Economic data and central bank interest rate decisions continue to be major drivers of market activity this year. But when will the Federal Reserve begin its cutting regime? This is the question traders and portfolio managers are eagerly trying to predict for. Scott Kimball, chief investment officer at Loop Capital Asset Management, is in the camp that markets won’t see any Fed interest rate cuts in 2024, contrary to many forecasts that expect cuts to begin in September.
In this episode, Kimball also discusses how it’s been an atypical summer for markets with higher-than-usual activity and looks at what he’s seeing across bond issuance.
He also drills into the recent US stock rotation; what it means, where he is seeing parallel moves across the bond markets, and whether he’s concerned about the maturity wall in the credit markets.
Finally, Kimball unpacks why he thinks markets are underestimating the possibility of an escalation of the wars in the Middle East and Europe and exposure to geopolitical risks.
Interview Transcript
Jo Gallagher Welcome to Trader TV This Week, your insight into your trading desk and prepare for the week ahead. I’m Jo Gallagher today and joined by Scott Kimball at Loop Capital Asset Management to discuss the main topics and events leading this week. Scott, welcome back to the show.
Scott Kimball Thanks for having me.
Jo Gallagher To kick us off, what’s informing your investment decisions going into this week? And what have you seen from trading activity so far this summer?
Scott Kimball Overall, it’s been an active summer. Typically we hear people in the bond market reference the summer doldrums. People are on vacation. Children are out of school. All the things that can pull somebody away from their day job. However, we’ve seen a lot of new issuance in the corporate bond market, and we’re seeing a lot more secondary market activity, which we think is particularly interesting. And that has really drawn investor attention back towards the relationship between the new issue bonds that are being printed at a very high volume, combined with where the secondary positions are on their books.
So we’ve seen a lot of activity and a lot of volumes on the M&A front. We’ve seen some pretty big stories coming out, a lot of potential deals, I think, most notably to the investment grade bond market, has been Paramount, a content distributor that’s in play for an acquisition. We’ve seen the deal both ebb and flow between highly likely to completely falling apart. And we’ve seen corporate bond spreads in that name alone move between 50 and 75 basis points in the context of just one day. There’s a lot of discussion about, you know, what’s driving the markets, what’s driving interest rate volatility, what’s driving cross-sector trades between things like mortgage-backed securities and corporate bonds and high yield in emerging markets?
We really think the key driver now is still the basic U.S. economy. It’s what’s going on with the Fed and those expectations. We’ve seen some signs of inflation abating, but we just recently received the new information where GDP came in above consensus, its price to the upside.
So we think that the lion’s share of what’s going to dominate the fixed-income market continues to be the domestic economy. Certainly, you had the opportunity to view a tremendous amount of information in what now is the futures market that covers literally everything. And you can look for big swings in market opinion on things like the U.S. election. But the biggest thing that’s really driving volatility and driving flows is interest rate expectations and that ties directly to the Fed monetary policy and the readings we are getting on things like inflation.
Jo Gallagher I know your focus is fixed income, but there’s a lot of attention being paid to the US stock rotation and whether the large-cap dominance is starting to slip. What are your views there?
Scott Kimball Well, I wouldn’t be a lifelong fixed-income guy if I didn’t have an opinion on equity. I think we talk about these things as though they’re these two distinct markets. But we start talking about equities versus, let’s say, corporate credit spreads or high-yield bonds spreads.
There is a lot we can infer from both markets. And they do somewhat mirror each other in many ways in the context of the equity market, valuations are giving you a perspective look on return. In the fixed-income market, the narrowness or expansion of corporate credit spreads gives you insight into the potential return opportunity relative to the risks we see in the bond market. I do think the valuations in the large part of the equity universe, large caps, particularly with the AI trade, have gotten a bit rich for some investors, and they’re starting to look elsewhere in the marketplace for value. That might mean mid-caps, and that might mean small caps.
That could be on the value side. It could be on the growth side. It’s not tremendously different than what we saw in the fixed-income market. A lot of the S&P 500 type issuers, the big benchmark type names, are trading fairly tight on a spread basis, or all-in yields might still be attractive, but the spread basis that incremental return looks a little bit thin, all things considered. So you’ve seen investors look elsewhere during yield.
They start looking at smaller issuers off the run issuer’s secondary paper, but also things that are outside the public domain. For instance, private credit. You know, a lot of flows going from the traditional bond market into private credit, looking for more incremental yield, but certainly for more diversification and maybe to get some more specific intentional credit risk that references a smaller basket of issuer they can sort of hand-pick, which is not tremendously different than what we’re seeing in other asset classes.
