Michael Kushma, Morgan Stanley Investment Management CIO of Global Fixed Income joins Yahoo Finance Live to break down how markets are faring following the U.S. Capitol riot last week.
- As we consider the changing administration in Washington, of course, a lot of folks are trying to consider the prospects for some kind of fiscal stimulus and how large it could be. One of them is Michael Kushma. He's Morgan Stanley Investment Management Chief Investment Officer of Global Fixed Income. Michael, it is good to see you as always. And so, as we look ahead to fiscal stimulus, we had one economist on with us yesterday who suggested even a package of $2 to $4 trillion that might include infrastructure, for example.
Does it matter to the markets-- there was a lot of debate about the size of the stimulus checks in the last package. How much attention are you paying to how large a package might be and what that could do to the markets?
MICHAEL KUSHMA: It's a good question. We really don't know what the Biden administration's priorities are going to be with regard to support for the economy during the pandemic and then the second round in terms of infrastructure spending and other spending initiatives to help grow the economy post pandemic. So we'll have to wait and see how those are revealed over the next several weeks and months and, of course, how they get those programs through the Congress when they have a very slim majority in the Senate.
Our baseline scenario is something like $500 billion to $900 billion, which would take the total package to where we were back at the end of October when they were discussing a $1.8 trillion package, less than what the Democrats originally wanted but more than what the Republicans wanted, which [INAUDIBLE] not happening. But we got the $900 billion earlier this year, late last year. And that is a very good holding for the economy in the near term, and we'll have to wait and see what comes next. But it should be fairly significant, which changes the narrative of what fiscal policy is going to do for the US this year. Prior to the latest package and the likely coming up package, we were talking about fiscal tightening in 2021. Now we're looking at a substantial fiscal easing, which is very different from the rest of the world.
- And Michael, I would argue that speculation around the next round of potential stimulus has fueled really a run in the 10 year yield. The 10 year yield is up for six straight sessions. It's gained about 25 basis points during that span. But the stock market continues to go up. What level do you think on the 10 year that equity investors start to care about that move in the 10-year?
MICHAEL KUSHMA: Well, I think it's very important to decompose the changes in the 10 year yield to its inflation component and [INAUDIBLE] real rate component. And I think, as long as your yields are tracking nominal inflation higher, then the real interest rate's not changing. And that's not a terrible thing at all. It's reflecting higher expectations of growth and inflation down the road, which is not bad for equities or risky assets or high yield or things like that.
If real yields start rising, particularly because there's expectations that the Fed is going to move to tighter policy or less accommodative policy earlier than expected because fiscal policy is going to turn so much easier, then that is a bit of a worry sign. In other words, fiscal policy could start moving to blunt the impact of fiscal policy in an anticipated sense. I think that's what the bond market is trying to figure out, is it's reassessing the probabilities of how monetary and fiscal policy are going to interact in the months and years ahead.
And right now, given vaccines, given the extra stimulus that things are looking up for a better economy down the road, which means higher interest rates-- it's a reflection of good things happening, not bad things right now.
- Important point-- I just want to follow up on that, Michael-- an important point you mentioned there on the Fed. Do you think the Federal Reserve will spook the market this year and signal later this year that in 2020, over the next maybe 18 months, they will start looking at potential rate increases? Because we had Raphael Bostic, Fed member, yesterday signal-- I would say-- slightly signal that's a possibility.
MICHAEL KUSHMA: It's a very good question. I think a lot of it has to do with, I would call, the old guard versus the new guard at the Fed, the ones who are really keen about the new monetary operating procedures and focusing on outcome based measures, letting inflation run above 2% to get it to average 2% versus I would call the old guard, who want to run monetary policy more similarly to how it's run in the past, don't want to take risks with inflation getting too high.
But that is an important question they have to answer, and I think the market's beginning to tilt the probabilities that, given how much fiscal policy is going likely to be eased, then discussing tapering at some point or becoming more clear about the plan for tapering is going to need to be discussed. And that's probably at the June meeting in 2021 this year when a decision with more information in hand by then will have to be made about, do we just hold the line and just not talk about it till the end of the year when we really think we need it, and have we learned the lessons of 2013 when we had the taper team chairman Bernanke was chairman. And we had a 140 basis point back at 10-year yields in four months on the back of that noise, which turned out to just be noise because the Fed did not start tapering right away.
- Michael, we're really focusing here on what's happening with the Fed and what's happening on the Treasury curve obviously with good reason. But I'm curious for your thoughts on what's happening in the corporate debt market and if any dynamics there might change as a result of this back up we've seen, especially again in the 10 year now well above 1%. And the ease with which companies came to market last year was certainly a big part of helping them shore up their balance sheets. Do you expect that to change at all next year?
MICHAEL KUSHMA: It's a good question. Right now, the corporate bond market is behaving well with the ride back up in yields. Spreads are hanging in there, getting a little tighter year-to-date and so far in January. I think with the corporate bond market we'll be most concerned with is the pace of increases in yields. If yields go up very quickly because people are anticipating the Fed becoming more hawkish at some point later this year, that might undermine some confidence in the bond market like a temper tantrum 2013 when credit spreads widened, as people worry, the markets worried about rising interest rates and tighter monetary policy.
So right now everything looks OK because as long as rates are driven higher by a stronger economy, improve corporate cash flows that should be fine for the corporate bond market. This corporate bond market is in no way undervalued at the current point. But we would argue it's not necessarily overvalued given that it's around historical averages. But given the strength of the economy likely to be seen, corporate bond spreads should be fine.
- Interesting. Michael Kushma, we're going to check back in with you soon I am sure. Happy new year. It's good to see you. Morgan Stanley Investment Management CEO of Global Fixed Income, thanks Michael.