Hello and welcome to The Download. I'm your host, Dave Richardson. We are joined by our good friend, Andrzej Skiba from BlueBay Asset Management in the US. Actually, Andrzej, we had a fabulous opportunity to catch up. You were up in Toronto, and we were able to go out. What did we have? We had carbonated sparkling water, something along those lines.

I think that's the official line.

That would be the official line. It was fantastic to actually spend some time with you face-to-face and catch up. You can share it with the audience, you're doing very, very well.

Always pleasure to speak to you, Dave. Yes, it's been definitely a good environment for fixed income. We have a variety of clients that are relieved after a few difficult years for the asset class to have one with plus signs next to their performance and heading towards double digits, even potentially, in our opinion.

For those who have been listening to you before on the podcast, as much time as you've spent in the business and as sharp as you are, it’s very difficult to pin exactly what and when the return is going to be, when things are going to turn. But you painted a picture for when we could see a fairly positive environment for fixed income. And sure enough, that's what's played out. For our more conservative investors, investors looking for income, investors using bonds as a diversification tool, aside their stock portfolios, it's been a really nice first few months of the year.

Absolutely. And we think this could continue. At the beginning of the year, we were worried about the ability of the Fed to cut rates. We needed to see inflation moderate, and that has happened. We are on a much healthier path when it comes to inflation. In a matter of weeks, we expect to see Fed cutting rates for the first time. Now it feels more like a foregone conclusion, and that should set the stage for more rate cuts happening over the following meetings, which will further support returns within fixed income universe.

Do you anticipate them moving in September? And do you think it's a 25-basis point or 50-basis point move? Or how much do you see them moving this year and into next year? A range of possible outcomes once they start to cut rates?

From our perspective, they are likely to cut 2 to 3 times. We're talking about 50- to 75-basis points of cuts this year and probably around 100 in 2025. That is a bit less than what the market is pricing in currently. When you're looking at market pricing, investors assume as much as 100-basis points of cuts in this side of 2024 alone. We think that is too much. But broadly speaking, whether we disagree on plus or minus one cut doesn't really change the trajectory that much. In a very short term, we think the market has overshot a little bit in expectations, but we agree with a broad direction of travel, and that is to stay positive on fixed income.

Yeah, and that's really been the story this year, the swinging pendulum of expectations in the market around how much the Fed is going to cut. We come into the year with expectations that are far too optimistic for cuts. We get to a point through the summer where they get a little bit too pessimistic, and now we've swung back to overly optimistic. But the main point is, and we've been talking about this for a while, as we look out 12 months from now, we're fairly confident in the direction. The direction is down and fairly significantly to the downside on rates. Of course, longer-term rates have already picked up some of that move.

Absolutely. While in the near term, we're not expecting a 50-basis point cuts, we felt those expectations that were shared by a number of investors in the market were premature, and you would need to see a more pronounced slowdown in the economy compared to what we actually see. We think a healthy pace of 25-basis points moves is what is ahead. So broadly speaking, you should remain constructive on the asset class, but also be vigilant because there are aspects of this market where if we see changes from our base case scenario, investors should react, and we should be vocal about helping protect their portfolios in those cases. Those two key areas to watch, first is inflation, i.e. whether the benefits of moderation continue as we're trending towards 2%, the magic level required by the Fed. So far, so good. But again, we had disappointments earlier in the year, and there is no assurance that they will not reappear. That is not our base case scenario, but we need to be vigilant looking at the data. The other area where we need to be careful is to do with the elections, because we clearly see a scenario where, if Trump were to be successful in winning the presidential contest, the prospect of a trade war with a variety of trading partners happening as soon as in 2025 could have meaningful negative implications for how fixed income universe is trading and how many rate cuts can we expect ahead. So quite a lot at stake in this election indeed.

So for the listeners, just because we're not used to trade wars in our modern world that most of us have operated in for the last 25 to 30 years as interest rates have consistently fallen before COVID and the snap back after COVID. But we've generally been in a world where we look for the benefits of trade and open trading around the world. What's the impact of a trade war on inflation and interest rates and currency that would concern you as a fixed income manager?