Jo Gallagher We also have the Fed interest rate decision coming up. What is your base case for cuts this year?
Scott Kimball So I’ve been in the camp that we’re not going to see a Fed cut in 2024. As always you have to prepare to be incorrect. But I’m going to stick with that call and there are a few reasons why but I think principally we look at the GDP print we recently received 2.8% positive U.S. growth it doesn’t scream cut. We start looking at the inflationary frontier on the backdrop.
Yes, there’s been disinflation and prices have come down in aggregate some very high levels in certain areas. But I think the Fed’s done a particularly good job of being in tune with the fact that the U.S. economy is 70% domestic consumption. If you start talking to consumers about the price pressures they’re feeling, where they’re spending their money, you have energy prices, you’re on road trips, they’re going to and from work, their daily commute, those are up significantly. A lot of that geopolitical very difficult for the fed to tackle something like that. You start looking at food prices. Look at beef prices trailing over a three-year period.
I think the annual compounded rate for that is 15% intuitively 60% overall increase post-Covid. You start looking at the overall spending requirements for housing. Yes, there’s been some downshift in some softness, maybe in some rental markets, but overall still very strong. On. And, you know, the big thing we look at is health care expenses as well. Another area where we’re seeing some pressures, you know, things that are difficult for the Fed to wrangle. The Fed really spent the last decade fighting to keep deflation out of the US economy. They were trying to inflate things. They may have overdone it. However it happened, we had a pretty big surge in inflation. And while it has abated and has come down some, we think from an interest rate regime perspective, the next ten years, the Fed is going to struggle to keep the lid on the inflationary jar.
Jo Gallagher, Are you concerned about the pressure that this high interest rate environment is having on bond markets and is forsaken maturity wall, or is that just a 2025 problem?
Scott Kimball So I’ve been hearing about the maturity wall every year of an over 20-year career. I think this is a key thing to look at. Your last question on the Fed, they’re also very in tune with the health of the credit markets, and that is an important leading indicator for them. As long as credit markets are functioning and capital is available, and companies are able to refinance their debt in a way that sustainable for their business. I think the reality is the maturity wall is going to be next year’s story yet again. I think that the overall health of the bond market is on a very firm footing. I can’t speak for all of my colleagues, but if I think back over the last 10 or 15 years, I’m pretty sick of buying bonds with one and two coupons. We have both nominal yield and real yield back into the U.S. bond market.
So it’s an exciting time. It’s an attractive time. As long as we have interest rate stability like we’re seeing. I think you’re going to continue to see that the capital base supports credit markets. I think the Fed is also looking at that. I think there’s a two-way conversation that has to take place.
Yes, higher rates do raise borrowing costs. They do raise the cost of home financing for our consumers. But on the other side of things, we have savers in through the path interest rate cycle. When things were kept very, very low intentionally, you couldn’t really earn an interest rate consistent with the cost of living without going into parts of the risk market.
Now you have an attractive situation where whether it’s municipal bonds, agencies, corporate bonds, MBS, you can earn positive real yields in this part of the bond market and that’s a very attractive thing for savers and it is a shot in the arm for the U.S. economy.
Jo Gallagher What is a non-consensus view or a piece of advice that you would offer traders going into this week?
Scott Kimball Well, my most significant non-consensus view is I don’t anticipate a fed cut. I think we’ve seen the market pleading for an interest rate cut before the Fed even started hiking. As inflation does abate some there is a higher real yield component to the bond market that we think is here to stay, and we should probably be positioning for that. So I think more holistically about where to position bonds in the asset allocation model if you’re doing cross-sector trades or cross-asset class trades, you know equity valuations look to be pretty rich.
That’s not really a shock coming from bond guy. But I think at this point we can say that. And compared to the bond market, the long-term averages got so low with financial repression over the last decade-plus that they’re actually now in the upper part of their trailing 12 and trailing 36 trailing ten-year corridors. So from a valuation perspective, a steer towards fixed income is likely to continue.
But what can really cause near-term or weekly volatility surges or damage to the health of financial markets, we do think is geopolitical. We have a lot of different parts of the world right now that are running pretty hot in that regard, and the overall response from financial markets has somewhat shrugged it off.
So as risk premiums get lower and market valuations are getting higher, that incremental amount of risk you’re taking in your portfolios or putting into your trades becomes more exposed to the exogenous factors with higher potential drawdowns and more limited potential upside. So that’s something we would keep our eye on. In particular, I don’t think it’s nearly out of consensus, I just think it’s out of market pricing.
Jo Gallagher Thank you, Scott, for your insight and of course, you watching this been Trader TV This Week.
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