Bond market braces for potential summer turbulence

Yahoo

07-05-2025

0:04
spk_0
Welcome to a new episode of the opening bid podcast. I'm Yahoo Finance executive editor Brian Sai. Like I always say, this is the podcast that will make you a smarter investor, period. And to that end, we have a real treat for you today that will make you a, a very, very smarter investor. Double line Deputy CIO Jeff Sherman. Jeff, good to see you. It's been a while. Thank you for coming on here. So for those not, uh, as familiar with with Double I as I am, having covered you guys and and talked to you many times, what does the business look like today?
0:33
spk_1
Yeah, we run a little bit over $90 billion in in assets um for very, very diverse set of clients out there. We run institutional money, we run private placements as well as publicly available 40 act funds, think mutual funds and exchange traded funds. Um, if you think about the way we invest, uh, the bulk of our assets today sit in the fixed income arena. Uh, we focus on products that are kind of more traditional or traditionally oriented.From the standpoint of thinking about what people think about when they think about the broad bond market, like the the Bloomberg US aggregate, uh, to very customized strategies, whether it's that limited interest rate exposure risk on the duration front, uh, but it's a credit specific strategy where people are looking to kind of actively allocate across the fixed income space, but.Our core, we're an active manager and so what we try to do is use kind of the top down macroeconomic landscape uh to inform views about how we see the world and couple that with bottom up security selection through fundamental analysis with the analysts that we have, uh, that are experts within their specific areas of the fixed income market.
1:37
spk_0
I imagine over the past month, you've really been leaning into the active side because it has been, uh, some would say bonkers. Of course, we saw the big stock market slide in early April after Liberation Day. We've seen markets stabilize, but we still have the 10 year close to 4.3%. It was a little bit higher than that. What have you been doing and and what have the past few weeks been like for you and your clients?
1:59
spk_1
Yeah, that's, it's pretty interesting, uh, Brian, because you would think being an active manager that we've been extremely active in trading and moving, uh, moving our allocations and credit exposures around. Uh, but you have to think back about the landscape we came into in 2025. And what I mean by that is that um we had a market that had very high valuation. You think about the stock market, people talked about the price earnings ratio, the cap ratio, that long term PE uh being extremely elevated.Levels, uh, we also had in the credit markets as well. Um, in the credit markets, that's referenced by tight spreads the incremental pick up that one gets for investing in credit assets over kind of treasury assets. And so what, what we found, uh, during the month of January, you know, coming into the inauguration was assets were still on a tear since that post-election run and um essentially anything credit oriented or anything risky or riskily or risk oriented.Um, was, was really doing quite well. And so as we sat down ourolocation committee meeting, um, as, as we went into kind of February, we said, you know, look, this administration.Seems like there's going to be, um, there's going to be provoking a lot of uncertainty, right? Uh, we weren't sure about Liberation Day, we didn't think it would be as severe as anyone else. But what this led us to do after giving the run on the assets and knowing that there's heightened uncertainty was reduce some of the credit risk within our portfolios back in February. And again, it wasn't because we saw Liberation Day, uh that was coming in in 5 weeks' time.It was more of the standpoint of saying, look, spreads their type, there's not a lot of incremental risk premium out there in the marketplace today, and if we live in a world that has heightened uncertainty, right, you should command a higher risk premium. And so what that made us do was kind of rotate some of those assets um into kind of more uh high quality things like government guarantee, like treasuries or agency mortgage backed securities.And so what happened on liberation Day, obviously, um, it was, it was much more fearful than people thought. It was much more extreme than people thought. And in some ways, parts of it have gotten significantly worse since then, although you, you mentioned the markets have rebounding. So what we've actually been doing in our portfolios over the last 3.5 weeks since we've been liberated.Is that we actually have just been re-underwriting risk in our point flow, making sure that we're comfortable with it, making sure what we own is what we want to own, and we haven't actually been highly active in today's market. And why is that? Well, because there still is uncertainty, right? Uh, markets have rebounded in some way, um, they retraced somewhere between 1/3 to 5% of their levels, um, when I, when I talk about spreads of the sell-offs we've seen, uh, in, in credit assets, but really I feel like the uncertainty hasn't changed.Right, we still have an elevated level. We still have these uniform tariffs that are out there. Uh, we have an extremely elevated tariff policy against China, uh, which is having a significant impact on, on kind of the trade data we got trade data this morning, uh, the deficits at a at a new uh nominal record out there as well. And so what's happened out there is that some of this like by the dip mentality came into the marketplace, and right now we just don't think it's a good time to be adding to risk in portfolios. So welike our positioning coming in, um, what we've done is reassess where we are in terms of that return to risk payoff that we see in the future. And today we're very comfortable with those assets. But again, we're looking for some direction in the marketplace today. And again, I would say in the last 3.5 weeks, all we've seen is more turmoil, more uncertainty, and it doesn't give you as an investor, this nice fuzzy warm fuzzy feeling of wanting to up one's risk budget today. Jeff,
5:36
spk_0
II love the Yahoo Finance community, but, you know, they, I think, are very active with the top 7 largest stocks in the world. This is Apple, this is Nvidia, this is even a test all thrown in there after its posterings rally, and they only pay attention to.The headline on the 10 year yield, and if that goes up, they are trained to think stocks go down. Frame this for this, uh, frame this for this community. How important is it that we are seeing the 10 year above 4%, and then if it were to rise further as we layer on more debt, I haven't gotten to the potential next Trump tax plan, we layer on more debt on this country, but how worrying is it if we do hit that 5% level?
