Hello and welcome to The Download. I'm your host, Dave Richardson, and it is our World Cup fever episode of The Download. I just finished watching the all-time great, in my opinion— and I'm old enough to have a longstanding opinion on this— Mr. Messi scored his World Cup record 17th goal. And every podcast needs a GOAT or a Messi, and we've got him right here. Because when it comes to US interest rates and what's going on in the US bond market, there is nobody better than Andrzej Skiba. Andrzej, we haven't had you on for too long. That's the one thing. So we will never make that mistake again. Because if you've got a GOAT, you got to go to the GOAT all the time, especially with everything that's been happening. But we've got you here today, and thanks for always accepting our invitation.

Always a pleasure. With such kind words, I'm only likely to disappoint you, but I'll give it my try.

Yeah, and maybe calling a bond guy or somebody who scores goals like Messi, the greatest center-back of all time might be better for someone who likes to play around in the bond market.

That sounds very much so. This is not a world-like equities. We all think about the downside. But I have to say, it's just so great to have the World Cup happening in our neck of the woods. I've been to one of the games and the atmosphere is just phenomenal.

Oh, really? Did you go up to Boston or down into New York?

In New York. I saw Brazil play. It was a great experience.

Oh wow, you're very lucky. Well, let's get to what you do so well, and that is, set us up in the bond market and what's going on with US interest rates. Of course, it's been a very interesting year on that front, and particularly if we go to last week. Since we haven't had a chance to talk, maybe your impression of the new Fed chair, Kevin Warsh, and his debut last week, which unsettled markets for about 5 minutes, and then things carried on. But what were your thoughts on the last decision by the Fed that was ultimately announced, and then the sense that people got of the direction of where things might go under his leadership?

Well, I would say that Chair Warsh came across as expected, which is mildly hawkish. It was important for him to come across as credible when it comes to fighting inflation, and that's exactly what he has done. At the same time, it's important to state that he was nowhere near as hawkish as some investors feared. He did not point to a need to a lot of tightening in the near term. He did not remove a lot of the information that was shared by the Fed with investors, i.e., the summary of economic projections and the famous dot plots. So for the time being as Fed is assessing its communication policy— and he announced a lot of working groups to assess that— we are in a realm that feels a bit more familiar than some investors might have feared. Having said that, what is interesting is also how quickly things have changed compared to us having this discussion earlier in the year. Prior to the war, most investors expected Chair Warsh to push for rate cuts, not rate hikes. And only a few months later, we're in a situation where a mildly hawkish press conference is actually the status quo for the market. So it shows you how much the market situation can evolve in the space of a few months.

So there you go. As you know, you're talking to an elderly man now. I turned 60 this year, Andrzej. I don't know if you knew that. I tell everyone I run into. It's very frightening to me, but we won't go there. We won't talk about my issues there, but I did fail to recall that we haven't had you on since before the war. And so now, as we are moderately optimistic that we're closer to the end than the beginning— perhaps even the end— and particularly from the economic impact standpoint of the war. What's your view in terms of inflation? Has this done any permanent damage in terms of the global economy? And then particularly, it comes back to inflation when you're looking at it in the market that you focus on down in the US.

