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About this podcast

This episode, Andrzej Skiba, Senior Portfolio Manager, Head of U.S. Fixed Income, RBC Global Asset Management (U.S.) Inc., provides an update on U.S. fixed income markets. Andrzej comments on recent political and economic developments, including the U.S. debt ceiling debate, the labour market and the Fed’s direction on inflation. [22 minutes, 16 seconds] (Recorded: June 2, 2023)


Hello, and welcome to the Download. I'm your host, Dave Richardson, and I’m really pleased to be joined by Andrzej Skiba, who is the head of US fixed income at BlueBay in the US. Andrzej, thanks for joining us and thanks particularly on joining us today. And we'll lay out the background as to why it's particularly good for you to be here today. But thanks again for being with us today.

Always a pleasure to speak to you, Dave.

Yeah, and I'm sorry, we wanted to get Andrzej on a couple of other times. And as regular listeners will know, I travel everywhere. And if you do travel at all, you know that traveling right now is not a lot of fun. It's delay after delay, cancellation, move, shift. And so we had to move a couple. But again, we land on this day today where we're just coming out of what we would say is a resolution of the negotiations around the US debt ceiling. And we have the May jobs report in the US which creates all kinds of conversations around Andrzej’s expertise, which is in US fixed income and thinking about how this moves the Fed and where the economy goes. It's a great day to have you here. For Canadians, who are the predominant group of listeners we have, this US debt ceiling discussion, we watch it and we hear mostly about the political dynamics of it. That's what we look at. But in your world, what kind of disruption did that create the last few weeks and what does this resolve for you in the way you think of US fixed income?

That's a really good question because the debt ceiling has manifested itself not just in the political headlines. Fixed income markets were deeply impacted by the tumultuous few weeks that we've had. And you have seen that expressed particularly in very short duration securities, in treasury bills, where there was a genuine concern whether the government would be in a position to repay those obligations when they come due. And if an agreement was not reached, that was quite a credible risk. So we have seen some of the treasury bill maturities close to current timeline increasing as much as 7%. So a massive impact in terms of those markets. But generally, investors were also concerned about how will the market function? Are we going to see an avalanche of outflows from the money market industry? How can that be mediated by investors and how can liquidity be provided? And in that regard, it was very helpful to know that this time around we had the benefit of the Federal Reserve's reverse repo facility that would enable money market funds to manage liquidity on a daily basis. But away from that, focus was really on strength of the economy, on the potential increase in the likelihood of a recession if an agreement was not reached, and also a simple fact that we have investors all over the world holding US government securities. And if an agreement was not reached and a default would occur, would that imply damage to the reputation of US government securities on a global basis? So it was great to see that despite all the fighting and all the aggressive commentary on both sides of the political spectrum, we have seen an agreement pass both sides of the Congress and now we can essentially breathe easily. So that battle is over. But at the same time now we have a whole new set of questions about what follows next and the impact on US fixed income markets.

But that disruption and then I imagine you come into that and you're working through that with somewhat of a view of how it will likely play out. So are you able to take advantage of that as an investment manager? In the near term, you get into that last month and you go, okay, this is the way it's typically played out. This is the way I think it plays out this time. And can you take advantage of that if you make the correct call? Or do you just want to steer clear of that and not get too much on one side or the other just in case it goes the wrong way?

I think it's a bit of both, actually. On one hand we have a fiduciary duty to our clients to make sure that we don't step into a landmine. So for example, our team is managing very large money market funds and we wanted to make sure we do not own any treasury bills that in a worst case scenario might not be repaid. So that's just basic response as a manager that you have to employ to showcase your risk focus in day-to-day investing. But aside from that, you're absolutely right, this whole volatility also created opportunities across broad set of fixed-income securities. For example, we had a number of issuers coming to the market in the credit space that recently have been offering very modest concessions for investors to buy their new securities compared to where the existing ones were trading. But suddenly, over those few weeks prior to the resolution of a debt ceiling standoff, they were much more generous in terms of the new issue concessions because they wanted to make sure that they execute those transactions and even in volatile markets they can achieve their goals. So we could absolutely take advantage of buying securities that are in no way related to the debt crisis, for example, those of pharma companies at attractive valuations. So it's a combination of both making sure that what you're doing doesn't break but also taking advantage of opportunities as they arise.