6:20
spk_1
Yeah, I mean it is worrying, but you, you have to remember that we went down below 4%, um, you know, previous to this kind of this this sell-off in rate yields and pushing them back up. And so the reason interest rates are important is because the 10 year treasury, it feeds the economy. That's kind of how mortgages are priced when when the homeowner goes to take that out, uh you can think about longer.Term corporate debt, it's how corporate America finances itself. And so what that does is that feeds into kind of mechanism and it also leads to a discount factor for thinking about your future earnings and how to value stocks. Um, now, the issue that we've seen is that rates have been extremely volatile, and they're volatile for kind of two reasons, and I, I call it this push in the pool that you have in the markets.So the push of rates going down is the lack is really the fear that economic growth and activity is going to diminish, right? And some of that is because of the tariffs, right? It's because of the uncertainty of the policy, it's because of the unknowns out there, um, and again, if prices are going up meaningfully, um, it probably reduces overall consumption.And so from that standpoint, that that is a gross scare, I'll call it, which pushes rates down. On the other hand, um, I don't have to rewind the clock very far, uh, we can take it back 3 years to when we had very elevated levels of inflation, and the bond market has not forgot about these levels of inflation. Now, I'm not saying we're going back to a 9% inflation rate.But what's happened there is that the bond market now realizes that it has to price in inflation uncertainty. And what that means is that if the bond market thinks there's a level of inflation, it will command what we call a real yield, that incremental yield above the expectations of inflation.But it also has to price in some uncertainty around that inflation level. And because in the short term tariffs can be inflationary, right? The bond market is struggling with what is the inflation narrative today, and also that kind of pulls rates higher.And so these two things are kind of battling one another, and you mentioned 4:30. Well, if you actually look back over the last, let's call it 18 to 24 months, what you see is a 10 year trading range has really been, you know, kind of like mid 360, call it 365, to about 470. So where does that put you at a 4:30 today? We're roughly in the middle, maybe slightly above the middle of that range, but what you see is these push and pull factors have been driving, you know, the the the tenure up and down.And so, if the tariffs come through and there's price, um uh there's price pressure out there, and look, you saw Amazon be castigated by the White House this morning, right, uh for the idea that they were going to publish uh what how much of the tariff is pushing that rate price up, uh, they were talking about that policy, butThis is the idea that ultimately, if that has to pass through, that's going to cause higher prices and these higher prices will ultimately change the consumption pattern of the consumer. And the challenge is, is that, you know, the, the problem that this administration has is they want us to buy American. They want us to buy goods that are produced in the USA.And there's nothing wrong with that. That's a that's an admirable goal. The problem is we don't have substitutes for a lot of these goods that we consume that are produced in the US. So if we want to buy them, we have to pay the higher price, or we choose not to consume them, which can cause pain for some of those industries. And so this is the dynamic going on in the marketplace, and this is why I talk.About there being massively elevated uncertainty today. And then you brought in the policies that the administration is trying to push, right? That they want tax cuts, they want to extend the TJCA from 2017. They probably get that done. But then they want an incremental tax cut on the back of that as well. And again, are they going to be able to find the funding, uh, thus far, what we've seen.When you look at the quarterly refunding of how many treasuries are going to be issued, uh, that was announced yesterday, it really hasn't changed the dynamic of the market. So for all this talk about those and government efficiency, and we're going to reduce the deficit, thus far in 99 days in, there hasn't been a lot of progress. That said, the onus typically sits with Congress, not the president, uh, to push these policies through.
10:30
spk_0
All right, hang with us, uh, Jeff, we're gonna go off for a quick break. We'll be right back on opening bid.All right, welcome back. Having a great chat here with Double Line Deputy CIO Jeff Sherman. Uh, of course, continue, continue to hit us with all those likes on the social media platforms and podcast podcast platforms. Always, uh, enjoy your feedback and, uh, it's always very interesting stuff. Look, Jeff, I don't want to sit here and be aYou know, someone in our field that is trying to get headlines, but people are telling me this summer we might be headed toward a bond market crisis. They point to the trade war, they point to potential debt, they point to an economy that might be in a mild slowdown. All these things seem plausible to me. Do you see a potential bond market crisis this this summer, and what in the world would that even look like, and what would it mean to markets?
