Two More Interest Rate Hikes 'Very Likely' for 2026, Earnings Boost Investor Confidence

SPEAKER_1 (0:01)

Welcome back to Morning Trade Live. It's now time for the big picture. So let's welcome in the team from Charles Schwab. Collin Martin, Head of Fixed Income Research and Strategy, Schwab Center for Financial Research, and Alexandra Semenova, Financial Insight Strategist. Charles Schwab, thank you to both of you for joining me for this Friday. Collin, kicking things off with you, because you've actually updated your bond market view following last week's Fed hike. Just walk us through that.

Collin Martin (0:23)

Yeah, well, we're actually expecting an additional hike, at least one more hike this year, with a second hike as highly likely. You know, the Fed is clearly a hawkish pivot, inflation's above target. It's been above target for about five and a half years right now.

And importantly, in the press conference last week, Kevin Warsh said that the economy was strengthening. So it's not just kind of stable. It looks like it's improving, at least in the eyes of Kevin Warsh and the Fed. So it seems like more work is needed here. The Fed removed a dose of accommodation, which suggests there's probably another dose or two that's probably in there that can be removed. So with that outlook, we've changed our view. And instead of projecting a hold, which we had previously been projecting, we think we'll see at least one more hike with a second as highly likely also.

And then beyond that, the pace of inflation is gonna be the key driver. So we're gonna be looking at monthly core inflation readings. That's something we've been paying attention to for a while now, but also the breadth. That's what Kevin Warsh is focusing on. So when we get the PCE report, we're gonna see that share of components rising at a 3% plus year over year pace. And if that's broadening out, that's gonna be a little bit more concerning.

SPEAKER_1 (1:39)

And so Alex, how have you and the team been thinking about this? As you do have, obviously, the 10-year having crossed past 5% once again, really on the strength of the economy and some of that data we got last week.

Alexandra Semenova (1:50)

Yeah, it's all about the moves and yields right now. And 5% has historically been a long-standing psychological and economic tipping point for equity markets.

Also significant is the pace and magnitude of the move. We saw some extreme moves in yields this week and also worth noting that the 10-year treasury yields is on track for its seventh consecutive monthly gain, something that we've only seen six times since 1950 So could we see some additional volatility from here in equity markets? Absolutely. However, is this necessarily a precursor to a 2022 style event in stocks? Evidence would say no right now because the starting point is very different. Typically, when the Fed enters a late stage hiking cycle, it's to slam the brakes on an overheating economy. In this case, we and the team have been saying that it's more like tapping the brakes, right? Inflation is a problem, as Collin just mentioned. However, it's mostly being driven by supply side factors like energy. At the same time, you have very strong growth across the economy and corporate earnings which is extremely significant for equity investors and that's the important distinction to hear.

SPEAKER_1 (2:58)

Yeah.

Alexandra Semenova (3:00)

Looking ahead, we're going to have to see that earnings picture hold up.

SPEAKER_1 (3:04)

Yeah. That's what my last guest had to say. I mean, the earnings are really saving the day here and why stocks can probably live in harmony at least for now with 5% on the 10-year, close to $100 oil as well. I did want to pick up on something that you mentioned in your notes as well, Collin, about the junk bond spreads finally reacting. I mean, speaking of, I was looking at SoftBank and what they did this week with the dual currency junk bond too. I mean, it was the biggest ever that we've seen of that kind. How are you watching this market?

Collin Martin (3:34)

Yeah. Well, so far the junk bond market, in fact, most of the credit markets have taken the increase in treasury yields in stride. Even with the Fed rate hike last week and projections, suggesting at least one more hike, credit spreads, both in investment grade and high yield, have remained low. Now, there have been cracks forming under the surface in the junk bond markets, where year to date, we've seen triple C spreads increase pretty considerably, while double B and single B spreads have remained low. So at an index level, there hasn't been much movement. But the sharp move in treasury yields, and Alex hit the nail on the head, it's been very swift, it's been very sharp.