivalentof 21 times 21,.
25 basis point hikes wereinjected into the economy.
Now there's a lot of debateabout the transmission mechanism
of that Fed policy.
(07:52):
A lot of people locked in lowmortgage rates and things like
that, so maybe to that extent,the transmission mechanism isn't
as great.
Companies locked in low bondrates during 2020, 2021, when
rates were very low.
But the reality is that 21 ratehikes into the economy will
have some effect at some point.
(08:12):
And so the logic that it has noeffect and perhaps it's
mitigated in this cycle by thelarge fiscal impulse that came
into the business cycle postCOVID, I think we certainly
think about that.
There's no mathematical model.
At least that we have that tiesit all together in a perfect
(08:32):
bowl like that.
But these are considerations wemake.
I just think that it's one ofmany variables we consider.
With respect to that late cycleindicator, I do believe that
the Fed is using lagginginformation because we know
empirically we can look back atthe last 60 years of business
cycles and see that whenunemployment is typically going
(08:53):
higher, you're very late in thebusiness cycle.
When inflation is back to theFed's target, you're typically
very late in the business cyclein or around a recession.
Does that mean we're going totip over in a recession tomorrow
?
Of course not.
It just means that these areall aligning with respect to the
business cycle overall and interms of late cycle indicators.
Ryan (09:14):
Yeah, that makes sense.
So this has been a weird cycletoo.
Right, it's been an unusualcycle, and I think there's been
a lot of surprises foreconomists, for portfolio
managers, for strategists.
As you think about thisparticular cycle, is there
anything that jumps out at youthat has surprised you the most,
either for the good or for thebad?
Bill (09:33):
positive, negative there was certainly no textbook on
investing through a pandemic.
When the government shuts down,the business cycle shuts down,
the economy injects trillions ofdollars.
I mean, there were a number ofunique circumstances that played
through here and I think youknow these are the things that
we have to be thinking aboutwhere we could be wrong.
(09:55):
Could it be that, for example,that large fiscal that's held up
construction employment in thisbusiness cycle far better and
far longer, despite the risingrates?
I mean, certainly, if you justthink about previous cycles,
rising rates would lead toweaker demand for housing, lower
housing prices and loss ofconstruction jobs, but we had
(10:16):
this big fiscal impulse thatsupported construction jobs.
We had a dearth of supplybecause people had such low
mortgages they didn't want tosell homes, so it led to higher
prices.
So when you've been doing thisthrough multiple cycles, you see
that each cycle is unique andwhat we have to do is look at
all the data the best that wecan in an attempt to try to test
our thinking with the dataright.
(10:37):
So we try to avoid justcreating an opinion as opposed
to relying on data.
So we're always looking at themath, we're always looking at
the data to drive the decisions,and I think that that's a
really important thing that wehave to do to test our thinking.
Ryan (10:51):
So all that fiscal spending, all that money that
was passed into laws there'sstill a lot of that that is
authorized to be spent over thenext couple of years and that
has to be having an effect on alot of the economy.
So I mean, does that figureinto your thinking?
(11:11):
Is part one of the question,and part two is that has to be
paid for and we're running hugedeficits and deficits are
projected as far as the eye cansee.
So what does that mean forinterest rates looking forward?
Bill (11:26):
It's a really good question, so let's break it down
.
There are definitely pockets ofthe economy that are feeling
more pressure than others.
I think wealthy consumers feelreally wealthy in their spending
.
I think weaker consumers areunder a lot of pressure right
now, particularly with respectto what's going on with interest
rate policies, and I thinkthat's partially why the Fed is
cutting right.
It's one of the many reasonsthey are looking at the real
rate in the economy as beingpunitive, especially for weaker
(11:50):
consumers.
Right, the real rate Rememberthey raised 21 times for 9%,
inflation for 8%, for 2%, sowe're at whatever 2.4% as of
today.
So you start to think aboutthat.
That's it becomes.
That real rate becomes punitivefor people, and I think that's
what you're seeing now.
As you bridge that then to thedeficits.
With respect to the fiscal, theway I've thought about this is
(12:13):
and Bob Stein, our deputy chiefeconomist, has said it best.
He said it's the most recklessspending in the history of our
country.
Right, we're not at war, we'renot in a recession, and we're
spending as though we are, soit's incredibly reckless.
What I would say, though, isthat the bond market has clearly
coalesced around.
An understanding of this iswhat the deficit is and this is
(12:35):
what bonds will be needed tofund that deficit, and has sort
of said this is the type of bondmarket pricing that's necessary
to clear that deficit as weknow it today.