Look, it's fair to say that countries outside of the US were more impacted by this conflict. US is a pretty closed economy. So disruptions in the global supply chains don't impact US as much. It's also energy self-sufficient, which helps to limit the negative growth impact. But at the same time, it's also worth highlighting that outside of the US, a lot of investors were fearing almost like a doomsday scenario where recession is on your doorstep if you have disruptions in the Strait of Hormuz for a number of weeks. And what has been fascinating was watching how resilient the energy market ended up being despite these disruptions, that, yes, initially energy prices spiked, but they came down pretty quickly. And also, when it comes to products— so not just oil, but products that feed into multiple economic sectors— the price pressure there also abated pretty quickly. So, it's actually been fascinating to watch how much less powerful this conflict has been in increasing energy prices than investors expected. Only a few weeks ago, so many commentators were suggesting that even with a peace, oil prices are likely to remain in the $90s or $100 range because of the lasting impact of this conflict. And here we are sitting with WTI below $75 and Brent in mid-high $70s. So clearly, the broader backdrop has been more positive, or actually I should say less negative, than we have feared only a few weeks ago. One other factor that was very important is how China managed to draw on its strategic reserves and not lead to panic buying in global markets that push prices aggressively higher. So the way China managed its energy demand over this period helped to prevent a much uglier scenario for the world. So where we stand now, it's probably fair to say that recession fears for places like Europe have abated somewhat. Growth will be lukewarm. There will be disruptions, but the recession scenario is probably no longer your base case, whereas US is doing exceptionally well. We see a very good chance of growth in the 3% range in the US, where you would think that a conflict of this nature would have a more pronounced impact on the US economy, but it doesn't seem to have so. And consumers are doing fine. And also, corporates just had a record earnings season. So US is firing on all cylinders right now.

Yeah, and I'm so glad you laid that out exactly the way you did, because it goes back to my initial comments, which obviously are somewhat of an exaggeration. In my mind, you're Messi. And you'd be surprised that I think Messi is the greatest of all time when the debate currently goes on. Many go Pelé or others in the past. But I'm a Portuguese soccer fan because my mother-in-law is Portuguese. So, you would think I would be a Ronaldo fan. But Ronaldo to me, although he's flashy and he scores lots of goals too— not to say that he's not a great player— but he's flopping around. He's down. He gets a little touch and down he goes. Whereas Messi, you just watch him play and he gets a shove, and he just stands up and people are expecting him to go flopping down, but he just moves forward and then the ball's in the back of the net. And I think what you just said about the analysis of some around this war, it seemed like people wanted to be out and be flashy and oil's going to $150 a barrel and oh, inflation's going back up. This is a repeat of the 1970s where we had the initial energy crisis and then here we follow up again and the Fed's not doing all they need to do. And I just wonder. Because you're never like that. You always get up and move forward and just add a few basis points to the portfolios you're managing and chug along. Why do you think so many analysts get something like that so wrong in terms of that view? Because the modern world, the dynamism of the global economy, we always find a way to work things out usually fairly quickly. So I don't think this was that much of a surprise, but I read so many articles, like you say, of doomsday from some of these analysts. How do you think they got it so wrong on this one?

Well, first, it actually pays off to be quite bearish because every blue moon you're going to be right, and then you can build a name for yourself. And we've seen lots of examples in financial markets of commentators who were saying the same thing for years, who were wrong and wrong again, and then eventually, they strike gold and are remembered to be a hero. So the temptation to share these scenarios is definitely there. But the other thing is, I think markets first look at the worst-case scenario until more information comes to light, and only then have a chance to reflect on that, which is why a lot of the initial takes are quite negative. It's fair to say that market massively underestimated the ability of China to manage its energy needs in a way that did not cause huge energy price spikes across the world. But with every following week, your job is not to be anchored in your view and adjust that view based on incoming information. The other thing that from our perspective here in the US was clear to us is that while most US voters don't care about the war too much, they care about the gas prices. They care about inflation and the cost of living and impact on food prices, things that really matter when you have a midterm election coming. So we had a very strong view from the early onset of the conflict that this is not something that the Trump administration wants to continue well into the summer, into the autumn, that this needs to be relatively short-lived because the elections are coming and majorities in both the House and the Senate are at stake. So is it really worth fighting an extended conflict? And I think that perspective helped us navigate how this situation evolved and look through some of the bombastic comments on the way and different tweets that contradicted each other every 5 minutes to actually look to the final destination. So we're very much hopeful that the peace agreements that are being negotiated now is that endgame and we're in the final throes of this conflict. But a political perspective related to midterms to us was very important. And a lot of market participants that focus on the economic impact overlooked that in the analysis.