Based on our analysis that takes into account what Trump himself has publicly spoken about, which is increasing tariffs on China, but more importantly, beyond that, imposing 10% unilateral tariffs on a variety of trade partners, friend and foe alike, whether that's Mexico, Canada, Europe, or Asia, you name it, 10% broad set of tariffs. On our numbers, that could potentially add up to 1% to your inflation rate. As you can imagine, when we are trying to reduce the pace of inflation by half a 1% here, 1% there, just to get to Fed's ultimate target, a move in the opposite direction of as much as 1% could have huge implications in terms of how much Federal Reserve could cut, if at all, in such an environment. So it's definitely worth watching. Our experience from the previous Trump administration was not to try to read between the lines of what Trump says and assume that this is just bluster, and when he comes to power, such policies would not be implemented. But instead, actually read the lines because Trump tended to do exactly what he was promising during the elections or during his tenure as president. The election is very close. It's not a foregone conclusion who will win. But if that is Donald Trump, then we see a significant risk of those tariffs implemented because he has now publicly, repeatedly spoken about it.

Sometimes as Canadians, we sit and look across the border and we are confused by how the US, the most powerful nation in the world, gets to where they are around election time. So we have Trump with the bluster, and you say, you listen to what he actually says. On the other side, just to be fairly critical, as Canadians observing, we don't have any lines to read between at all, for the most part, around policy for the potential Harris administration. In terms of what you're seeing and what you're anticipating, if Harris is to win the presidency, how would her policies, do you think, affect Fed policy, inflation, trade, etc.?

From our perspective, if Harris were to be successful, you should essentially expect more of the same. There will be some nuances of policy where the new administration could depart from Biden's preferences. But for the most of it, especially when it comes to economic policy, we should not see any meaningful change from what we have seen so far. That would mean an administration happy to run elevated fiscal deficits to support the economy. And by the way, a Republican administration probably would be no different. The times of sequestration and cutting budgetary spending to balance the books, those times are gone. From a fiscal perspective, both administrations would support the economy on the fiscal front. But the big difference would be to do with trade, where there are no threats of escalation coming from the Harris camp. We believe that the base case of rate cuts and moderating inflation, as the economy slows down as well, would be maintained. From a fixed income perspective, it is definitely easier to forecast what could well happen if we're essentially having continuation of existing policies rather than having a big question mark about how will the market trade around all those trade policy scuffles with international partners.

Yeah. That's important. We've talked about this before, the idea that whoever wins has not expressed any concern about running up additional deficits or managing current deficits and debt down. So that is a longer-term concern. We've talked about that impact before, and I'm sure we'll come back to it again. But for now, we've talked about government, and we see what's going on with the Federal Reserve. What do you see in corporate credit markets? And as we move to a lower rate regime, what typically are the areas of the bond market that benefit the most? And where are you looking for opportunities outside of this government bond area?

The key area within fixed income where investors are trying to guesswork the impact of rate cuts and what it means for demand for fixed income assets is further out the duration curve. We have seen massive inflows into money market accounts over the recent years, and so far, that money has not left the building. What we've heard from many money market investors, including our RBC colleagues who are managing such portfolios, is that within money market space, investors tend to wait for actual cuts to happen before money starts moving further out the curve. Even though multiple cuts are priced in on the forward curve, even though it's almost a foregone conclusion that they will happen, in reality, money is not moving until actual cuts materialize. It will be interesting to see how aggressively multiple trillions that we currently have within the money market space move further out the curve. As you could imagine, longer duration assets, those that would benefit the most from a rally in prices and have the biggest impact in terms of profit of investors could be of main interest to those investors relocating away from money markets. When we're thinking about corporate credit, especially within areas like investment grade, it's probably the easiest one to give people comfort over switching from money markets into that space in the context of slowing economy. Absolutely, there will be investors who will be courageous enough to venture towards high yield pastures, and we would actually encourage them to do so because of the much stronger credit profile of US high yield compared to us entering previous slowdowns. But it is fair to assume that most of the money would move towards investment-grade assets and corporate credit in particular. Whether we're looking at funds, looking at US aggregate space or specifically credit funds, those should be the main beneficiaries of money flowing away from money markets once rate cuts materialize.

