The Julia La Roche Show
#166 Nancy Davis: 'Whatever They Say, The Opposite Happens' — Fed Meeting Reaction, Why Inflation Is Here To Stay, And The Opportunity For Investors
Description
This episode covers reactions to the Federal Reserve's interest rate policy, opportunities in inflation-protected bonds and rates market, considerations for financial portfolios, comparison of yield curves and uncertainty about rate cuts, impact of stagflation on portfolio assumptions, and risks and implications of short duration bonds.
Insights
Importance of Inflation Exposure in Portfolios
Investors should consider having inflation exposure in their portfolios, particularly focusing on the rates market and mortgages. Inflation affects real-life purchasing power and savings.
Predictions for Rate Cuts and Yield Curve Indicators
Based on market pricing and yield curve indicators, there are predictions for a possible rate cut this year. The yield curve is currently highly inverted, but there are expectations for normalization or uninversion based on various macro environments.
Considerations for Financial Portfolios
Lower real yields are desired with exposure to tips and a widening spread between short and long-dated rates. Longer dated options with lower volatility levels are attractive due to the backwardation in the volatility curve. Inflation should be considered in financial portfolios as everyone is exposed to it, especially with signals from the rates market.
Comparison of Yield Curves and Uncertainty about Rate Cuts
Japan has a positive upward sloping yield curve, while the US has a negative one. Inverted yield curves historically precede economic downturns. Investing in long-duration bonds may not be favorable when rates are expected to stay higher for longer. There is uncertainty about whether the Fed will cut rates, but inflation protection in the rates market is considered cheaply priced. Stagflation, characterized by high prices and low growth, could pose challenges for investors.
Impact of Stagflation on Portfolio Assumptions
In a stagflation environment, stocks and bonds may become positively correlated, impacting portfolio assumptions. Higher fixed income volatility is expected in such an environment. The yield curve is likely to steepen during a period of stagflation. The guest speaker suggests considering making long options the portfolio instead of selling options against an existing portfolio.
Risks and Implications of Short Duration Bonds
Short duration bonds can be risky due to credit curves potentially inverting. Credit curves are currently very upward sloping, offering little premium for short-dated credit bonds. Investors need to carefully assess the amount and type of credit risk in short duration portfolios. Structured credits like ABS, MBS, CMBS, CMO should be scrutinized for potential risks. Expectations of tenure reaching five percent could have implications on asset markets.
Chapters
- Reaction to Federal Reserve's Interest Rate Policy
- Opportunities in Inflation-Protected Bonds and Rates Market
- Considerations for Financial Portfolios
- Comparison of Yield Curves and Uncertainty about Rate Cuts
- Impact of Stagflation on Portfolio Assumptions
- Risks and Implications of Short Duration Bonds
Reaction to Federal Reserve's Interest Rate Policy
00:01 - 07:24
- Nancy Davis, founder of Quadratic Capital Management, shares her reactions to the Federal Reserve's interest rate policy and Powell's comments.
- Davis discusses the importance of investors having inflation exposure in their portfolios, particularly focusing on the rates market and mortgages.
- She highlights the embedded short volatility within bond portfolios due to exposure to mortgages, emphasizing the impact of increasing volatility on mortgage prices.
- The discussion delves into the Federal Reserve's interest rate policy contradictions and expectations for potential rate cuts in the future.
- Davis analyzes the yield curve indicators and predicts a possible rate cut this year based on market pricing.
Opportunities in Inflation-Protected Bonds and Rates Market
07:01 - 14:18
- Investors have opportunities in inflation-protected bonds and rates market due to new markets emerging
- Inflation is not just a trade but affects real-life purchasing power and savings
- Treasury inflation-protected securities (TIPS) are long duration bonds tied to consumer price index
- I-Vall ETF combines TIPS exposure with interest rate options for inflation hedging
- I-Vall aims to benefit from lower real yields and widening spread between short and long-dated rates
Considerations for Financial Portfolios
13:49 - 21:25
- Lower real yields are desired with exposure to tips and a widening spread between short and long-dated rates.
- The yield curve is currently highly inverted, but there are expectations for normalization or uninversion based on various macro environments.
- Longer dated options with lower volatility levels are attractive due to the backwardation in the volatility curve.
- The spot yield curve starting to uninvert could be a precursor to a recession, despite current market euphoria.
- Inflation should be considered in financial portfolios as everyone is exposed to it, especially with signals from the rates market.
Comparison of Yield Curves and Uncertainty about Rate Cuts
21:02 - 28:07
- Japan has a positive upward sloping yield curve, while the US has a negative one.
- Inverted yield curves historically precede economic downturns like the tech bubble burst and financial crisis.
- Investing in long-duration bonds may not be favorable when rates are expected to stay higher for longer.
- There is uncertainty about whether the Fed will cut rates, but inflation protection in the rates market is considered cheaply priced.
- Stagflation, characterized by high prices and low growth, could pose challenges for investors.
Impact of Stagflation on Portfolio Assumptions
27:51 - 35:08
- In a stagflation environment, stocks and bonds may become positively correlated, impacting portfolio assumptions.
- Higher fixed income volatility is expected in such an environment.
- The yield curve is likely to steepen during a period of stagflation.
- The guest speaker has a background in trading options and prefers long options for managing risk.
- Selling options is viewed as selling away the upside potential, while buying long options can offer asymmetric payoff.
- The guest speaker suggests considering making long options the portfolio instead of selling options against an existing portfolio.
Risks and Implications of Short Duration Bonds
34:39 - 38:41
- Short duration bonds can be risky due to credit curves potentially inverting.
- Credit curves are currently very upward sloping, offering little premium for short-dated credit bonds.
- Investors need to carefully assess the amount and type of credit risk in short duration portfolios.
- Structured credits like ABS, MBS, CMBS, CMO should be scrutinized for potential risks.
- Expectations of tenure reaching five percent could have implications on asset markets.