11:22
spk_1
Yeah, well, I mean, look, the deficits obviously some debts untenable in the long run, um, and so it's something we need to address, and as we talked about in the last segment, I was talking about the idea of like trying to reduce the deficit, having more policies that were friendly towards that. But what that means is austerity, Brian, and and the challenge with that is that austerity.Means that we have to tighten the belt. That means we have to slow consumption, and we got to quit spending money on, on programs out there, and that will obviously slow down economic activity. But then what happens kind of again, this is like the the the ills of that side, it sounds great in theory.But the problem is, once the economy slows, usually the government is the backstop to help ignite it once again. That is, they issue debt, um, they promote policies that are trying to promote job growth and the likes. And so it's that if, if we are austere and we cut the deficit, there's going to be a consequence which may may make us have to turn back on the spigot and increase the deficit again. Um, so this is the challenge with kind of where we are in the overall kind of state of the of the markets today.However, you would talk about what does a crisis look like? Well, it looks like it looks like something back in let's call it the fall of 2022 when we saw the UK dealt crisis. And what what that was was a function where the bond market responded to policy. There was a policy issued by by then, I, I believe it was Theresa May at the time, and what happened, uh I'm sorry, it was Liz Truss at the time. I apologize. Um, but what happened with Liz Truss was that she was talking about 5.Inflation, they were going to do QE again. They were going to do tax cuts. Does that sound familiar, Brian? They were trying to stimulate the fight inflation, right? And the bond market said, no, you're not. And so that's what it looks like. It's when the bond market revolts and watching the, the, the two weeks ago, people said, oh, the bond markets revolting because the treasury curve and that that's talking about the 2-year rate all the way up to the 30 year bond, most of them went up approximately 50 basis points that week, butBut I, I, I point out to people is that, yeah, that's kind of what it looks like, but it's probably 50 basis points a day, and it's consecutive days. Um, the other thing is, is that don't forget during that 50 basis point rise, rates had rallied almost 50 basis points over the preceding like 6 or 7 days. So it it was just kind of an inverse of of of some of that move. And so sometimes you have to step back and look at the bigger picture when you look at these micro moves. But ultimately what it would look like is that the bond market is reform.against the policy, it's saying that no, you cannot continue to pursue this, and that's ultimately when you know that the market has had enough. And what is it the old um, there's the old quote about that I want to come back as the bond market, right? Um, if he gets James Carville that it's attributed to, right, because it can bully anyone, uh, and it's the biggest, the biggest bully in the room. I'm paraphrasing there, but, but he did say he wanted to come back as the bond market.
14:19
spk_0
Yeah, that's a good one. somewhat uh actually probably really tied to this.So one of the benefits of working at a company like Yahoo, you got a lot of data and you could very easily go back to certain things very, very quickly. I found you did an interview with my former colleague October 20, 2017, where you, you're talking about the Federal Reserve, Jeff, and you predicted that the next chair of the Fed would be Jerome Powell. It was right at the top of the story. I mean my colleague did not bury the lead, so he nailed it there, um.Have you started to, and your team started a handicap on who the next Fed chief will be, and what do you think about these attacks on the Fed's uh independence from the president?
14:58
spk_1
Well, let me take him in reverse order. Let's just start with the attacks is that, you know, one of the, the, uh, pleasures that we have, and as the US and having the dollar and having the big bond market is that we have the independence of the Fed, right, that it isn't leaning on the political whims and we don't vacillate back and.For, um, as criticized as the Fed can be, uh, at various points, uh, through time, they ultimately are trying to serve the good of the people. They're, they're trying to achieve their overall mandate. And so I think what you've seen from J Powell is that he has not been reflexively responding to the to the president. Um, what you also see is that he's been adamant about he's staying in charge.And um look, President Trump roiled the bond market and and the markets in general, uh, by saying that, you know, he want that Powell should be fired.And so then he backtracked it. I think some of that uh was Scott Besson and Howard Lutton that get in the room with him and saying we need to we need to do this. But ultimately, I think when you when you think about who the next Fed chairperson is, it's a political appointment. So it's probably someone who's going to align themselves more with the views. Um, you know, I, I think if you look at kind of the betting markets today, Kevin Warsh is the, you know, kind of front runner there, but he doesn't have a lot.a lot of confidence in there as well. And so I think the, the question becomes is that, do you find someone and who is going to try to shade themselves to what the political means. By the way, from my understanding, Jerome Powell is a lifelong Republican, right? He was appointment the first time as well. And he's done a very good job of being independent. And so I, I think the independence of the Fed is extremely important becauseUltimately, we saw this, you know, prior to the the era with Volcker, where you had, you know, someone in charge of the Fed that leaned politically and tried to really push those policies and keep rates too low for too long. And so I, I think for as much criticism as J Powell has got, especially during 2022, he's done a good job since then of kind of having a steady hand, not reacting to whims in the data, uh, looking at the overall data set.And at this stage, I, I think it's important, and the market really appreciates having that, and having someone who is not independent in charge of the Fed, then the question becomes do the Fed governors start to have much more dissent as well, right? Because remember, it's supposed to be a policy, it's supposed to be cohesive, usually the Fed chairperson is the one that brings everyone together. So, um, we could see something more like what you see kind of the Bank of England, where the votes are like.eked out by 11 vote. It looks like a a Supreme Court ruling, like a 5 to 4, right? And instead this unanimous uh type of decision. So ultimately, I think it's very important, and there is a concern there, but the thing is, is that there's so many other concerns between now and the end of J Powell's tenure that I think I put it lower in the stack right now as we try to get through these tariff policies and what this trade war ultimately means for the US economy.
