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Interest rates: ‘Buying the dip has been dangerous,’ strategist says

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Michael Kushma, CIO of broad markets fixed income at Morgan Stanley Investment Management, joins Yahoo Finance Live to discuss how investors can navigate the current market volatility amid rising yields, record inflation, and interest rates.

Video Transcript

- Welcome back, everyone. The major indices still in the red, but off their session lows at the moment, ahead of a busy week for the markets and the economy. Joining us now is Michael Kushma, Morgan Stanley Investment Management CIO of broad markets fixed income thank you so much for joining us. So a lot of people wondering-- they're seeing, obviously, tech stocks particularly getting hit hard as we see the NASDAQ performing poorly today. About this buying the dip mentality, what should people be thinking as they approach this period?

MICHAEL KUSHMA: Well, buying the dip makes a lot of sense when there's relatively low volatility. So the market has-- there's a bad piece of data, market dips whether it's stocks, bonds, commodities, but there's no sense of worry about a continued trend deterioration in that price. So you're in a trading range, those kind of environments are good for by the dip.

However, in the case of interest rates, which are on a steady upward trajectory for a sustained period of time now, buying the dips has been dangerous. You know, yields rise and you buy it and then the yields go up again, credit spreads have been the same way. They narrow then they widen, they narrow then they widen. So it's difficult to do that when you have a belief or there's a worry that markets are trending the wrong direction. And there's no sense that the trend is over in an adverse sense.

- And, hence, BlackRock warning against dip buying today and adding to it the Federal Reserve is likely to choke off the restart of economic activity and only change course when damage emerges. Michael what do you make of that sentiment? And if they're waiting for damage to emerge, what is it?

MICHAEL KUSHMA: Well, they need to slow the economy down-- I mean, basic macroeconomics that they follow and most people follow-- if you want inflation to fall, aggregate economic activity has to slow down, barring a sudden drop in inflation no-- from nowhere, whether it's the supply side wages, it's just-- that's not likely to happen. What we're likely to see is weaker economic data, which drives down economic activity, which drives down wages, which drives down employment, which then lowers inflation as individuals, corporations, households buy fewer goods. So in that sense for the Fed to achieve its lower inflation objective, it has to make people more worried about the future as the economy slows down. The question-- the big question is can they do with a so-called soft landing, so they don't really go into recession and inflation gradually falls with a slow downward trajectory in the economy. That happens sometimes, but not usually.

- Will it happen here?

MICHAEL KUSHMA: It's going to be a challenge because inflation is at decades high and the economy had a huge head of steam in 2000-- end of 2020 through 2021. And that head of steam is coming off now clearly, but it takes a lot to slow once inflation starts going up the way it has. And we're still challenged on the supply side and the logistical end. We see reports out from various industries they can't produce as many goods as they'd like with the shortages of key components or inputs. So it is a challenge specifically because inflation is so high.

And I'll caveat that with the following point that makes it even a stronger point is that inflation can't just fall, it has to fall meaningfully. So we have a CPI release out on Wednesday and markets expect-- or the market forecast is for the core PC number to fall and hopefully it will. Because if it doesn't fall, then the Fed may actually have to tighten more down the road.

- And as you mentioned, there's CPI data coming out this week, as well as PPI as well, and obviously you also have a number of bank earnings that are due out this week that markets are really bracing for. What are your expectations then when it comes to bank earnings and how that might affect market sentiment?

MICHAEL KUSHMA: I don't have a strong view on earnings on the equity market. The economy has been strong, interest rates have risen, banks should be benefiting from higher interest rates on the loans they make. So from that perspective, earnings could be better. But in terms of the aggregate performance of banks, I don't know.

Certainly markets are worried about earnings generally speaking across industries going forward in this key period for Q2, Q3 earnings. And it will be a big important number to-- not just for the health of the equity market, but health of the bond market. Because the weaker the equity market is, the more likely it is that US Treasury yields fall from current levels.

- And, Michael, given all this uncertainty we've now discussed the last couple of minutes, what's your strategy?

MICHAEL KUSHMA: The strategy is to keep some powder dry. We are in a deteriorating market in terms of economic-- activity is slowing particularly on the good side, the service sector holding up a lot better. So be conservative in terms of your exposure to risky assets. Risk sentiment is very low today. That's a reason-- a potential reason to buy the dip because sentiment is so bad. But, on the other hand, there's been a continuous deterioration, and economic growth has been weakening steadily, and inflation has shown no sign yet of falling materially. So you want to be a bit cautious here in the bond market and not take on too much risk today. And be ready for when we get a little more clarity, hopefully soon, about the trajectory of the economy and, most importantly, inflation, which will decide what the Fed does in the next 6 to 12 months.

- So to that point then, over at least interest rate-sensitive assets, where do you see the best opportunities?

MICHAEL KUSHMA: Well, we focus on areas that are linked to the US households. The US households have had a rock solid balance sheet. The benefited from very low interest rates for a long time. They've been in a lock in low fixed rate mortgages until the last six months or so and that is really help them. They've got a lot of cash, savings rates are very-- [INAUDIBLE] very high, savings balances are very high.

So lending to households with relatively clean balance sheets, as strong as they've been in a long time, that this bodes well for their able-- their ability to weather an economic recession or even a modest economic downturn. So it's like buying those, sort of, floating rate assets linked to the short-term interest rate, which has been rising, relatively short maturity, five years and in, and earning a decent yield for now while waiting for opportunities on longer fixed rate maturities.

- All right, Michael Kushma, really appreciate you, sir. Thanks so much.