Yeah. Andrzej, I guess I should be proud of the podcast. The podcast is very good. I think we do a good job. But what I'm most proud of is everyone we had on, all of our guests had that balance, had that view. And I just want to remind people we're 7 years into this. By the way, if you want to listen to all 7 years' worth of episodes, you can go and find us on any of the places you get a podcast. Subscribe. We love a review. My mom's tired of putting in 5-star reviews. So, we need some other people to throw those in as well. So, we'd love to see those numbers come up. And of course, you can watch us on YouTube and see the always stylish Andrzej Skiba and what he's wearing on any particular day roaming the streets of Stamford, Connecticut. But we've stayed balanced on this and kept people invested. And being invested through this was a good thing, as it is most of the time. And we'll hopefully be there to tell you when you have to worry about stuff. But this was one that I think for a lot of us set up— with particularly again those midterms in the background— that the president just was not going to want to get out on a limb too much. He probably got out there further than he wanted to, quite frankly. But nevertheless, things were going to have to unwind, and that's what we're seeing happen.

Absolutely. I think that's a spot-on take, and it's kind of a guide for the markets how to deal with this intersection of economic reality and politics over the months and quarters to come.

Yes, and we have so many bond experts like Andrzej all over Canada, all around the world, particularly in London. And don't worry, all they do is look for the next disaster that's coming. So there's somebody watching for you. We'll have them on when it happens. Andrzej, just before we get more specifically into the current view, we'll check back with you closer to the actual midterm elections because that's where we'll have a better sense. Once people start paying attention really after Labor Day is usually when that happens in the US. Any initial thoughts now on the impact of what could potentially happen in the midterms? Are you getting any sense of the direction, or is this one still so much in flux with so much time left that it's difficult to play it one way or the other?

Look, I think it's fair to say that Republicans losing the House was base case assumption for quite some time now, and that's unlikely to change. The key question, however, was who's going to control the Senate. And that is really important because the Senate sets the agenda. So having control of the Senate is hugely important. And we know for sure that a lot of Republican operatives and donors have been in a mild panic mode about the risk of losing the Senate in the upcoming election. So if this conflict lasted much longer, and if the pressure on gas prices and food prices remained elevated, I think that risk would start becoming your base case scenario, something that Republicans clearly want to avoid. Right now, it's moving back into the 50-50 camp, so it's a very close call. It also is worth highlighting that on both sides, both parties have selected some Senate candidates that are a little bit more on the spicy range, where that might not have been the most pragmatic choice in these particular races. So that adds to the uncertainty heading into the elections. But clearly the risk of losing the Senate is still pretty high for Republicans, even if it has moderated a tiny bit over the last few days. And that is a scenario that was not even contemplated half a year ago. So it shows how the public, particularly independents, have swung against the policies of this administration. So clearly the pressure is on Republicans, and they are the ones who are the most happy that the conflict is coming potentially to an end.

Yeah, so, Andrzej, that's a great outlook. And again, we'll check back with you. And anyone who wants to see how Andrzej has to form a view— he and his team have to form a view around this— go back to some of the episodes we had in September, October, and in mid-November that we did with Andrzej back in 2024. And you'll really get a sense of the position. Because you're never 100% sure, but then you move closer to the date and you get a little more confident about your view. And then how you manage your portfolio around those differing views. And I'm sure we'll be able to do the same thing again this fall, Andrzej, when we have you on. But let's get back to where we are today. So, I'm glad I have you on today because we had the 10-year yield in the US just pop back above 4.5%. And as we met, we talked about the Fed and the new chair and the announcement last week where they held rates steady. But again, they've rattled some sabers, and you explained what might have been going on there. But are we in a case now, if we are moving towards the end of the war, that we actually even start maybe to see some inflation prints? We've got another one later this week, the Fed's favorite inflation measure coming. And we're not going to see it now, but when we start to get into the numbers for June and July and August, that maybe we even see some softening of the inflation numbers. That could be a possibility, right?