And I want to really emphasizethat as we know it today,
meaning if there's a newadministration and they take the
deficits from $2 trillion to $4trillion, well that's clearly
not in the price, right?
(12:56):
I've used this old analogy.
If you're old enough toremember the old Prego pasta
commercials, they'd say it's inthere, right, the ingredients in
the sauce, right.
And so when I look at the bondpricing of those deficits what
we understand them to be today,I would say it's in there, it's
in the price.
And the reason I say that, andthe reason I say that the bond
(13:17):
vigilantes haven't come yet, isbecause the bond market is
trading on what the Fed is doing.
The bond market is trading onthe economic data.
It's not decoupling from that.
The auctions have been clearing.
So if you look at the data, youlook at the evidence, you would
make the case that very clearly, the bond market isn't, the
vigilantes aren't there.
(13:37):
Now, if we get a newadministration or there's a
major policy change and we'regoing to uptier the spend.
Well, clearly that's not inthere and that would be damaging
and you would clearly see thevigilantes coming out in that
environment in our view.
So we're not trading that todaybecause I don't think you can
trade that.
It's very speculative in thatsense.
(13:59):
But that's how we're thinkingabout that?
Ryan (14:01):
Yeah, so that would imply, when you say the bond
vigilantes would come out.
Just for those who don't knowwho these bond vigilantes are,
that would imply higher interestrates, right, because they
would demand that in order toactually have demand for that
debt.
Bill (14:17):
The bond market, investors would say I need to be
compensated for this risk ofheavier funding.
Now, compensated for this riskof heavier funding.
Now you know, if you look atgrowth in the economy 3% a year,
that type of growth, 2% to 3% ayear could the US government
fund a trillion dollar deficit,have a trillion dollar deficit
into perpetuity?
Sure it could, right, Justbased on the size of the economy
(14:39):
.
Does that mean it's responsible?
No, it's irresponsible, right,and we see it clearly that way.
But is it at such a point wherethe bond market is extracting a
pound of flesh for it?
Not yet, but if there is amajor change, I think we would
see that.
Ryan (14:57):
The other thing I wanted to ask about with respect to
inflation you brought upinflation a minute ago is how
tariff policies you think wouldimpact inflation.
You know, of course you put atax on, it's passed along to
somebody and it seems like abipartisan agreement that
(15:19):
tariffs are.
Now, you know, maybe we'regetting a little bit more trade
protectionism in our overallpolicy from both sides.
Maybe we're getting a littlebit more trade protectionism in
our overall policy from bothsides.
It's interesting that none ofthe Trump tariffs on China were
actually rescinded by the Bidenadministration and even more
were put on.
So it's not necessarily apolitical discussion about who
wins the election.
It seems like both are going tohave tariffs.
(15:40):
So my question for you is, as abond manager, as you think
about the impact on inflationand therefore rates, potentially
, how do you think about tariffs?
Bill (15:50):
There's a number of ways to take that conversation, but I
think the best place to startis to go back to 2019, trump's
tariffs come through.
You go back to what occurred in2019.
Former President Trump's amarkets guy, like if he puts a
policy out there and the stockmarket starts to crater.
President Trump I thinkPresident Trump's a markets guy,
like if he puts a policy outthere and the stock market
starts to crater.
President Trump I think he's anegotiator.
He would look at that andlikely say, hey, the market
(16:15):
isn't digesting this the way Ithought it should or would.
But, more importantly, thenarrative around tariffs is that
you push tariffs through,prices go, surge higher and
there's no doubt about it.
We've looked at the data.
We know the data that when youpush tariffs through, it is
inflationary.
But it is a one-timeinflationary thing, right?
You don't.
(16:36):
If you raise, if you put atariff in place and you assume
prices increase to offset thattariff, it happens.
It's, they're recovered and itdoesn't go up every single year,
unless the tariff is changingevery single year, right?
Yeah, the other thing is thatthere's a presumption in most of
what I've seen that's writtenabout tariffs that when you have
a tariff, a company immediatelytakes the price higher and
(16:57):
offsets the tariff through thathigher price.
That's not what we saw in 2019,right, what we saw in 2019 was
companies attempting to take theprice higher but unfortunately
unable to take the price tofully offset the tariff, and
profits actually would comeunder pressure.
And many companies look toreact to move production, to
find ways to mitigate the tariff.
(17:18):
And so I don't believe it's aslinear or black and white as the
narrative would have onebelieve.
I think that if you had asignificant or sizable tariff
come into the market, you wouldlikely have profits coming under
pressure.
I mean, we're back into a midtwo and a half type percent
inflation environment.
The idea that the consumer willjust willingly bear the brunt
(17:41):
of a full tariff, I think, is areal stretch in my opinion.
