Fed’s positioning on government debt is ‘a game of chicken played by turtles’: Strategist

Brian Jacobsen, Senior Investment Strategy at Allspring Global Investments joins Yahoo Finance Live for the latest Fed statements about their interest rate hike forecasts, the inflation target for this year, and the larger impact of ongoing debates over the debt ceiling.

Video Transcript

– Brian, it’s great seeing you here. Today, we are looking at losses again. Today’s jobless claims numbers were released. Lael Brainard, Fed Vice Chair, also commented. What did you think about the statements made by Fed officials over these last two days? How does it signal that policy should be changed?

BRIAN JACOBSEN Yeah. I appreciate your time. It almost seems like we are listening to a broken record when we listen to Fed officials. You can actually look back at their speeches and do the track changes to find out what they changed. It hasn’t really changed much. This is a sign of the current environment in which they are waiting for more encouraging data.

Lael Brainard’s comments are very interesting to me. She’s an important person to listen to, and I believe she’s one of the smarter. They are all brilliant. However, she is probably the most intelligent member of the board. She is also a voting member. Others, such as Bullard or Collins, are not voting members. It’s important to listen to their opinions and ask if they really have any impact on policy making.

Brainard seems to be more comfortable with the idea of a 25 basis point hike on February 1st, followed by the possibility of a further hike if data dictates. This data dependency is what I believe it is. They’re waiting to see if the short-term trend of falling inflation continues. We think it will.

– Brian, it’s a pleasure to meet you. There seems to be increasing consensus that perhaps the Fed will change their target subtly from 3% to 3%. It seems like this is what you are hearing from Davos. Are you sure that this will be true, for example, in one year?

BRIAN JACOBSEN No. No. They also codified the PCE inflation headline figure at 2%. That’s the goal we are trying to reach. They revise that. They kind of reaffirm the pledge, renewing their vows to it each January meeting. They’ll likely reiterate that at the next meeting.

However, they do not really conduct a policy review to decide if that target should be changed except maybe once every five or so years. It’s not on their calendar. Many people believe they should use this opportunity to increase the target to 3%. However, I am not sure how much good this would do. It could be even more disruptive for financial markets than if they simply affirm that 2% is our goal. We aren’t going to change the goalposts yet.

– Brian, investors should be concerned about the debt ceiling fight and the possibility of default in the coming months. Is this something you are paying attention to? How big of a risk do these represent for the markets in the future?

BRIAN JACOBSEN Yeah. We were discussing this with our systematic edge multiasset group. Many of us have been in this industry for quite some time. It was August 2011, when the industry really reached its peak. It was a wonderful day on August 3, 2011. My son was also born. They also signed the Budget Control Act, which raised the debt ceiling. Of course, two days later, S&P decided to downgrade the US debt because they didn’t like how that standoff went.

We learned a lot through that experience. We discovered that the Treasury did have a backup plan. As far as what they would do, the Fed also had a backup plan. It doesn’t seem possible to prioritize all payments. They could probably prioritize debt payments. In the 2013 minutes, the Fed stated that they would not want to but were willing to purchase government debt if necessary.

To me, it seems like a game involving chickens, but with turtles moving very slowly towards one another, one in New York, and one in Los Angeles. This will continue for a long time.

– It’s impossible to not see it. It’s a game of chicken with turtles. Next streaming series on the way. Brian, guest after guest here buried 60/40 last season. You think it might be ready for a comeback. Why?

BRIAN JACOBSEN I believe one reason is that we have seen rates rise. Fixed income markets are now offering decent coupon income. Some movements indicate that yields can fall more often when there is a risk-off day on the equity markets. That was very different than 2012 where any risk-off day in the equity markets– so you saw the S&P 500 falling. You would typically see yields rise. That has now changed. The dynamic of people viewing bonds as decent diversifiers has slightly changed.

For our portfolios we are adding some of the duration exposure to provide diversification benefits. Additionally, we recognize that there is decent coupon income if correcting for growth slowing and inflation falling. We’ll also be wrong about 2023’s comeback tour of the balanced portfolio if that’s not the case. However, we are quite certain that this is the direction we’re headed.