That what makes your job so exciting and difficult at the same time, right?

Well, it's a team effort so at least I can spread the pain across the whole of the team.

Excellent. Ok. So we get the resolution. Boom. It's got to go and be signed. It'll be signed off by the President. And now the focus just immediately turns to jobs report this morning and other data points which start to tell us what's happening in the economy and particularly what's happening potentially with inflation. So, really strong job number again. I had Andrzej Skiba on earlier who’s just continually confounded by these reports which time and time again come out above expectation as we all wait for the economy to slow down. But what did you take out of this morning's announcement and what are you seeing happening in the markets that you're watching?

I think you're spot on. The market has very quickly shifted focus to the Federal Reserve and also the growth outlook for the US economy. And it's pretty clear that labor market is in a good shape. We are not seeing any evidence yet of a dramatic weakening in the labor market in the US. Whether that's this morning's report or whether it's recent job openings data, they are all pointing to the fact that US is in good shape when it comes to the strength of the labor market. Having said that, we are starting to see evidence of moderating wage pressures. So for example, even though the payrolls were strong, you had a slightly lower than expected rate of wage inflation that was reported. And equally, earlier this week we had some reports from the ISM surveys that indicated decelerating pressures in terms of prices paid in the US. Federal Reserve actually would not mind this combination of a labor market that is in a good shape while at the same time seeing inflation moderate. But this conundrum of «can the two go hand in hand?». Is it even possible to achieve inflation moderation without a meaningful slowdown in the economy, including the labor market? That’s the reason why what Federal Reserve is indicating to us is that they're happy to pause in terms of the rate hikes, but they're not committing to being completely done in case the economic data remains very strong. So this conundrum of «can we see inflation start coming down» at a pace that points us towards Fed's 2% objective, not this year, but into 2024? That is the key question. As much as we believe that a pause at the June meeting is very much a possibility— it's our base case scenario— it is not a foregone conclusion that they will be done. It could well happen, but it's not an absolute given because the economic data is just too solid to make that determination right at this second.

Just for the listeners, what reports will you be keying on over the next few weeks, and what do you think the Fed was going to be looking for in terms of additional data points that are going to start to give you a better idea of where they go two, three, four months out from here?

Well, focus is consistently on inflation data. We will see those numbers coming in different shapes and sizes and different formats that they are released. But I think that will be the key focus. If the message will be that inflation is starting to move higher again— not only that the broader economy is in decent shape, but also inflation is refusing to moderate—, then that will disappoint those investors hoping for Fed rate hikes being done. So definitely a lot of focus there. So far as I mentioned, we have generally had encouraging data on the inflation front. It's been either roughly in line with expectations or a bit better over the recent weeks. But we need to see that trend continue to increase our confidence in Fed being properly done with rate hikes.

Yeah. And all of us up here in Canada just saw that little reversal in terms of our inflation actually ticked up on our most recent report. And so yeah, there's still a lot of ways that this could play out which again, makes your life very interesting. So if you're an investor looking at fixed income markets, what do you think is particularly appealing? After obviously a very challenging year last year, is this a fixed income market that's interesting for an average investor? And where in particular?