If we look at the history of this — and as we were discussing earlier, not so much the magnitude of the shift or exact timing, meeting to meeting, how much the Fed cuts and how — but the mere starting of the Fed cuts, that we're moving into an easing cycle. 12 months following the first cut tends to be a fairly positive environment for fixed income, historically.

Absolutely. We would very much expect a positive environment where essentially many investors start having FOMO, fear of missing out on the yields that we have currently on offer. As there is more clarity about inflation decelerating and economy slowing down — although we do not expect a recession, we do expect a slowdown — in that world, you will want to lock in the yields that are on offer before they decline further over the quarters to come. So that can significantly accelerate shift further out the curve and benefit longer-duration assets.

We just had Sarah Riopelle on the previous episode, and we were talking about asset mix and looking at the classic 60-40 balanced portfolio over time and the value that bonds or fixed income provides within that portfolio. Conditions are still favorable, after the first Fed rate cut. It tends to be a positive 12 months for equities as well, but there's a much wider range and there can be negative outcomes. But fixed income provides not only the opportunity for nice returns and income, but that counterbalance insurance against volatility and equities, which is another reason why in an environment like this, where we don't think we're going to have a recession, but the economy is clearly slowing, we like to have that insurance of fixed income in our portfolios, particularly if we're a more balanced or conservative investor.

I think that's spot on, Dave. It's important to remember that we've gone through a few episodes where fixed income did not help, but those episodes happened when inflation was high, sticky, and investors were afraid that the Federal Reserve would not be able to come to our aid because of elevated inflation. We are definitely not in that environment anymore. It's been interesting to watch a few weeks back when we had this flash sell-off across equity markets, how helpful fixed income exposure was to balance the losses on the equity side of the ledger. That fixed income, again, can play a role of defending your portfolio during times of dislocation, but also when growth fears escalate. And that is likely to happen. We mentioned that we do not believe in a recession as a best-case scenario, but there is a meaningful risk that as the economy slows down, investors will start worrying about recessionary risk and start trading that theme, even if a recession were not to happen. We've seen that before. In those environments, fixed income exposure will be really helpful to shield the portfolios, especially knowing that inflation is not preventing policymakers from acting.

And that's why I wanted to get you on today — and Sarah as well — because we just have in the last couple of weeks, immediately in the rear-view mirror, as great an example as you'll ever see. All of a sudden, recessionary fear spiking, the stock market reacts negatively, and what do bonds do? Bonds pay off as that insurance and protection against the volatility in the stock market. What a perfect example of the way that can work. Of course, I haven't articulated it as well as you always do, which is why we had you on to just do that a couple of minutes ago. But as you explained, it just worked absolutely perfectly. And in this kind of environment, where you're on that line — it's more likely that we don't have a recession than we have a recession — but as the fears move up and down, you'll have those little spikes of volatility in equity markets. So it's nice to have a fixed income friend like you along for the ride.

Well, we'll stay, friends, irrespective of what the markets do. But we can always offer our advice. It will be interesting to watch as these events unfold. As we mentioned, there are scenarios where this constructive stance needs to be questioned. So we will remain vigilant. But for the time being, fixed income is your friend.

Excellent. Well, I wish I had my friend back in Toronto tonight. My wife's having 40 of her friends over for a little party in the backyard, and I really would like to be somewhere else. So having dinner with you would be a spectacular protection against the volatility I'm going to see with her guests later on this evening.

It's only a one-hour flight, Dave. You're always welcome to come to the other side of the border.

Well, don't be surprised if I show up at the door. But more importantly, thank you for always being so gracious and as always, so articulate. I can't think of a better word to describe you around what's happening in fixed income and the opportunities ahead. So thank you always for your time, Andrzej.

Always a pleasure. And all the best of luck to your listeners. I appreciate the opportunity to speak to you all.