I think that some portion ofthat would be borne by the
companies through profits, lowermargins, if you will.
I think some portion of thatwould be borne by the consumer
over a period of time, but it'sa one-time effect.
Now I do think it still wouldshow up in inflation.
(18:04):
But the question is, you know,is it perpetual inflation?
Because you put implemented thetariff, and my thinking, at
least on this would be it wouldbe temporary, because you would
push it through and it's not anongoing escalation right.
It's a one-time type tariffthat gets implemented and then
exists.
Ryan (18:23):
So it seems like part of the incentive for adding tariffs
would be to maybe have somere-industrialization, some
shifting manufacturing back tothe states or at least back to
some place where there was notariff in place.
And would that be part of yourthinking with that as well?
Bill (18:40):
Absolutely.
I mean that's one of the mainpremises of the, you would
imagine, of the policy right.
Shift production back andcreate jobs domestically.
Those are clearly drivers.
Also create a revenue sourceback to the US from those
tariffs, from the businessesthat are producing elsewhere,
for example.
I think those are all parts ofthe policy discussion.
Ryan (19:06):
Yeah, okay.
So if you're a financialadvisor watching the podcast and
are listening to the podcastand you're thinking about how to
position from a durationperspective, what would you say
to that?
Bill (19:15):
Today, as we sit here around 4%, slightly above 4%,
with a realistic sort ofexpectations for the Fed cutting
cycle that's underway.
When we look at that, we'reback to an environment where
stocks and bonds are notbehaving in a way that they're
(19:36):
correlated anymore.
The old traditional reactionfunction is seemingly back in
place, where bonds are offeringsome protection against stock
volatility.
I think that's a very importantconsideration, and so for us,
ultimately, I don't think thatwe have to be interest rate
strategists anymore.
I think we're in an environmentwhere you can own the bond
(19:57):
market, and when I think aboutthe bond market, the duration of
the bond market, which is yourinterest rate sensitivity, lives
around six years for the bondmarket.
So when we look at theBloomberg Aggregate Index, which
is inclusive of treasuries,corporates, securitized debt,
core, fixed income right, thatduration is around six years.
(20:18):
I don't think investors realizewhat their reinvestment risk
looks like today.
They've ridden these reallyshort-term rates at a very high
level now for a nice period oftime, but I think, as we look
forward over the next 12 monthsand perhaps we are a later cycle
we do believe that the Fed isgoing to continue to cut.
(20:39):
We're expecting as many as sixcuts by the end of 2025.
If you really sit there inultra-short investments, you're
just going to ride that yielddown in most traditional forms.
Of course, there's differentways bond fund managers, active
managers try to mitigate thatrisk, but in the traditional
sense, the way most investorsare sitting in I think the last
(20:59):
number I saw was close to $6.5trillion in money market
accounts they're not positionedin a way that they would be
mitigating some of thatreinvestment risk.
So the way we've thought aboutit is owning a duration where
the bond market is of around sixyears seems like a very
reasonable set of you know sortof investment policy decision to
(21:22):
have today.
Ryan (21:23):
Are there any specific sectors of the bond market that
you think are particularlyattractive?
Bill (21:28):
There's really not an always or never in my mind when
it comes to the bond market.
What we try to do is we lookacross different sectors and we
say where's the value?
These are a lot of relativevalue trades that are taking
place.
So even in pockets of themarket that we may not love, we
still find value in differentcorners of that market.
Pockets of the market that wemay not love, we still find
value in different corners ofthat market.
I would say for most investorstoday, whether it's in taxable
(21:50):
or tax-free, given whereinterest rates are, there's no
reason to chase a lot of riskbecause you can earn a really
attractive level of income inthe bond market that you haven't
had in a very long period oftime, in our country at least
and you can do it withrelatively safe fixed income.
So when we look at core fixedincome things like whether it's
(22:11):
corporates or securitized debtand even Treasuries as a safe
haven, for example I mean youcould really construct a nice
portfolio and even in municipalbonds with tax-free, high
quality, a really nice durableset of bond portfolios that you
can create without taking a lotof excessive risk, and I think
(22:32):
that's really important Now inthe riskier pockets of the bond
market.
Things like high yield, forexample, or even senior loans,
those types of ideas, those canmake sense.
But I think those make moresense today in an equity bucket,
meaning I can de-risk equityexposure by using some of those
opportunities where there'sstill a compelling equity-like
(22:57):
return that's capable of comingout of some of those pockets.
So I think you can reallybifurcate the market into safe
and risk and really use yourbond money for safer fixed
income and look to use thatduration not to swing for the
fences.
I often tell people they say,hey, should I buy this really
long duration?
