Welcome to the No More Risk Better of Credit Sites Podcast. I'm Winnie Caesar with Global Head of Strategy. And I'm Zach Rifis with the Credit Sites Senior Investment Grade Strategists. As strategists, we aim to make sense of the macro and the micro, highlighting opportunities and the risks facing the fixed income markets.
As important as the macro call may be, we understand that credit investing at its core comes down to keen, symbol name selection and we have credit sites benefit from the expertise of our team of over 100 analysts across the US, Europe, and Asia. This podcast offers a look at the conversations that we have with our analysts on a regular basis. If you are an investment professional focused on the wide universe of fixed income, you'll want to give this podcast a listen. Hello everyone, and welcome back to the credit sites podcast.
This is Winnie Caesar Global Head of Strategy for Credit Sites. And today marks our end of season wrap up podcast. And I am so, so happy. Cannot tell you how happy to have my right hand man, our head of US investment grade and macro strategy.
Zach Rifis back on the podcast back from paternity leave back from jaunting around Europe with a newborn questionable decisions. He makes but he's a darn good strategist. Zach, welcome back. Thank you Winnie.
It's great to be back. I've really missed the podcast among other things. So it's good to be back in the seat here with you. Great.
That will factor indirectly into your bonus consideration that you missed being here. So I appreciate that. So Zach, as you are returning to work and spent some time across the pond over the past 10 weeks, do you have any deep thoughts on the market to which you have returned and maybe thoughts from our friends in Paris and London? I got to admit, Winnie, I didn't learn a lot about the market across the pond.
There was much less interest in our election in France than there was in the UK, which was interesting. I'll turn that into any kind of trade idea. I think one thing that has surprised me, even though market levels have changed a lot, the focus items and how much those things are driving markets really haven't changed much at all. And so while a ton has changed, particularly with the election, I'm sure we're going to unpack that in a fair bit of detail, while those things have changed, it doesn't, I don't feel like I missed too much in some way, even though I missed a lot in another way, if that makes any sense.
It makes a ton of sense. I have been out on leaves as well and it is funny to come back and be like, all right, the world kept on spinning and stuff didn't really move that much. Still saying stuff, yeah. It really does.
It kind of reminds me of a client conversation I had recently. We were talking about the credit market and how there hadn't been very much spread volatility this year and it just felt wrong. And we were talking about how the credit markets are defined by these long periods of boredom on the valuation side of things that turn into pure terror and panic so quickly. I feel like that's it.
That's it. I mean, we've only seemingly gone tighter all year and reps tighter even in the past, let's say month or two, even past week or two. It just feels a little too good to be true in terms of the market reaction broadly to the election results, which have certainly been surprising. I had bought into the idea that Harris stepping in to be the Democratic nominee would have been a reinvigorating force for the Democrats that did not play out at all.
And I feel like the market is very optimistic on Trump 2.0 and I love the optimism. That's great. Can things really be this great? I'm a little skeptical.
And to your point, when things have been so stable and there are these concerns about valuation, I feel like I've been saying that for a year. They've only gotten richer. That's when it seems like something comes out of left field and blows things up a bit. That is so true.
I think the big question that I'm grappling with is if we are going to make America great again, does that mean that we are going to make bonds great still? Or do bonds have a problem, right? Because inflation was the big issue that drove the election. Every article that I've read has been that the election was effectively determined by people's sick of inflation, which I totally understand.
But the bond market also is driven significantly by inflation. Can we say that it is vanquished? Can we say that it is not going to return? I don't know.
It seems like there are a lot of inflationary propositions in the Republican policy agenda. And my biggest question is how can I figure out a way to make these policies disinflationary? How do I wrap my mind around that? And so far, I'm coming up with nothing.
I'm with you. And that's why it's so shocking that inflation was seemingly the biggest issue. I certainly understand it from what we've experienced over the past four years. But shouldn't we be focused on what the next four years are going to look like with the the incoming policy proposals?
