Core PCE's Critical Market Role This Week, U.S. Diesel Ban "Temporary Fix"

SPEAKER_1 (0:02)

Welcome back to Morning Trade Live. It's time now for the big picture. Let's welcome in the team from Charles Schwab, Center for Financial Research, Cooper Howard, Director of Fixed Income Research and Strategy, and Michelle Gibley, Director of International Equity Research and Strategy. Good morning for both of you. Cooper, let's just start with you, given of course, bonds are really stealing the show at the moment. You say it's not time to extend duration. I was just listening to Yardeni this morning, who doesn't believe that five and a quarter is the top of yields right now, particularly on the 10-year, but I suppose if you can get 5% on the 5-year, you don't really have to go far out on the curve. Just talk us through the thesis here.

Cooper Howard (0:38)

Yeah, so don't get me wrong. We do think that there are opportunities in the fixed income market. We think that where yields are today are fairly attractive. However, we wouldn't necessarily get ahead of the steamroller. So we think that extending duration at this point, it might be a little bit too early because there is potential for momentum to be on higher interest rates going forward.

So we do necessarily think that that's a potential risk going forward. Given higher potential for inflation, we know that we're going to see PCE tomorrow. So I think that that's going to be telling of where the market comes in.

Also, the Fed's clearly in a bias for hiking interest rates. So we think that that's also a potential risk. Then ultimately, if we break down the moves in the 10-year treasury, Sam, we break them down into the Fed funds rate, the term premium and inflation expectations. If you look under the surface, a lot of the move higher in the 10-year treasury has been due to the Fed repricing. So we think that that's a little bit of a concern or a little bit of a risk going forward. Potentially, the market might shift there. So we just think that, yes, there are attractive opportunities in the fixed income market, but we wouldn't try to get in ahead of the curve right now.

SPEAKER_1 (1:46)

Okay, understood. And Michelle, casting the net overseas, obviously we saw Australia move on rates last night, firing the gun on its, what, fourth hike this year. I know you say that energy has become the swing factor for inflation, central banks and also valuations. Just walk us through the significance of what we saw the RBA do last night in light of that.

Michelle Gibley (2:09)

Yeah, the Reserve Bank of Australia had been on pause for a couple of months, but things have really changed dramatically since then, and they had to raise rates to the highest level in 15 years last night. A lot of it has to do with inflation being high, and a lot of that is due to diesel prices. They have the highest per capital diesel consumption in the developed world, and those higher diesel prices have the risk of spilling over into non-energy inflation. If we look elsewhere in the developed world so far, we're not seeing higher wages yet from higher energy prices, but inflation remains sticky, and the more the inflation remains elevated, the more likely that central banks have to raise rates. And eventually, higher interest rates reduce the present value of stocks in a discounted cash flow model. So diesel prices are an important thing to continue to keep our eyes on.

SPEAKER_1 (3:07)

All right, and Cooper, how are you thinking about the data this week? I mean, obviously, we're waiting for the PCE, the Fed's preferred gauge, and also the jobs on Friday. We just got a pretty downbeat consumer confidence read, as to how people are feeling about the economy right now. I believe that was the lowest since 2014

How are you tying all the data together, and which metric, I suppose, when you look under the hood this week, are you going to be scrutinizing the most?

Cooper Howard (3:36)

You know, I think that if you look at the, if you had to pin me down and make me choose one metric to closely watch this week, it's going to be PCE. I think that that's going to be the telling figure, and ultimately that's going to feed into what the Fed does. And right now, if you look at the market, the market's expecting an over 3% year-over-year gain on PCE, and then a month-over-month of about 0.3%.

I think that's probably too hot for the Fed to like, and that's therefore why they've shifted into a little bit of a hiking bias. So our expectation is there's probably one more hike at least this year, and then potentially another one either this year or early in the next year. And that really comes down to how inflation performs. And it's not just the month over month change or the year over year change. I think that we'd be a little bit more comfortable, and the Fed would be a little bit more comfortable seeing 0.2 month over month, 0.1 month over month, potentially even lower. I also think the other thing that they're closely watching is the breadth. And Chair Warsh has said this before, but there's too many figures under the surface in PCE that are moving in the wrong direction or are above the Fed's 2% target.