Hani Redha

Welcome to this PineBridge Podcast. I'm Hani Redha, Head of Strategy and Research for Global Multi-Asset. And with me is Anders Faergemann, Head of Global Sovereign and Economics, and we'll be discussing the global rates and FX update. We've just concluded our strategy meetings for the month, and before we look at some of the details of our discussion Anders, how would you summarize our conclusions? 

Anders Faergemann

Thanks, Hani. What struck me as interesting was the clear divide in the Fed outlook, notably on the number of cuts we can expect. So, some see the Fed front loading rate cuts this year and really getting to two and done. Others expect political pressure to push them into cutting at every meeting and get five to seven cuts. So there is a real disparity in view. It feels like a sliding door moment for monetary policy here. In the end, however, we affirmed our soft landing scenario and revised our US 10 year yield forecast up marginally from 4% to a four and a quarter, and here's why. 

So number one, there's limited scope for easing in 2026 considering our growth outlook. We expect three more cuts over the next 12 months, whilst the market is now pricing in five, the Fed will ease once per quarter until summer Is our core view. 

Second curve dynamics. There's a real tug of war between the front end of the curve and the long end. So the short end reflects the Fed cuts, but the long end is vulnerable to sentiment shifts, fiscal concerns, global term premium and inflation expectations all play a role. 

And finally, it was a bit of a tactical view change. So we hit 4% and we have effectively monetized that view and now see an equilibrium between the economy and rates. So below 4% is tough to sustain, while any move towards four and a half percent would be considered attractive and would attract demand. So how can we be wrong? 

Clearly, the theme around what the Fed will do versus what the Fed should do is clouding the Outlook. So one tail risk is a US led recession, which, in all honesty, is less and less likely, and I'm sure we'll hear from you in terms of the current growth sentiment. Another tail risk is fiscal dominance. That's when monetary policy serves the Treasury, not the economy. To us, that would lead to more aggressive curve steepening. But so far, those risks are manageable, and we've seen volatility declining in the marketplace. 

The Fed's credibility to pull off this hinges on inflation, and more importantly, inflation expectations remaining anchored. And so the bottom line is that the 10 year is caught between a rock and a hard place. The Fed controls the front end, the short end, but the long end, which is more important for the US, economy, is driven by credibility, inflation expectations and fiscal fears. So we see 4% as a floor, four and a half percent as a ceiling. But with that balanced view Hani, as our base case of a soft landing, what is your current assessment of the US economy, and what risks do you see to your global macro view from this?

Hani Redha

Sure, so you know, what we've been calling for is that, the economy has clearly been slowing coming into this year, and we had a bit of a shock event in April, which also added to our conviction that the economy would continue to slow. But we've always kept our 12 month horizon ahead of us, and have been expecting to see some re-acceleration at some point. And what we discussed in our meetings was the possibility that we're actually already seeing that re-acceleration starting to take hold, and I'll just point to some data points which are pointing in that direction. 

So, the Atlanta Fed GDP Now forecast is at around 3.3% for Q3, back to 2024 levels. We're seeing manufacturing PMIs now at a one year high. And in the US, we're at about 53, which is pretty robust. Economic surprises are coming in increasingly positive. Tax receipts, which is a good indication of total incomes, bottomed in May actually, soon after the so called “Liberation Day” shock, and have actually been recovering since then. And the labor market, where the market is laser focused, they are continuing claims where the deterioration was actually most clear, they are also declining. There are no signs of trouble in initial claims at this point, and mentions of layoffs in earnings transcripts actually peaked in Q1 and they've been declining since then, and we're seeing this reflected in some markets. 

So, there's a really interesting divergence playing out now between what risk markets, equities and credit are pricing in versus what we are seeing in Treasuries. Bonds are really focusing on the here and now, seeing the slowdown and concerns about softness in payrolls, but equities are looking ahead. Not only are we trading at all time highs in equities, but small caps are outperforming large caps and there's a massive outperformance of cyclicals versus defensives. 

Credit spreads are literally at multi-decade lows or tights, and these are things we would expect to see in an economy that's starting to re-accelerate, so the market could be completely wrong, but there's a lot of evidence that risk assets are looking ahead and underwriting our soft landing scenario and expectation that real acceleration is going to take hold. But maybe that re-acceleration is actually already starting to happen. So that's how I'd summarize the situation in the US. And I think that leaves Treasuries vulnerable here, just as you described Anders. But maybe you can now take us through some of the views on Europe, and then we can talk about the implications for FX.

Anders Faergemann

Thanks, Hani. As you say, the bridge between US and Europe will be the FX component. And what you're describing sounds very positive for the dollar, maybe not immediately, with the Fed, you know, in rate cutting mode, but into 2026 it's certainly something we are on the watch out for. 

Concerning Europe, let's turn to France and Italy. Here, we've seen fiscal fears rising in France in particular, but we're seeing surprising developments in Italy, and if we compare the two, yields have now converged, so France rating downgrade from Double A minus to Single A plus really reflects the debt sustainability concerns and the political gridlock. And as I said, the spread between Italy and France has now converged, and even we even saw France yields rise above Italy. It's quite a rare inversion. 

Our view and the analysis we've done justifies the spread compression between France and Italy, and we should get used to Italy trading inside France on a forward-looking basis, as the credit trajectories are diverging in favor of Italy. So, if we look at France, France is facing a political gridlock and lags the will for fiscal consolidation, really, across the political landscape. So even with the new PM, meaningful reform is very unlikely. 

Italy, meanwhile, is benefiting from growth momentum, EU funds and surprising political stability, and whilst Italy's demographics and debt to GDP has a worse starting point than France, the policy makers have worked hard to stabilize, to consolidate debt, and there is an extra motivation for domestics to own Italian debt from a BTP value proposition from the government, maybe something other countries will be looking into, as we've seen a lot of concerns around fiscal fears and rising long end yields. 

But in conclusion, Hani, we've revised lower our 10-year Italy rate forecast to three and a half percent, and so that leaves the spread to German Bunds at 75 basis points. With that, Hani, why don't you summarize our views and wrap up? 

Hani Redha

Sure. So it's been an interesting journey, traveling down to 4% on US 10 year, we think we've reached that destination and are actually going to turn the other way now, moving our forecasts up, and market seems to have recognized that and bounced off that 4% quite clearly, we think that the dollar has also gone far enough in pricing in a US slowdown and an accelerated cutting cycle by the Fed. When we look at the data, we're already seeing signs of re-acceleration of US growth, which leaves us wanting to buy dips in the dollar and turning towards short side for Treasuries. Great, hopefully that is all very clear and actionable. We'll be back next month. For more information, please visit pinebridge.com Until next time, thanks for listening.

 ENDS