And now I do feel like tariffs, that seems to be, as we've been going through this analysis of what the Trump administration is focused on and what Trump himself can do more or less unilaterally, tariffs are pretty much top of the ticket and the easiest for him to do on his own. And so when I think about the market reaction and what is most likely to happen quickly, tariffs is at the very top, which is not good for inflation and is not good for global economics broadly. And the market seems to be either A, looking past it or B, taking the view that some of the tariffs that have been proposed or promised by Trump on the campaign trail, there's going to be a significantly watered down version of those proposals. And I certainly take that point, but I don't think there's going to be nothing.
And so all of this focus on deregulation and at the very least extending the tax cuts and jobs act tax cuts, that's driving the narrative tariffs are not. And how do we get to a disinflationary impulse? I think the one other thing that we've been talking about, Winnie, that isn't as focused on it, maybe it's because there is a lot of ambiguity to what it ultimately looks like is the drill baby drill initiative. Can Trump really drive down oil prices or energy prices further?
I think you made some great points on just how much the US is already producing. How much more can we do? What is the risk reward of some of these other federal lands being drilled on? Sounds like you're not buying that that's going to be the white knight of further disinflation in terms of the incoming administration.
No, it seems problematic because when you look at US energy production, we are producing at historically high levels. We are the biggest producer of natural gas, doubled out of the second largest producer, which is Russia, also the top largest producer of oil. Now, I guess you could theoretically make the argument that we're going to stop exporting energy. Maybe we just produced for the US, keep it all at home, and just have some sort of government intervention around supply that delinks the US energy market from the global commodities market and our energy prices decline materially because of it.
Seems like a long shot, but I think that's where you have to go to figure out whether energy policy drill baby drill can help drive that disinflationary impulse to offset some of these other items that feel a bit more inflationary via tariffs, tax policy, fiscal expansion, more broadly, immigration policy, all of those things. And I guess that gets us to some of the working assumptions for 2025. Right now, we had put together a red wave scenario in our preliminary outlook for 2025, appropriately titled Everything is Awesome because clearly the market believes that everything is awesome. And in that scenario, which we had assigned a 30% probability to, we have fed policy effectively getting stuck around 4.5%.
Zach, how are you thinking about that policy path? I guess in terms of what we had penciled in, and I think having the ability to not get too specific on the path is generally a good thing in this business. But just to offer a little sneak peek into how we were thinking about how you end up at 4.5% at the end of the next year, we're thinking to cut again in December and a couple more cuts at the start of 2025, which would ultimately get reversed as some of these policies are going to take time. Even tariffs, Trump takes office on January 20th.
So even in the first couple of days, couple of weeks, even month, that's going to take time to affect the data. And so when thinking about when the Fed would react, they've made it very clear they're not going to speculate on policies that could get implemented by the incoming administration. They're going to need to see the policy changes themselves. And more importantly, those changes impact the economic data the way people are expecting.
And so getting stuck at around 4.5%, and I think the big thing that we have from a macro perspective in this outcome is a bear steepening of the curve. And so you have a 10-year at around 5% in that scenario at the end of 2025. And that's certainly not what the consensus was expecting coming in through the election. That would be above what all of the Bloomberg forecasts, that the high end of that forecast range right now granted that has not been updated for these recent election results.
And so when I think about the path of policy and what's priced in right now, the market has fed funds going to around 3.8%. Let's say, and so that's a little bit lower than what we're expecting. If you think about what's priced into the rest of the curve, before call is right, we'd expect to see rates rise a little bit further from here around 440 on the 10-year. And so I think that all makes sense.
