Why Rates Could Keep Rising

(upbeat music) - This is the markets. I'm Chris Hossie and today is Thursday, May 21st. I'm here in the Goldman Sachs trading floor with Phil Lee, who's had a real money rate sales within global banking and markets, Phil. Thanks so much for joining us. - Thanks for having me. - All right, I gotta ask. - Scythe, what is real money rate sales? - Yeah, a real money is basically, if you wanna keep it simple, it's the non-head fun side of clients. So we look after our banks, insurance, asset managers for the most part. - Okay, great, that makes sense to me. Okay, help us understand what's happening with rates 'cause rates have moved higher. What's going on inside the markets? - Yep, so rates, I wish there was a smoking gun answer for this. I think there's a variety of different things that are happening in the markets. One, our inflation risk, so oil tariffs, near-term AI cycles are adding to some of that uncertainty. And making investors less confident that inflation is going away from the Fed's mandate. And so I think that's keeping the Fed cautious and investors are asking for higher real yields. In addition, I would say that you've had a lot of resilience in risk assets and growth. And so like, we've seen equities do really well. We've seen other risk assets do really well. And so that part of the narrative is really, it's really held up better than expected. And I think that if growth doesn't slow materially, rates have to stay restrictive a little bit longer. You have to add in fiscal premium today in terms of, you see that people need to be compensated for holding on to more longer duration risk. And that compensation leads to higher rates, especially in the back end. And then finally, I would say, you have global spillover. So coincidentally, the UK and Japan are also having some of this slippage into higher rates. And so that's also spilling into the US markets as well, in US treasuries. - All right, so sort of a confinity of reasons. You've got inflation, you've got better growth. Interestingly enough, you've got some issues around the US government. And then you've got a competition from a bunch of other countries in terms of their rates going higher. And so US rates kind of go higher in sympathy. A lot to think about there. But you also got the Fed. And we've got a new chairman who's come in. We're going to have a June meeting. That'll be the first time for that chairman to opine. We went into the year thinking that the Fed was definitely going to cut. And we thought a new chair would be more dovish. Where do we stand with the Fed? - Yeah, I think at this point, I expect, and I think many do expect that the Fed will stay on hold for a bit. I think the base case has moved from, as you said, when and how much will the Fed cut to now, how long will they stay on hold? And that seems like the center case. I think that what's interesting is that we moved in February with two to three cuts priced in. And now we've kind of swung all the way because of the nature of the conflict. And some of the shock that's out there to actually hikes priced in. And so there's almost 30 bases going to cumulative hikes priced into 2027, which I think is a bit tough for the market. - Yeah, so inflation kind of keeps the Fed on hold at best, maybe even raises rates as the markets are suggesting it could. But you also mentioned the government, the need for investors to ask for a little bit more return in this environment, unpackage that for a little bit. Is there a big fiscal premium getting priced in here? Is that a bit of a story? - Yeah, I think when you look at, again, not only the US, but the UK, Japan, a lot of these countries are running deficits, right? Six to 8% deficits. And so for that, plus all the supply that's coming about. And that's sustainability. I think all of those concerns are making folks increasingly demand for more compensation to hold that risk as that uncertainty unfolds. And I think that that is, it's not that the markets are pricing a default risk per se. It's just saying that structurally, if that much supply is coming into play, and you need to kind of take account for that, and that should be compensated for that risk. - Yeah, no, it's a great point. You don't have to go all the way to a dark scenario in order to ask for more compensation, which makes a lot of sense. Okay, so we've covered the inflation side with the Fed. We've got the fiscal issues and better than there, the competition from other countries. - Let's slice into that growth question you had, though, because you were talking about growth accelerating, but at some point, rates go so high that they stifled growth. And we've had this 30 year above 5%. Are you worried at all that rates could stifle the housing market and the economy? - Yeah, that's a great question. I think everyone, all our clients will ask about mortgage rates. I think that you started to see that mortgage rate start to take up towards 6.5%, which is stifling, I think. And that's seen in some of the home sales, the