From upcoming central bank meetings to key economic data, there will be no shortage of potential signals for investors to digest. Scott Colbourne, Managing Director, Active Fixed Income at TD Asset Management, speaks with Kim Parlee about possible implications for markets.
Kim Parlee: Are we there yet? That’s the question many are asking when it comes to whether the Fed is at the end of its tightening cycle or if another rate hike may still be likely, and if so, when. At this year’s Jackson Hole symposium, Fed Chair Jerome Powell once again said he’s ready to raise rates if needed, especially as the economy continues to defy expectations.
So what does that mean for rates, fixed income, and the economy overall? My next guest says it could be a very interesting September. Scott Colbourne is managing director of active fixed income at TD Asset Management. I don’t know if I like the word interesting, as Confucius’ “May you live in interesting times.” But what do you see? What could be happening in September?
Scott Colbourne: It’s an interesting time period, right? It’s back from vacation, kids back to school. Market participants are back at their desks. So we have a lot to chew through. We’ve got sort of like — we’ve had an appetizer this week of interesting data. We started with Jackson Hole, and then we’ve had some data — you know, it’s going to be interesting because we have central bank meetings.
We have four key central bank meetings in September. It’s typically a time that leads into volatile periods. Historically, October has been interesting, as I say, in the market. So I think we’re going to get more signals on where the economy is going. Headwinds are starting to develop.
Does it move to a soft landing or a harder landing is an interesting question. And that is sort of how I’m framing the fall. And we’ve come through a very good summer. Equities have had a great run. Credit has a good run. Rates are obviously higher. But I think it’ll be a time for a new narrative to develop in the market.
Kim Parlee: I think I’m going to start word searching the word interesting and realize that is a new bearish indicator when I talk to people. Let me ask you, though, I mean, I know you watch the data very closely. Are you starting to see cracks? And what is that telling you about — I know you were saying earlier it depends on the journey. Is this a slower, longer journey? Is this a more rapid descent? What are you seeing right now?
Scott Colbourne: You know, I think a lot, for fixed income participants, in particular, have been flat-footed this year by a variety of narratives, right? We started off with a real focus on recession. Then we got hit by SVB and the response by the Fed. And so we had a huge rally in rates. Then we expected a credit contraction, recession. That didn’t play out. We’ve had a tremendous rally and tremendous lift in economic growth.
So now we’re into sort of the next quarter, next third of the year. And that is, those tailwinds from policy are ebbing. The tailwinds from fiscal policy are ebbing. And a lot of the surprises that we saw on growth are sort of abating now. And so US was really exceptional through the second quarter. The growth was amazing.
But we saw Europe slowing down. We saw China slow down. We saw it even in Canada. And it was a bit of a US exceptionalism. So now, as we move into the last third of the year, we’re seeing most of the economies really start to slow down.
And if there is any rebound, it’s a very modest rebound. So I think it’s setting itself up for a bit of a bond rally, a modest bond rally. I’m not pounding the table, but I do think we’ve seen the end of the rate cycle. We’ve got the Bank of Canada next week.
Kim Parlee: Yeah.
Scott Colbourne: Nothing is priced in.
Kim Parlee: Yeah.
Scott Colbourne: And I don’t think we’ll see anything. On balance, the data tells them to stay on hold here. Two weeks later, we’ve got the Fed. Again, nothing’s really priced in. We’ve got both the ECB and the Bank of England, possibly one, and possibly one hike each. But that is a bit of a coin flip, as well.
So I think the evidence of data is starting to show itself that growth is slowing. We’re seeing cooling in the labor market this week in the US, which is a welcome sign. But I think that there are other cracks emerging that’s going to lead to the end of rate hikes and a bit of a pause and a rally in rates.
Kim Parlee: Can I ask, I mean, one thing you were mentioning, too, is that the data, to state the blindingly obvious, matters. But when you look at corporate debt, as an example, you were talking to me earlier about how there’s a bifurcation, if you will, in terms of the stronger corporate issuers and those maybe who aren’t. But what are you seeing?
Scott Colbourne: We’re definitely seeing credit stress. The big surveys by the Fed, the senior loan officers survey, has definitely told us that credit is being tightened by the big banks. Bankruptcies, July was one of the biggest record years for bankruptcies — months in the US. And we’re on track for the worst year in bankruptcies in the US since 2010.
The default rates are modestly ticking up. And so that, to me, is sort of the leading indicator. We’re also seeing some of the banks reserve for loan losses —
Kim Parlee: Yeah, increasing, yeah.
Scott Colbourne: Credit delinquencies are starting to show up in credit cards. So it’s all sort of small sort of building signs that the direction is more stress. And so I think, to lead into the opening remarks about interesting times, the stress is building in the credit market. The stress has globally, on the economic side, is there, and it’s evident. We’re seeing slowdown in growth. We had GDP numbers today in the US that was lower than expected.
And one of my favorite indicators that doesn’t get a lot of traffic is GDI, Gross Domestic Income. They have to equal, GDP and GDI. And it’s been telling you pretty flat growth, even recessionary growth. So the evidence of growth slowdown is really emerging in the US, and cooling labor market, cracks in the credit market. So these are leading to the interesting times this fall.
Kim Parlee: I’ve only got a few seconds yet, but I do want to touch on the fact that you also mentioned that you’ve got some of the stronger debt issuers where you’re not seeing that stuff, and it’s because they’ve used this time to pay off debt, load up on cash, and that can almost distort, one could say, some of the things that are happening. At the same time, they’re also big employers, so that could also prove that resilience longer at the same time.
Scott Colbourne: There is a real bifurcation in the credit market. The top, the mega-cap and the large-cap borrowers have done remarkably well. And in fact, with this 500 basis point increase in rates, nothing’s really happened for them. But when you dig down into the next tier down and the next tier down below that, you’re seeing the evidence of credit stress.
They don’t have access to the capital markets to have termed out their debt and really sat on cash. And so that interest impact is hitting and will continue to hit through 2024. So definitely something further to watch.
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