Fed Hike Risk Jumps as France’s Bond Market Flashes Warning Signs

Sam (0:00)

Let's turn our attention to the recent turmoil in the European bond market with our good friend Ben Emons, CIO and founder of FedWatch Advisors, who comes to us from a fixed income conference over in France. Thanks so much for your time, Ben, but I do have to kick it off with this hot CPI print. I mean, this seems to have very much put the rate hiking bets back in play now.

October, interestingly, went to almost a coin flip once again earlier this morning. We've come back down to 35% now, but what's your read on all of this?

Ben Emons (0:32)

Sam, it underscores the worry that the Fed has been putting out there, that the market isn't paying, I think, enough attention to. I noted from various speeches of any of those Fed members, whether they're voting or not voting, that the tone was really shifting towards like, we have to do more perhaps, not just one more, but perhaps several, to get to a restrictive stance and try to control the trend in inflation.

For example, I mean, like, what's worrying there is that the shelter, for example, was picking up, it looks like almost like accelerating, which has been such a misinflationary force behind the core numbers over a while now, so that's reversing on top of the energy effects that are playing out obviously, and the AI build out has been an impact too on CPI. They were in for higher numbers, and the Fed has no choice but to respond to it, and that's the reaction today in the market, like reassessing the odds that, yes, October is a live meeting, and yes, they could hide rates, even though they're mid-term elections, so my model indicates actually there were more like 70 percent odds based on the tone of the Fed, and the market is still, I think, underpriced for this possibility that we may pull the trigger in October. So I think that's why we're getting this quite strong reaction in equity markets today.

Sam (1:50)

Yeah. What about the round trip on the 10-year? Can you explain the move behind that? Because we're back to the levels pre-print. I think that's the first time we've seen a move to the upside, then back to the downside since the end of 2022

Ben Emons (2:04)

Yeah. I think what that did was that we have the surprise of the CPI itself. In other words, the thing wasn't right for that particular upside on Cormoran. I think once people realize that, okay, this is not a so hard number that it may trigger immediately, the chances for a hike towards 100 percent, flipped over, that's why we kind of pair off.

Maybe some buying today, people are looking at the 5.3 level that we talked about previously as a resistance level, but now myself and others are more in the camp, but that's probably more of a support level building there. And so I think that's part of the dynamic around it, other than some secret flow, as then that may be playing a role here. I think what the market is doing is that inflation is just not cooling off. There's too much pressure building, and there's just no choice but for this fact to get more restrictive. And I think that's why you see this new jerk reaction in the tenure.

Sam (3:03)

Yeah, I mean, you just wonder what heights are going to mean for this housing market as well. I mean, the 30-year fixed rate, 756 right now, the expectations is that that is going to continue to dampen demand as it rises into 2027 But I do want to park that there for a minute, because I want to speak about sort of the epicenter of this global bond sell-off, and that is where you are in France right now. I mean, obviously, we've been watching that spread between the French bonds and the yields, I should say, and the German yields, which got up to like a 15-year gap last week, 150 basis points. Could you just explain the move behind that, and why that is so significant for a place like France, which had been typically seen as risk-free?

Ben Emons (3:51)

Yeah, to start there, you know, France was the part that is part still, I guess, of the core group within Europe. So it's also therefore core allocation and a lot of portfolios. And I think this is what played a role where there's a lot of talk that many, several Japanese institutions have been rotating out of French bonds back into Japanese bonds. Of this concern that this runoff election that we've seen playing out, it's just not going to lead to any really fiscal consolidation. And therefore, we already had one downgrade recently, the more down the rates are coming, that's what these Japanese portfolios are particularly sensitive to.