(23:17):
That's like buying a small capstock.
Right, you're picking a veryspecific point on the yield
curve.
You're hoping for a veryspecific outcome to make money
in that point of the curve.
What we're saying is you canown the bond market today and
you can reduce your reinvestmentrisk by doing that or making
sure you're with a managerthat's working actively to do
that.
Ryan (23:36):
So you're an active manager and you mentioned
considering high yield or someof the below investment grade as
an equity substitute in anasset allocation.
When it comes to those,specifically those parts of the
bond market, but also, I think,probably corporate and the other
the other sectors as well,municipals Managing risk is
really important, right?
(23:57):
So, as an active manager, whatare some of the most important
levers that you pull as you'rethinking about managing risk?
Bill (24:05):
The first thing, particularly if we think about
it through the lens of thecredit side, it's a really deep
understanding of the businessesthat we lend money to.
When we look at these companies, we're really thoughtful about
what could go wrong.
So if I'm buying a stock,there's a lot of embedded hope
and expectations into whatfuture earnings will be, because
I need that stock to go higher,to be driven by something.
I need a catalyst to drive thatstock higher.
(24:25):
Our CIO, Dave McGarrel, talks alot about what's the catalyst
right?
When it comes to the bondmarket, it's more about risk
management.
So we have to be thinking aboutwhat could cause us to lose
money, because our upside islimited typically to earning our
coupon and getting our moneyback.
So we're very thoughtful aboutwhere the volatility could come
from.
So that's where it comes back totaking those hundreds of
(24:48):
earnings calls financialmodeling.
Even through all the workthat's done across all the
various sectors, whether it'ssecuritized sector, municipal
sectors, corporate sectors, allthe way through.
It's that deep understanding ofwhere the risk resides.
And you know we're not.
Our base cases aren't built onhope and dreams.
If you will that really, whenyou see stock multiples expand
(25:11):
that you really need to.
You need those earnings to comethrough to support those stock
multiples.
For us, we're trying to ensurethat when we're buying a bond in
any capacity, that it's adurable investment, that we're
not taking an excessive amountof risk relative to the return
potential in that bond, and thatcomes through an enormous
amount of work that has to bedone upfront to ensure that
(25:32):
we're protected.
Ryan (25:34):
What I'm hearing you say is, in particular, security
selection is really where youcan do that work to know those
businesses and maybe theduration positioning key rates,
something like that, is alsoimportant.
But for the funds that youmanage, would you say that
security selection is really thekey, very important.
Bill (25:53):
We're going to use all the tools that we have.
So each one of these thingswhether it's duration management
, credit selection,diversification, liquidity each
one is a lever that we can pullas an active manager to try to
drive value through thestrategies that we manage.
Great.
Ryan (26:10):
Well, time's flown by once again, Bill.
Last time you were on, by theway, you mentioned this book
about Teddy Roosevelt, River ofDoubt, and I read that book
Really fascinating story.
Put you on the spot again,Because I'm always looking for
something to read.
What would you recommend myselfand the listeners to the
(26:32):
podcast?
What should we check out next?
Bill (26:34):
One book that I would definitely recommend is David
Horowitz's A Radical Son, aGenerational Odyssey, and it's a
great book about his journey asa 1960s revolutionary to a
conservative thinker.
So is that an autobiography?
Ryan (26:50):
Yes, it's an autobiography .
Okay, fascinating.
We will add that to the ROIpodcast reading list.
Bill, thanks for that bookrecommendation.
Thanks again for coming on thepodcast.
Hopefully you can come backagain.
Thank you, ryan, great to bewith you again, and thanks to
all of you for joining us onthis episode of the First Trust
ROI podcast.
We'll see you next time.
Popular Podcasts
On Purpose with Jay Shetty
I’m Jay Shetty host of On Purpose the worlds #1 Mental Health podcast and I’m so grateful you found us. I started this podcast 5 years ago to invite you into conversations and workshops that are designed to help make you happier, healthier and more healed. I believe that when you (yes you) feel seen, heard and understood you’re able to deal with relationship struggles, work challenges and life’s ups and downs with more ease and grace. I interview experts, celebrities, thought leaders and athletes so that we can grow our mindset, build better habits and uncover a side of them we’ve never seen before. New episodes every Monday and Friday. Your support means the world to me and I don’t take it for granted — click the follow button and leave a review to help us spread the love with On Purpose. I can’t wait for you to listen to your first or 500th episode!
The Breakfast Club
The World's Most Dangerous Morning Show, The Breakfast Club, With DJ Envy And Charlamagne Tha God!
The Joe Rogan Experience
The official podcast of comedian Joe Rogan.