What's interesting is the market is priced for the Fed to go to around 3.8% in the next 12 months and then stay there, as in the 3.8% maybe is the terminal rate in this easing cycle. Now, that seems a little bit high to me, but we have been in the camp that the US consumer is showing signs of slowing beneath the surface of some of this macro data that has shown quite a bit of resilience by the US economy broadly. And so I think to get a terminal rate or for the Fed to stop there, you're going to need to see growth pulled up a little bit better than what we're anticipating right now. And the one other point I'd make that I think is important to consider when thinking about the re-acceleration and inflation that we could get from the incoming administration is how the Fed would treat inflation driven by tariffs relative to more demand-side driven inflation, which is what you'd expect to get from tax cuts.
If the Fed is willing to look through tariffs, is that as less likely to be impacted by changes in monetary policy, then maybe we are a little bit too aggressive on these policy rate and treasury curve expectations. And so I think using this red-wave inflation acceleration scenario is a great starting point for us as we put together our thoughts for our final outlook, which we'll have out in early December. But right now, we are thinking that the policy rate doesn't go as low as the market is priced for over the next 12 months, leaving some further upside risk to rates really across the curve. And where we get that bear steepening expectation is this expectation that fiscal deficits will worsen more in an incoming Trump administration and assuming the red-wave is realized, which it looks like it will, than what we would have gotten in a Harris and divided government outcome.
So that's kind of the whole rate picture in terms of how we're thinking about it right now. Winnie, how are you thinking about credit spreads and how maybe how the market has repriced now relative to what you think makes sense in terms of a pricing of credit risk over the next 12 months in this red-wave scenario? Yeah, it's a great question because credit spreads gapped tighter on the back of the election results, seemingly looking at these positive things of continued reduction in corporate tax rates, perhaps a reimplementation of bonus depreciation for catbacks and R&D and expensing extension of personal income tax breaks, which should help benefit spending all of those things. And maybe forgetting a little bit about the market volatility in 2018 that was driven by tweets related to tariffs and trade wars.
And I think that looking back at the Trump 1.0 playbook makes some sense while also factoring in that there are a lot of key differences. Right now, the strongest argument that you can make on the corporate credit side of things for spread stability or continuing to grind tighter is that technical. We still have a lot of cash on the sidelines. We have a Fed who is at least currently inclined to cut rates at a moderate pace.
And that is going to continue to draw cash off the sidelines and into fixed income. We saw that in October with a run up in yields, lots of outflows from short-term treasury funds, inflows to long-term treasury funds, inflows to corporate credits, really inflows to everything. And that technical is not something that I want to underestimate. Now, the big question is, at what point do we start to see any sort of negative credit behavior that increases some jitters around the outlook for corporate credit fundamentals and the potential for ratings downgrades or perhaps a rise in defaults?
I think we're a ways away from that. But heading into 2025, even before the election, we had been telling clients expect a year of consolidation and that we are now in those middling stages of the credit cycle where companies who have been in balance sheet repair mode, focusing on deleveraging, defending ratings, are probably going to shift to a little bit more lax approach to their balance sheets. And that generally comes with consolidation, with M&A, spin-offs, with LBOs, with all of these different types of financial engineering that ultimately drive growth for shareholders. Now, we still have a long way before we understand what the true regulatory environment is going to look like, what the true antitrust environment is going to look like, whether companies are willing to pay fairly lofty equity valuations.
We can't forget about the whole bid-ask component and also how much debt capital companies are willing to use for some of these M&A activities. But I think we can fairly safely say that this focus on ratings defense is probably going to shift in 2025. And that coupled with some concerns around input costs and tariffs and just kind of the broader geopolitical environment, I think, you know, gives us a reasonable case to expect some degree of spread widening. And so we had put in our forecast a 120 spread target for IG in that red wave scenario and 400 basis points for high yield.
We're a long ways away from those levels right now. We are very tight. Historically speaking, 120 and 400 are not heroic moves in the investment greater or high yield markets. Those are actually kind of more normal-ish spread levels, albeit those spread levels are more historically consistent with lower all-in yields.
