Bond market action ‘has been really strange,’ strategist says

Wells Fargo Head of Macro Strategy Mike Schumacher joins Yahoo Finance Live to discuss inflationary pressures, Treasury yields, rate hikes, bond market action, and the outlook for the Fed as Fed Chair Powell testifies before Congress.

Video transcript

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- Welcome back to "Yahoo Finance Live," everyone. We are now on day two of Jerome Powell on the Hill, Fed Chair Jerome Powell, this time, in front of the House Financial Services Committee. Joining us now for more on the latest guidance from the Fed, we've got Mike Schumacher, Wells Fargo head of macro strategy. Of course, we've been keeping a close eye on what comes out of today's hearing, given that yesterday's hearing certainly did move the markets a little bit. What will you most notably will be watching for here that he could say differently that would still send the markets into a tizzy?

MIKE SCHUMACHER: I think, a few things, Brad, number one is the inflation outlook. Certainly, Chair Powell's talked about this quite a bit recently, and yesterday, of course. One thing that surprised me, frankly, is not many questions on Fed governance, a little bit about the trading with respect to personal accounts. But, of course, there was the news story that came out a couple days before the last meeting. Perhaps, there will be some questions about that. But in terms of big market moves, I think it's going to be regarding the inflation outlook. And, frankly, day two is usually as you'd expect, much less of an event than day one. So potentially, a little bit on the margin, but not nearly as much as yesterday, at least in our view.

- Let's talk about yields for a minute, Mike, because you know, we've been seeing yields come down, which is still not necessarily what you might expect here. Yes, you have perception of a slowing economy, but you also have the Fed raising rates and signaling that it's gonna continue raising rates. So how are you viewing the action that we've been seeing in the bond market?

MIKE SCHUMACHER: Yeah it's been really strange, Julie. And I think what's been going on here is that inflation is so dominant with respect to investor views and market actions now, it's dictating just about everything. So today's a good example, bond yields are down 15, 20 basis points, let's say, across the US Treasury curve. Why is it happening? People are probably a little bit less concerned about inflation after some of the weak news out of Europe. So it's taken bond yields down substantially.

But still, we do think, at the end of the day, and probably not too far off in the future, maybe a few weeks to a month, the Fed's going to push rates up at the end of July, almost certainly, whether it's 50, 75 basis points, who knows, but a big number. And that, we think, is going to push bond yields up too. So, day to day, it's been more of the inflation discussion. But longer term, it's very difficult to try and go against the Fed. He just can't do it.

- Some of the stocks that we've seen move down in tandem with what the Fed has had to say since November has been tech. However, as we were discussing earlier, it sounds like some of the sentiment could be re-emerging about where a buying opportunity might be. Within your macro strategy, what sectors would you be looking towards right now?

MIKE SCHUMACHER: Yes. As far as the macro view goes, Brad, I'd say it's been a very challenging time for risk. And we think that continues, because you've got central banks everywhere, not just reaching for the punch bowl, but taking away, whether it's the Fed, the ECB, Bank of England, Bank of Canada, lots of banks everywhere, same basic theme. We're going to raise rates of bunch. Inflation scares us, we don't like it. We want to try and knock it down quite a bit. So this long era we've had of very, very cheap money is basically ending. And I think it makes it really challenging against that backdrop to be excited about adding risk of any sort, whether it's credit, equities, you name it. So, tough for us to get really keen about any particular sector at this point.

- Do you think that we're gonna end up seeing a more protracted yield curve inversion? And what are the sort of implications of that?

MIKE SCHUMACHER: Yeah, we do think that's going to happen, Julie. And, frankly, I'm surprised it hasn't happened already, or at least on a sustained basis. It was very brief. And a lot of people, when they talk about the yield curve, will focus on, let's say, the two year versus 10 year Treasury yield. We think that'll invert, probably, in the next four to five weeks, so after the next Fed meeting.

And I think what that really means is that it's not a sign of a recession. A recession could happen, but not for that reason. But it does make it tougher for financial institutions. It's very difficult to say, well, we're going to go out and try to play the yield curve when it's inverted. That's not what they're set up to do, whether it's banks, or insurance companies, or what have you. So I think it's a bit of a headwind as far as those institutions go.

But it really gets back to your comment about the Fed. The Fed could really control short-end rates pretty well. Longer-term rates are set globally. So if you think about a two-year, a three-year Treasury dictated by the Fed, largely, but the 10-year, all sorts of factors impede on that. So global rates might be hemmed in a bit on the back end, but we do think you're going to see that inversion pretty soon.

- And the significance of that inversion, of course, it typically precedes a recession. What would you put that probability at?

MIKE SCHUMACHER: Yeah, it's interesting, Brad, a couple of comments here. Number one, we do think the chance of a recession's gone up quite a bit. So I'd say 50%-plus. Let's say by the end of next year, early '24, something like that. With respect to the curve being a recession signal, that worked really well until the financial crisis. But the thing is, since at that point, the central banks have added so much to their bond holdings, it really, maybe not broken, but dramatically weakened that link between the curve and future economic activities. We think the signaling power's pretty limited. But still, the recession likelihood's very strong simply because you have so many rate hikes that are likely to happen by many, many central banks. It's going to be very difficult, we think, and most of my colleagues at Wells Fargo would probably agree, certainly our economics team. Tough to go against that over the next, call it 18 months.