Current rate levels ‘projecting very robust growth in inflation,’ strategist says

And as the market's digested Powell's recent comments, investors are wondering what's in store for growth and inflation going forward. Joining me now to discuss is Bonnie Wong-Trakul, portfolio manager at Western Asset. Bonnie, thanks so much for joining us. You heard Jerome Powell's comments yesterday, not on a set path. The Fed's not on a set path. Data dependent, we are waiting for that jobs report tomorrow to give us a better picture of what's happening. What should investors be making of the current environment right now and what's expected over the next six months or so? Yeah, so I think investors really need to ask two questions.

And the first one is really what are current rate levels implying for growth and inflation going forward? And the second is can the U.S. economy really deliver what's being implied by the market? So we view current rate levels as projecting very robust growth and inflation that's going to be sustained over the year. And those numbers we saw in January were indeed very strong. But when we think about the prospects for the economy to continue along those levels, we are a bit circumspect about that data in January. I think it's been well discussed that there was warm weather, seasonal adjustments, there are cost of living adjustments. We even had mortgage rates dip towards 6% and now they're closer to 7%.

So all of those are idiosyncratic and one-off. But alongside that, we have seen that manufacturing has been slowing down arguably has been in recession. So has residential construction. Now we're seeing the consumer become more cautious and savings rates go up. So all of this is leading us to believe that growth is going to moderate over the coming year along with inflation. Of course, we are going to get a lot of very important data over the next few days between employment data tomorrow. We have CPI and retail sales next week.

So we will be looking at those really closely to help us fill out the picture more. Bonnie and Julie here. So if indeed January was a bit of an anomaly and we are going to see some moderation in growth in inflation as well, what should the bond market look like? What should the yield curve look like right now? If indeed that is going to be the case? So if we're seeing that growth is going to moderate, then clearly the longer end of the curve needs to come down. That is an area that we like, longer dated maturities, because that is going to reflect the longer term growth and inflation prospects. And we've seen that the 10-year does have some interest and support at that 4% level. We think that does make sense. On the shorter end of the curve, there is going to be some more volatility.

There is going to be a lot of data that the Fed is going to be looking at over the next couple of months. I don't think anyone can really say whether they're going to get to what's priced into the market, not the Fed themselves. So on that area of the curve, we recognize there is upside risk. We think there's going to be volatility and we would prefer to be underweight that part of the Treasury curve. And following up on that, I was going to ask you about what your views are as far as investments. I mean, how should investors be positioned in this environment? Yes. Well, outside of Treasury, so I just talked about our Treasury view, outside of Treasury, we still think that corporate credit makes a lot of sense.

The fundamentals are still good. From a bondholder perspective, interest coverage, it's very strong still. And so we still like being overweight that asset class. And there we do like being shorter on the maturity curve. You can get very good all-in yields five years and in. So investment grade is offering 5.5%.

And for below investment grade, it's 8.5% around that area. So we think that's quite attractive. In addition to that, we do like emerging markets, which we think could benefit as the Fed hiking cycle starts to wrap up as you see the US dollar normalize, which could also benefit from the China reopening, particularly for countries that are exporting tourism and commodities. So we do like that sector as well. And for the investors that have the risk tolerance, we really do like frontier market sovereigns, which are these smaller below investment grade rated emerging market countries, which have issuance in US dollar denominated debt and offer actually double digit yields. Bonnie, switching gears for a second, because all of this strategy flows, at least in some part from the Federal Reserve and the decisions that they make.

And reports out this morning suggest that Janice Eberle is the front runner to be nominated for vice chair of the Fed. You've written a little bit about this. If indeed that's the case, if indeed she gets that position, what does that mean for Fed policymaking? Well, she's clearly very well qualified. We have to see how the rest of the the Fed is going to work with her. But we would look forward to her leadership. If that confirmation does indeed go through. And, you know, if she is indeed going to go through, it's interesting as we think about the Fed, because obviously, they speak with one voice on decision days, right? When they come out with their policy, when it's Jerome Powell, who does the press conference.

But in between that, we get a lot of Fed speak and the market has been very reactive to that Fed speak. So is there anything we can sort of extrapolate on that basis if she does get this position? I think you're going to continue to see a variety of voices within the Fed. I don't think that her addition is going to change anything. And I think Powell does a good job of bringing together those voices. But yes, you're right. We do see variants in opinions. We've seen the Fed speakers kind of evolve their thinking as the data's evolved.

And we don't expect that to change as the Fed is going to be very reactive to each data point that comes in. Yes, it will. And so will we. Thanks so much, Bonnie. Appreciate it. Western Asset Portfolio Manager Bonnie Wong-Trickle. Appreciate your time this morning.

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