So we are a little bit more cautious on taking credit risk right now. And I think that my big inclination to downgrade corporate credit is because there is now this incremental uncertainty coupled with just very, very thin valuations. You know, at this point, why am I buying US investment grade in the 70s when I could get, you know, perhaps MBS at a similar yield have a bit of a shorter duration and feel a bit more up in quality in my portfolio. Similarly high yield, you know, at what point do borrowing costs challenges become part of the conversation again?
And we're focused very much on some of those factors for 2025. We might change those point estimates as we finalize our 2025 outlook and as we look at different scenarios. But for right now, I kind of like them. Yeah, I feel like 120 and 400 from the current spread levels, it feels like a big move.
I was looking at this the other day. I feel like that's right around the median for the long term, at least on IG, I think pretty similar on high yield. And when you think about our job as a strategist, we went underweight both IG and high yield following the election, thinking that a little bit too much optimism was being priced in, even on the run up. And we've gotten just a little bit more of that over the past week or so on that.
I'd say and sort of what we're trying to do here is identify when risks seem clearly asymmetric. And right now, from a spread perspective, it's hard to imagine it being much more asymmetric in terms of risk to widening relative to further tightening from here. Now, I feel like the big thing is we've been saying this for like a year, valuations look kind of rich, but yields historically, it looks solid. And if we are expecting yields to continue moving higher, that technical, when does it break?
I think that's the big question. Is there still too much cash out there that can kind of absorb and limit the amount of spread widening we get? I think the real question becomes, how does the market digest either the Fed cutting less than it's currently priced for or even following the path that I outlined before? If the Fed were to shift gears and start hiking again, I can't imagine equities and credit markets digest that very well.
I think underlying the strong performance for financial assets in the US broadly over the past year has been this expectation that rate cuts are coming. Borrowing costs will begin to come down. And really, what we have penciled in here is not that at all. You have base rates, treasury yields moving up with spreads widening.
And at what point does that become a self-reinforcing situation? And so I think that's what we're trying to grapple with, going underweight. I like it. Maybe it's a little bit early, but I just feel like the risks are very asymmetric.
I don't know. What are you thinking in terms of catalyst over the next couple of weeks, couple of months, I mean, we do get US CPI tomorrow. That can be a bit of a rude awakening to this marketing zuberance, even if it's not anything crazy, just kind of a marker to be like, all right, maybe I'll take some chips off the table. It's been one heck of a run over the past month or two.
Yeah, absolutely. So in terms of catalysts, your spot on inflation data, the next couple of months, I think are really going to matter. The Fed is going to be scrutinizing that data pretty closely. We also have to keep in mind that labor market data has been bizarre as of late, very choppy with that big September upswing followed by the big October downswing, lots of disrupting factors in there.
And then when we get back to start the new year, there are a few different things. First, we have the US budget, which expires mid-December. It does seem like there's going to be some sort of continuing resolution to give the new Republican administration some time to address that really next year. But that also brings to mind how quickly can we finalize tax policy, because that's going to be a big part of budget reconciliation, presuming that the Republicans in power are going to pursue the tax changes through budget reconciliation, which I think is a pretty safe assumption.
We also have the end of the debt-silling suspension in early January. Now, clearly, the Act's date is not also going to be early January, but it's something to keep in mind. And I'm really curious about kind of party cohesiveness as we get our new administration sworn in. Do we continue to see kind of everybody falling in line together, being all on the same page?
That I think is always a question mark in any political change. And I think it's still pretty true today, continuing to look at who are the key appointees of Trump policy. And if we get more of a focus on solid cuts of taxes and less concern around fiscal deficits, and that's early in the year, that's going to be something that I worry about. Also putting on my tin foil hat a little bit, I think we all know that non-US investors are massive holders of US Treasuries.
And I will be curious to see what types of flows we see from non-US investors into the US treasury markets, especially if tariffs are severely punitive. Could be interesting. Definitely tin foil hat. I remember that discussion coming up quite a bit, I guess, six or seven years ago now, while I can't believe it's been that long.
