Transcript:

Scott DiMaggio: We’ve talked a lot over the years about the shape of the yield curve, how that is a market signal, how that is telling us something about the future, about potential asset market returns. What’s our thoughts?

Eric Winograd: So right now, the yield on the 10-year bond is lower than the yield on the two-year bond, which we would call an inverted yield curve. And that’s unusual, but certainly not unprecedented. It has been inverted for some time now, and the extent of that inversion is quite large by historical standards.

One way to think about that is the market is telling you that the return on assets over the long term is lower than over the short term. That economic growth will slow over the long term relative to where it is now. And given that we expect a slowdown this year, that’s a signal that we take seriously. That’s something that is consistent with our forecast.

SD: Yeah. From the way we look at it, look—the yield curve will stay inverted until we get much closer to the Fed cutting rates. However, credit metrics across both investment-grade and high yield in both Europe and the US are entering this downturn, if you can call it that, in the best shape that they’ve ever been.

And if you look at where spreads are, we would say they are cheap to historic standards. So yes, we may see volatility, we may see volatility around the Fed, we may see volatility around the inflation and economic data, we may see volatility around the debt ceiling. We would view most of these as buying opportunities and would use that as ways to add yield to our strategies.

EW: Asset markets tend to perform at their best once the yield curve starts to steepen back out, right? And so again, when we look into 2024, as central banks start to cut rates, we would expect asset markets to do better. And alongside that, we would expect the yield curve to re-steepen.

SD: Eric, it’s been a couple years since we talked about the debt ceiling. What are our baseline expectations?

EW: US debt is considered the risk-free asset in financial markets. It is the collateral that underlies a lot of the transactions that take place on a day-to-day basis. And if all of a sudden that risk-free asset is no longer risk free, the consequences are unknowable and unpredictable, but almost certainly not good, right? We know that it would be a problem; we just don’t know what the magnitude of that problem would be. And that sort of financial market disruption would almost certainly spill over into the broader economy.

So we certainly expect that the debt ceiling will be increased. We also expect, unfortunately, it won’t be until right before the deadline. And I think we’re just going to have to adjust to hearing conflicting reports, hearing disappointing reports, about how negotiations are or aren’t going. It’s going to be tumultuous.

SD: Historically, these bouts of volatility have been very good buying opportunities. You see that widening in spreads, you see that sell often in stocks. That tends to be a good area to add exposure with the expectation, as you said, that we would expect there to be a resolution, right?

EW: That’s right.

SD: Probably at the midnight hour. And hopefully, that then puts capital markets back on much better footing.

EW: And that’s exactly right. It’s a timely reminder that this is not the first time we’ve had to deal with the debt ceiling, right? It has been disruptive at times in the past. The best example was in 2011, I think, where the deadline, the date at which the US Treasury ran out of money to pay its debts, was August 2, and then a deal was reached on the debt ceiling on July 31. So really, right up against the point at which it would’ve been problematic. We expect something similar this time around.

Scott DiMaggio is Co-Head of Fixed Income and Eric Winograd is Director of Developed Market Research at AllianceBernstein (AB).

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.