‘Central banks are accelerating towards tighter policy’: Strategist

Kathy Jones, Chief Fixed Income Strategist at Charles Schwab, joins Yahoo Finance Live to discuss the outlook on the Fed tapering, interest rates, the bond market, and inflation outlook.

Video transcript

KARINA MITCHELL: I want to start by talking a little bit of policy, right? The Bank of Canada says that it's going to push to accelerate the timeline of rate hikes. ECB, BOJ also set to meet. The Fed is coming out next week with its strategy. What does it do? What do we see from the Fed? And do any of these other central banks give it pause for thought about when it starts to taper?

KATHY JONES: Yeah, I think the Fed is pretty well determined to start the taper pretty quickly. We expect them to announce it next week and then start it soon thereafter. So that's pretty well carved in stone. I think the big debate now is how quickly the Fed moves towards actually raising rates. The expectation in the market has really shifted to expecting as many as two rate hikes in 2022 and '3 and 2023 and beyond. That's a pretty aggressive pace of tightening versus where we were just a couple of months ago.

But we've seen this with all the other central banks. Bank of Canada has came out today and said they were going to speed up their tapering and move towards rate hikes. Bank of England is expected to move pretty quickly because they have a lot of inflation pressure. So there's definitely the story here that central banks are accelerating towards a tighter policy.

And I think that's part of what got into the market today because what we saw was long-term rates come down and short-term rates, you know, hold up fairly well. And that idea is the more aggressive the central banks are, the quicker they go, the more we get slower growth, the quicker we get slower growth and lower inflation down the road.

JARED BLIKRE: Well, Kathy, I'm glad you brought up the bond market. That's exactly what I wanted to talk to you about and maybe drill down into that a little bit more. I raised the possibility with a previous guest, maybe seeing some month end flows. But structurally here, I'm seeing the five-- the spread between the five-year and the 30-year at the lowest since March of 2020. That was the beginning of the pandemic. So is this all about the Fed right now?

KATHY JONES: I think to a large extent, it is. I think there's a couple of things. Clearly, the Fed, because, you know, when you look at the slope of the yield curve, particularly, like, five-year versus 30-year, that's really telling you, the five-year's telling you what the market thinks is happening with short-term rates over the next couple of years. And then the 30-year is telling you what the expectation is really for inflation and growth longer term. And the faster the Fed moves towards hiking rates, the more the market contends that we're going back to that kind of slow growth, low inflation environment.

But the other factor is we do have some flows coming in. We have a lot of pension funds, insurance companies that are likely to rebalance towards the end of the year. And they've had huge gains in their equity portfolios. And some of that will simply get rebalanced into the bond market, particularly into longer term bonds, because those are investors with a very long time horizon. So there's a bit of a combination of things going on.

KARINA MITCHELL: And what's your view on inflation right now in this type of environment, when earnings are beating and there's still consumer demand? What is the tipping point?

KATHY JONES: Yeah, I think the tipping point will be, well, two things. One is, you know, when does the supply side kind of right itself? And that's looking like that's going to take longer than I think most of us thought six months ago. Have those supplies come on to kind of balance out against demand?

But it looks like the tipping point is really going to be coming up as we move towards tighter policy. You know, the Fed can't make more semiconductor chips or pump oil, but they can raise rates to slow down demand. And I think we may be getting to a point where the expectation is that we'll have tight enough policy, you know, that easy money will start to flow out. And that will start to bring the inflation pressures down.

JARED BLIKRE: And what are you specifically watching as part of your timing signals for the Fed? And we only have about a minute left here.

KATHY JONES: Yeah, I watch the yield curve very, very closely. And then I'm watching what they say and the rotation of the various Fed governors. You know, we could have as many as four or five new people at the Fed next year. So that's going to be important as to who's on the Fed versus who's possibly leading.