You're right. And we essentially see a fixed-income market where there's a bit of a tug of war between two forces. On one hand, investors do expect inflation to moderate, particularly as energy prices are coming down. And that is something that could support Treasury prices and help lower yields in the market. But at the same time, you have this other narrative of US growing really strongly, of US not showing any signs of deceleration. It was fascinating for us to watch incoming consumer spending data. And we're getting a lot of granularity these days on a weekly basis in terms of how consumers are doing, how they're spending money. And it's showing that even in lower income cohorts, we're running at higher spending levels than last year. And you would normally think for non-discretionary spending, that makes sense because your food prices, gas prices are higher. But it's actually also in discretionary spending, which tells you that a really strong labor market, stable unemployment situation, is helping to boost spending. So US is doing really well. And when you add to that insane amount of spending we're seeing on AI-related capital expenditures— we're talking about hundreds of billions of dollars pumped into this theme— that starts to move the needle for the whole economy. And we are starting to see a risk of US overheating as we head towards 2027. So you have this tug of war. On one hand, inflation relief from the conflict dying down, but on the other hand, US economy that is running pretty hot, and the evidence of that could actually raise fears about the need for tightening of policy and preventing overheating as we head towards next year. So in the very near term, maybe those incoming inflation prints will help to stabilize Treasury yields after moving up a bit. However, going towards 2027, it's tough to see an environment where Treasury prices rally hard and yields fall when you're facing such a strong economy.

Yeah, and you've also got the tug of war between all this spending that you have in AI and then what ultimately is the hope that AI creates all this additional productivity, efficiency, and drives costs down. So you get a negative inflation effect out of that. There's a whole lot of forces, but at the center of it is nearly a trillion dollars of AI spending just from the handful of companies that are at the core of AI. Let's not forget what other companies are spending around AI, whether you're a bank or you make tractors for construction and farming, whatever it might be. There's a lot of money being spent out there. And we focus on government spending, which we have to. There's too much government spending, which can be an issue. But this is an unparalleled level of spending from the corporate side in a short period of time focused in one area. You've got to think of all the different issues that that could cause near-term and longer-term.

Absolutely. When you think about the fact that it's a small bunch of companies that are responsible for the bulk of the spending. Just this year alone AI spend could increase US GDP by over 1 percentage point alone. That really plays with your imagination. So it will be fascinating to see how all of this will impact the economy over the coming years, because you have one set of arguments that actually right now it's more inflationary than disinflationary because you have some bottlenecks in trying to deliver data centers, deliver all of the processing power. But then it could be disinflationary through the negative impact on the labor market further down the road. So far, we're actually not seeing any meaningful evidence of increase in layoffs as a result of AI. Actually, it's the other way around, that companies need more people to help them adopt it and find ways how to use it best. The other thing that also is fascinating to us is that when you look at times when productivity has increased materially, that actually historically called for a higher neutral rate, for the higher R-star, which is one of the terms that Fed likes to talk about and economists like to talk about. It's a bit counterintuitive. Investors would think that higher productivity is disinflationary, but actually, historical evidence shows that periods of meaningful increase in productivity are followed by a need to tighten policy to have a higher neutral rate because just the economy is then running much hotter than monetary policy can tolerate. So it will be fascinating to watch that over the coming years.

Yeah, I've been reading a lot of papers about that very thing, around how that R-star goes higher when you have that productivity boost. But by the way, this is why you listen to the podcast because although I had several great nights of sleep reading some of those papers, I know they were very exciting to you. It'd be like watching a World Cup match for the rest of the world. But for me, I got some great nights' sleep. But I did learn some stuff, which is good so that I can almost keep up with you and know what you're talking about. But now, our listeners know as well. There's just a lot of push and pull right now. But like you say, the bottom line when we look at profits, you're seeing that profitability and you're certainly seeing the share price appreciation in core AI, but you are seeing something going on in terms of spreading out into the broader economy. And that strength, particularly in the US— and we've been talking a lot here on the podcast with some of our Canadian investment managers— that you're starting to get a sense that at some point, that's going to pour over the border and we're going to see it here. But that strength of the US is really quite palpable. It's interesting, again, to hear from you— and you're living in the US— that you really feel that and see that. And then more importantly, not just walking around and looking at things, but actually looking at the hard data seeing that in some of the numbers.