Thinking about the flows and sort of the balance of supply and demand, that's another thing. I think that treasury has held auction steady for a little while now. I think they're going to have to rise almost regardless of what policy changes that Trump administration brings about over the next 12 months. And now that we are on the other side of the election, I think that probably gets some greater focus as well, which we sort of had factored into these numbers.
And so I think you make some great points on the fiscal side with the debt ceiling, the x-state and some of these traditional risk off drivers, are they going to come to play? And maybe the bigger question is, if the fiscal concern for the US is the driver of risk off and yields rise in that environment, that's not really the traditional playbook. Risk off is treasury yields lower. You want to be in bonds in the safest assets.
And it's hard to imagine a scenario with yields snapping a lot lower, especially if the Fed can't deliver the kind of cuts that the market has already priced for. And so I think that's kind of weighing those things. And maybe the other thing that this brings about in my mind, Winnie, is all of this focus on the positive, not on the negative, maybe an expectation that Trump is going to dial back some of the more extreme rhetoric or policy proposals that all seems to be already baked in. So even if you get, like you said, a somewhat unexpected tweet with respect to foreign policy in some way, is that going to bring more volatility back in the market?
Markets don't like volatility and with things seemingly priced perfection. Just another thing to consider that doesn't seem to be top of mind with respect to the market moves we've seen over the past week or even over the past month and a half as the market seemed to price in a higher likelihood of a Trump victory and a red wave. I think that of all of our forecasts, the thing I feel best about is expecting more volatility next year. Just because we've had so little this year, it's not a heroic call by any stretch of the imagination, now how that volatility ultimately manifests and the magnitude of its impact on credit spreads.
Clearly a question mark right now, but we'll have a lot to talk about in 2025. That is for sure. All right, Zach. Well, I think we should wrap it up there because we need to work on our final 2025 outlook.
We have a lot to do between now and the first week of December. Not a lot of time to do it in. No, there's never a lot of time to do it in. But at least we have some fun things to consider.
I love the proposals of round 333, which is the assumed Treasury Secretary appointee Scott Pecent's focus on policy, cutting the budget deficit to 3% of GDP, spring GDP growth of 3% and producing 3 million barrels of oil per day. That sounds great. Ambitious. Ambitious.
You know what? I like it. I'm glad you bring that up because this potential Treasury Secretary advised President Trump at least at one point that he could perhaps create a sort of shadow Fed Chair incoming, even if he can't remove Chairman Powell by law until his term is up in May, 2026, creating this named duck situation by naming hit the next Chairman or Chairwoman of the Federal Reserve. And so I think that gets to my point of the potential for more volatility.
If we have some of these extreme proposals, some of these officials coming in to office with more eccentric views. And I think that's a sobering thing to keep in mind with all of this marketing zuberance that we've had recently. Elon Musk for FedShare in 2026. There we go.
And I think we should wrap it there. Now we need the cost cutting. Perfect place to leave it. Perfect place to leave it.
All right, Zach, thank you so much for coming back from paternity leave. I am delighted to have you back. Thank you all for listening to the credit sites podcast this year. We have done over 60 episodes of this podcast focusing on things from the leverage loan market to private credit to US banks to election to real estate.
We have covered a lot of bases. If you have suggestions for things that we should talk about next year, we would love to hear it. You can always reach out to us using the Ask an Analyst function on the credit sites.com website. Thank you all for joining us and best of luck through the end of this year and into 2025.
Credit sites to slamer. All price references correspond to the data this reporting. This podcast should not be copied, distributed, or reproduced in whole warden part. And the credit sites in North civilians makes any representation or warranty as to the accuracy or completeness of any information contained in this podcast.
Credit sites is not providing investment, legal, accounting or tax advice. It is not providing research or making any recommendations. Norths, credit sites offering more soliciting any transaction with respect to the purchase or sale of any security. Received by this listener of this podcast is not the giving other price by credit sites for its affiliates.