I think it's very important to choose what your time horizon is. Purely over the coming weeks, yes, you can see a lot of volatility because of incoming data. And the progress we're making towards better environment for fixed income assets could not be linear. It could be two steps forward, one step back. But if you're looking in a perspective that it's not a few weeks, but we're talking about six months, twelve months, eighteen months, we are very constructive on the asset class. And the reason why we're constructive is that we believe eventually inflation will moderate. And the key reason why that will happen is that you will see the impact of not just the Fed rates being deeply in restrictive territory, but also you will see efforts in a banking channel to cut lending across the economy. Because particularly for regional banks in the US, that is the only way how they can meaningfully improve their capital ratios. As you've seen before, there have been questions about the strength of the regional banking system in the US and there is a need for them to strengthen their capital ratios to account for things like unrealized losses on the securities portfolios. And you can't really do that by issuing equity because they're all trading below book value. The only easy way to achieve that is by addressing the other side of the equation, which is cutting your risk weighted assets. And you do that by cutting lending. And when you cut lending, particularly regional banks, they impact local economies, they impact small and medium-sized enterprises. So then when you take that combination of Federal Reserve having rates at elevated levels— well above neutral, deeply in restrictive territory—, and at the same time, banks, especially regional banks, doing a lot of the legwork of slowing down the economy, of withdrawing lending support from US regions, that together is a powerful combination, allowing inflation to moderate. And then as investors, we can look forward to Fed rate cuts, whether they happen at the end of this year or beginning of next year. But that is a powerful driver of investor demand for fixed income. And if we put this in a context, last year we had dramatic outflows from US fixed income funds just in investment grade funds. Looking at US mutual funds, you had almost quarter of a trillion dollars of outflows. That is a massive amount by historical standards. And that money always comes back when we're looking at past examples of such major outflows within a year to two years. And when we're speaking to US asset allocators, they are all telling us the same story: we love fixed income, we want to lock in currently attractive yields, we just want to have a bit more comfort that inflation is indeed moderating. And if that happens, we will pull the trigger and you should see meaningful reengagement with the asset class from investors across the US. So the prospect of having hundreds of billions of demand coming back into US fixed income assets while having at the same time Federal Reserve helping to offset the negative impact of economic slowdown with the rate cuts, should be a powerful mix, creating demand for fixed income assets and seeing spread tighten across our universe. So over the next few weeks, it could be a bumpy ride. On a 6–12-month view, we are quite positive on our asset class, particularly looking at high grade assets.

Yeah. And always important we think about yields, price of a bond, price of a stock. But they are markets, and a market is driven by supply and demand. Those are important factors. And right now, or over the last year, that demand has flown the wrong way and as you suggest, it always turns the other way as we move through these types of periods of uncertainty. The other thing that I think a lot of Canadians would not really be aware of, or maybe not make the connection, because our banking system is so different than that in the US, is that connection between the regional banks— which have been in the news and we're hearing those reports here about the regional banks and how they're struggling—, but the connection with small and medium enterprise. And it's small and medium enterprise in an economy like the US or Canada that drives the labor market. That's the key job creator or when they're constrained, where jobs peel off. And so I hadn't heard anyone really in the Canadian context anyways, connect that dot, connect those dots together in terms of regional banks and small and medium enterprise. That's quite interesting.

I think that's spot on. And that is the main channel through which we will see a slowdown in the US economy over the coming quarters. It could be a very strange situation where when you're looking at the big enterprises, large corporates, they actually could well be doing pretty fine because there are many consumer groups that are in decent shape. You have pockets of weakness, but it's not widespread. So because of the impact of regional banks, it could be a recession— if that is our destination— that is very much occurring at the small and medium enterprise level that is the driving force of the economy rather than for big corporates, many of which are going from strength to strength in areas like technology, for example.

Let's just finish off just by taking a look at your thoughts on the high-yield market. Again, people think high yield and they go recession coming, or at least a slowdown. That could create opportunities down the road, but it might be an area I want to avoid right now. What are your thoughts on the high-yield space?

I think that's a fair point when we're speaking to clients and prospects. Whereas in investment grade, what they want to have clarity about is inflation, in high yield, they want to see a few quarters of economic weakness and how the companies manage in that environment. So the setup for the high-yield investment universe is quite strong and the reason being is there are very few maturities on the horizon. And also you have a lot of companies that were expected to default in previous years already having done so in 2020 during the COVID crisis. So the slate is pretty clean when it comes to high-yield sector. But still a lot of investors want to see evidence of how the companies are doing managing through the crisis. And in our opinion, they will do fine. And the reason is their leverage. So the amount of debt that you have in high-yield companies right now, it's the lowest, not even since pre-COVID, but the lowest since global financial crisis. So this is probably the best shape companies have entered a potential recession within high yield. But having said that, we are hearing that again and again: show me the evidence, how well they're doing, then I will consider locking in those higher yields for my benefit.

And so that's the demand piece again in that space relative to what we've been discussing. Andrzej, just fascinating, always interesting getting your perspective. And again, it's a shame we missed a couple, we'll get you on more frequently. But this was just a fantastic update and again, just an incredible perspective from your chair. You have such a great seat to watch what's going on in fixed-income markets in the US. And it's great when you can share it with our Canadian listeners. So thanks for being with us again.

I Absolutely, my pleasure. And it's always so much fun speaking to our Canadian friends. All the best.


Recorded: Jun 2, 2023

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