Yes, we've gone through so many episodes in recent years where investors were looking for US economy to disappoint in a material fashion. And again and again, somehow we end up pulling this rabbit out of a hat and find new ways to do well when it comes to economic growth. So this time is no different. And again, there are risks on the horizon because if you lead to an overheating of an economy, that is not something that a fixed-income investor wants to hear. But it's important to say that really ugly scenarios for fixed-income assets on a forward-looking basis are quite unlikely because yields are already pretty elevated. Fed policy is mildly restrictive. This is a very different world compared to 2022, when, if you remember, it was this annus horribilis for fixed income with double-digit negative returns because we started from very low yields and the market had to adjust fast to much higher rates, and that killed returns in the asset class. Because our starting point this time around is much higher in yields with a lot more carry income for investors. Your worst-case scenarios are probably flattish returns which is a much better world to live in compared to where we found ourselves in 2022. So we might be cautious heading into 2027 on this overheating risk, and the need to tighten policy as a result of that. But a lot of that is already priced in and you're getting paid to own fixed income with these elevated yields already. So we're a bit cautious, but it's a very different world compared to 2022.

So we spent quite a bit of time on government and Treasury yields. Any other parts of the US bond market that are interesting to you or is it really still all a focus on what's happening in Treasury because you're not worth taking any additional risks out in other parts of the market?

Well, look, I would say that when you look at the corporate credit markets, what has been really interesting is that we had record levels of supply. We're probably going to hit $2 trillion of just investment-grade issuance this year. And high yield markets are pretty busy too. And yet, despite this avalanche of issuance, spreads are close to multi-year tight levels. So the market was able to absorb all this issuance pretty easily. And the main reason why that is the case is because the yields are elevated. It's because a lot of investors look at this and say, you know what, I'm very happy to lock in these yields as a medium-term investor. For investor in fixed income assets, it's way better than we've seen a few years ago. So I'm happy to ignore the fact that spreads might not look that attractive and just focus on the yields instead. And we've seen this play out across a lot of bond markets within fixed income. The other thing that is also fascinating to watch is the emergence of this brand-new data center asset class. We haven't had a data center financing in high-yield markets, not a single one a year ago. There is so much coming right now into the market that by the end of the year it's likely to be over 5% of the entire high-yield universe. So it's telling you how much issuance is related to the data center developments. And investors are actually loving these yields because as long as you have very strong contractual protection from someone like Google or Meta or Nvidia— and they can't really walk away from these contracts without paying back the value of the contract— investors are very happy to lend money towards that. And this has opened up a huge new source of demand for fixed income within our market. So we're like a little brother of the AI appeal in equity markets, but it's also happening in fixed income, and it's interesting for us to watch. And we're putting a lot of effort into distinguishing between the haves and have-nots in this space.

Yeah, you had me on the excitement of the World Cup game with Brazil. Saying that fixed income markets are going to be as exciting as equities, you don't have me there. But because I like you so much, I'll give you a point there. Google, what was it, $85 billion? The other one this morning, I think, was SpaceX who just had their IPO a couple of weeks ago. They tossed $25 billion out or something along those lines.

They're coming to the markets. Absolutely. And from the get-go, they're going to have strong investment-grade ratings. So it shows how fast things change.

Excellent. Well, Andrzej, we cannot make the mistake— and I'll be fair, it's my mistake because my travel schedule sometimes makes it hard to line up with particular guests— we should never, ever leave it so long between your visits. So hopefully, we'll get you back at the very least as we're talking about the midterms and some of the impacts there, but I imagine something's going to happen in between where we'll need you. Have a great summer. So glad you had a chance to get out to one of those games. And thank you as always for joining us when you can.

The pleasure is mine, Dave, and I wish all the best to your listeners in navigating these markets.