17:59
spk_0
So it doesn't sound like you're sold on Kevin Warsh.
18:03
spk_1
Look, I, I don't know enough about him to be honest, and, you know, we have this, we had this discussion recently, um, around the table here at Double I was that, OK, well, what does it mean? Is he, if he gets fired, who comes in? It would be much more disruptive to fire JPal, um, and try to focus on today, then get the next person. I think it's way too early to be handicapped.it. And again, I'm not against Warsh um being there. I just don't know enough about him. And I think personally, I'll do much more homework as we get closer and typically, you know, usually the Fed chairperson is someone that's like about 2 to 3 months out from the appointment, you start discussing it. Um, but they're talking about discussing it later this summer.
18:42
spk_0
Jeff, I think it should be you, man.I think you, I toss your hat in the ring. I, I, I, you got my vote. Not that it matters, but yeah,
18:49
spk_1
I, I appreciate that. I don't think I'd be like. I'm not as pretty as Jay on the, on the, on the podium and stuff, so I'll leave it to those good looking uh academic types and business leaders and so are myself.
19:00
spk_0
Fair enough. In the last minute and a half, we always love to get a hot take from our guest andI don't have anything written down here, but I, I love the complexity of what a double line does and how like nitty and gritty the business is. Give us like that one, I guess, complicated investment or trade that that your teams have on right now, um, that maybe the average investor could could go out there and employ in some manner.
19:24
spk_1
Yeah, I mean, look, um, I, I, I always say that the complication we try to make simple, and it's trying to distill the complexity down to basic facts and tenants and and just inputs. So it's the building blocks approach. So, uh, I like to think about the portfolio and think about it as being somewhat simplistic, um, you know, people always ask about what's a view on rates, and I don't have a very strong view now because of that push and pull dynamic we talked about earlier.Um, but what we do have a lot of confidence in it's what we call the shape of the curve, right? What we call a curve steepener, um, and this has been, um, what we want, what we think is that the term premium, that is the amount that you get for lending longer, should be higher in the long term than where it is today. And that that said in bonds speak, we would have a steepen our trade on, and what that means is that we own.The 2 year, and we are short the 10 year or the 30 year asset against it. And so what that allows us to do is play the shape of the curve. So we're saying is that we want to be long the front of the curve, or we want to be inherently short the back end of the curve, and what that means is we're playing for that steepness of the slope of of the of the curve. So it sounds complex, it's very simple. You do it in the futures market, you buy one contract, you sell the.Other, um, one thing is they have duration differences, so you have to adjust the number of contracts. So therein lies the complexity, Brian, but it is something that people could do with ETFs out there, right? There is, there's ETFs that focus on treasuries on the front end and on the back end, and there's actually inverses as well. So you can be a long investor, you go along the long, long the front end, and you go um along the inverse of the back end.
21:02
spk_0
Like I told everybody coming to this podcast, you would leave as a smarter investor. It feels like I'd be, I should be sending Jeff Sherman a check for all that, uh, stuff that he just told us. Uh, but good to see you, Jeff. It's been a while. Don't be a stranger. I hope to connect with you, uh, very, uh, very again soon. Please do tell Mr. Glock, uh, the outfits team says hello. Double line Deputy CIO Jeff Sherman, good to see you. We'll talk to you soon.
21:24
spk_1
Thanks, Brian.
21:25
spk_0
All right, uh, please do continue to hit us with the uh thumbs up on YouTube. Love all the feedback, all of your comments, always try to answer everything. Those 5 stars on the podcast platforms keep them coming as well. They add up and really help us. We'll talk to you soon.