Fed now 'skewed' more toward a dovish stance on rates
While stocks (^DJI, ^IXIC, ^GSPC) are ultimately having a good day following the Federal Reserve's decision to hold interest rates, Treasury yields (^TYX, ^TNX, ^FVX) remain mixed. Harris Associates Co-Head of Fixed Income Adam Abbas sits down with Yahoo Finance in-studio to comment on how far the Fed still is from accomplishing its chief inflation goal despite all the good news, highlighting volatility in the bond market.
"My expectation over the next 12 months is as we get closer and closer to the actual cut cycle and we can really lock in on inflation, it is going to come down and stay down and that the labor market is okay," Abbas says. "It's going to be somewhere between 3.8%, 4.25%, but there is no big spike in unemployment. Then the treasury volatility will be lower and more range-bound as we just have more visibility and confidence... in the outcomes here. That's good for all markets."
For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.
Editor's note: This article was written by Luke Carberry Mogan.
Video Transcript
JOSH LIPTON: As stocks closed at records, Treasury yields pulled back after the Fed decision and Fed Chair Jerome Powell reiterated the outlook of three rate cuts this year. Joining us now is Adam Abbas, Harris Associates co-head of fixed income and portfolio manager. Adam, it's good to see you.
ADAM ABBAS: Good to see you.
JOSH LIPTON: So listen, you heard us talking Adam, it is risk on-- right now we've got a record close for the Dow, the S&P and the NASDAQ. So investors clearly like what they heard. But what did you make of what the Fed did and said today?
ADAM ABBAS: Well, I think Jerome did a really good job today. I think there was a tendency. There was a risk really that he would come in and speak a lot about the last two inflation prints, the hotness, maybe even pivot hawkishly from a really dovish meeting in December. And in the risk there is that we just have a Fed that's flip flopping. You lose credibility and what he said. And I think he said correctly was, we had two data points.
Some of that was seasonal. We're going to wait for more data points to confirm a trend. And he gave us evidence that the labor market can be strong as well. And that there's no reason to change estimates. You saw the dot plot still had three cuts. And I think all of that was appropriate. I think he did hedge with a little-- we are data dependent if inflation were to remain sticky, we would make some changes.
If the labor market started to break down, we saw a tick up to 3.9%, we would make some changes. But importantly, he really didn't change his forecast and he reiterated to the marketplace, why? And I think that was a great job by him.
JULIE HYMAN: So do you share the positive vibes that we were hearing about from our Josh Schafer? I mean, that was mostly seen on the equity side to be clear. But the idea that the Fed has done it that they've engineered this thing and that it's worked?
ADAM ABBAS: I think it's too early-- I think it's too early until we're down to the Fed mandate of let's say two or above just above two. I think it's too early to declare victory. But again, I think this is the right decision. I think he gave us evidence that he leaked out. I don't know if you guys noticed that he gave us the current PC print that was intentional to basically tell the marketplace, hey, those were anomalies more than they were at the beginning of a trend for inflation.
He gave us-- he talked about the labor market supply. Supply is coming back, can protect from a big movement higher and unemployment. So he gave us all the right data to imply that they're not going to really shift course and that they're ready to cut when you get inflation below let's say 2% and 1/2%. And if you think about the skew here in the framework, if labor market goes bad, we're going to cut. If inflation comes back down from those two anomalies, we're going to cut.
And we're not going to raise rates from here. So we are skewed to a dovish stance.
JOSH LIPTON: I'm looking at-- there is a 10 year right now. So 4.3, call it. Where do you think the range is there, near to intermediate term. We were talking to another fixed income strategist earlier in the show. He actually thought you were rangebound here, 3.8 to 4.3, what do you think?
ADAM ABBAS: I think that's right. I think the 10 year is probably not too far off where it should be. And at Harris, we look out three to five years. We think fair value is around 3 and 1/2% to 4.5%. Where I think it's attractive right now is in the belly of the curve, the five and the seven year part of the curve. You can get real yields for, let's say, five years above 2%.
And again, if you think the Fed will meet its inflation objection, you should see what's happening today, which is a curve steepening. And it'll benefit the five year, seven year part of the curve. And it'll hurt the longer end of the curve. So we like to be in that 5 to 7 year part of the belly. We think inflation, they'll have success. It will come down. Now timing is the question mark here.
And if you notice he didn't say, yeah, we're going to cut. But we're not going to cut necessarily over the next two months, it may take six months. We may be patient. And that's the last variable here. And I think that's important, he's given himself that flexibility. Give himself a little out if some new things are introduced to his framework that may cause them to be a little bit more hawkish.
JULIE HYMAN: Does that also imply then just not a lot of treasury market volatility this year if you see this?
ADAM ABBAS: I think so. I think what-- my expectation over the next 12 months that is as we get closer and closer to the actual cut cycle and we can really lock in on inflation is going to come down and stay down. And that the labor market is OK. It's going to be somewhere between 3.8% and 4 and 1/4. But there is no big spike in unemployment. Then the treasury volatility will be lower and more range bound as we just have more visibility, and more confidence the market has more confidence in the outcomes here. That's good for all markets.
JULIE HYMAN: Besides the fives and sevens, what's exciting in, I mean, that implies that the fixed income market is not as exciting right now.
ADAM ABBAS: Sure.
JULIE HYMAN: Which has pros and cons. But are there places that you think are being overlooked right now?
ADAM ABBAS: Well, I don't-- I don't necessarily think overlooked. But I think this might be a boring answer, but if you can get 3% real yields in high quality investment grade corporate credit. And we believe that inflation is going to come down to 2 and 1/2%. And there's not structurally sticky inflation that's a lot higher than that. Then real returns of 3% annualized in asset class that defaults less than 1% annually. That seems really interesting to me.
So maybe you can classify it as boring--
JULIE HYMAN: Stability is exciting--
ADAM ABBAS: --but interesting to me.
JULIE HYMAN: --I guess.
ADAM ABBAS: That's exactly right. So I think it's not the time to really be too adventurous and go reach the lowest quality parts of fixed income. Here I think the most attractive risk adjusted returns really are in high quality fixed income, US treasuries, agency backed securities over the next three years.
JULIE HYMAN: Adam, great to see you.
ADAM ABBAS: Yeah, great to see you guys.
JULIE HYMAN: I'm glad you could be here today.
ADAM ABBAS: Yeah, great to see you here.
JULIE HYMAN: I appreciate it.
ADAM ABBAS: Thanks.
JULIE HYMAN: Adam Abbas of Harris.