slow down or the cool down there, and then, relatedly into kind of what home builders are doing as well. And they can't be building homes if the demand is not there if the sales aren't turning through the cycle. And so I think that that creates a gridlock and that is concerning. And now, logously, I would say, you have the consumer, which is, right now, I would even frame it in a K-shaped bifurcation, but at the moment, consumers are doing well in terms of the equity and risk assets performance so far. But I think our economics team have started to say that you should be worried about some of the personal consumption and the savings rates and things like that, whereby tax refunds are fading. You have the gas prices a much higher, you have healthcare subsidies fading as well. And so all of those things altogether are making the consumer weaker, and that's something to keep an eye out for. And I think that that's interrelated. - No, a good point. So you have these competing forces. Do you think rates are going higher or lower? - Yeah, I think it depends on part of the curve, but I think rates are going higher. And I think that I don't see, the main thing I would see is that, the backend is probably going higher still. We saw, at least on the desk, we saw clients looking at 5% in 30 year as a target zone to buy. Some did, it's the one higher. And so that goes back to that demand for more term premium or more compensation. And so it does feel like each time there's need for more compensation, more yield to kind of purchase more, but it does feel like all of the things that are coming up, whether it's treasure supply or other things, are going to continue to raise that rate. - Okay, given all of that, what's the trade? - Yeah, so again, I think if you bifurcate that out, I think it is a steepener. And I would say 530 steepeners, and you could do that in linear form, i.e. in treasuries, or you could do that in a vol conditional format. And the way to think about that is just more that, if the backend is gonna be a function of fiscal premium supply and just contends with a variety of heavy public and private sector issuance. And just uncertainty with fiscal trajectories, that is gonna go higher. The belly of the curve or front end even, I think is a little muted, like again, in February we were talking about labor market, AI, this intermediation, and the market was rallying and the market loved to be in receivers and other things like that. And I think that's where, that's where I think, especially like the fives part of the curve is where a lot of folks believe, and I believe, is pivot point four, buying. And so 530s is steepeners is my call. - And in sort of planning, let's see, the idea there, is that the five year yield stays the same, maybe even goes down a little bit, while the 30 year yield continues to rise. - That's right, so, and that's a bare steepener, where you expect the 30 year to kind of move higher than fives. You can see also that if where 30 years are, it's a bull steepener as well. If we just had some headlines for potential piece that might make the fives move a little bit and like people will buy that part of the curve. And so, I just think a steepener overall, bull or bear might be the right path. - So we started this conversation, you talked about how you talked to a lot of mutual funds. What does all this mean to a 60 40 portfolio manager? - Yeah, so I think obviously the 60 part has been doing pretty well, it's been steady. And I think that the 40 is where the concern is or where there could be a little more efficiency. And so when that would talk to some of the biggest money managers, I think the play there is a, to cite some things, it's a patience, it's investing in carry while waiting for macro uncertainty and macro clarity. And it's looking for ways to clip and wait along the way. Like, cannot make hero macro calls on these things, you just have to play it smart. And so when you, you know, when you, when you talk to some of these larger asset managers, I think it's been pretty consistent. and it's been a, I'll take a quote, a dynamic patience. - Dynamic patience. Two words that really sum up this conversation very well. Thanks so much Phil for taking the time with us. - Thank you very much, appreciate it. Go next. - Yeah, go next. That does it for this week's episode of The Markets. I'm Chris Hussie. Thanks for listening. (upbeat music) - The opinions and views expressed herein are as of the date of publication, subject to change without notice and may not necessarily reflect the institutional views of Goldman Sachs or its affiliates. The material provided is intended for informational purposes only and does not constitute investment advice, a recommendation from any Goldman Sachs entity to take any particular action or an offer or solicitation to purchase or sell any securities or financial products. This material may contain forward looking statements. Pass performance is not indicative of future results. 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