Talk Your Book: Interest Rates Go Kablooey

0:00Today's Animal Spirits Talk Your Book is brought to you by our friends at NASDAQ. Go to AmericanCentury.com and Thornburg.com for more information on the funds discussed on today's episode.

0:33Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:41Welcome to Animal Spirits with Michael and Ben. On today's show, we talked to Jason Greenblatt. Jason is a VP in Senior Portfolio Management, Director of Corporate Credit Research for American Century Investments. We talked all about the changing landscape of fixed income, how it's much harder than it was in the past, and how to think about short-duration fixed income, which is something that people have learned the benefits of this decade, I feel like. Yeah. We also spoke with Christian Hoffman. Christian is the head of fixed income and a portfolio manager for Thornburg Investment Management.

1:11So we recorded this on Wednesday after Powell's 19th presser over the last four weeks. He's been front and center, which I guess is appropriate given the state of uncertainty. And he effectively said, not on us. They are not going to step in? My take was he quoted Ferris Bueller. So he's kind of feeling himself a little bit, I feel like, kind of saying like, listen, I didn't do this. But a lot of people pay attention to the stock market, and rightfully so. It's been very volatile. Well, the bond market too. But I'm saying that the bond market is a little more getting more interesting, and a lot of people don't pay as much attention to it.

1:53So on Monday, when we spoke to Jason, Remember Sunday night, Sunday night scaries, the 10-year was as high as 4.6%. Right. Now, recording Wednesday, it's down to under 4.3%. So wild gyrations in the fixed income market. Pretty unsettling. So both of these talks with Jason and Christian, we cover fixed income from all different angles, the opportunities, the risks, what it means for the economy, all this stuff. So first, we're going to start with our talk with Jason from American Century Investments.

2:28Jason, welcome to the show. Great to be here. Thanks for having me. So last week, we saw a historic amount of volatility and an increase in US interest rates, particularly at, I guess, the belly to the farther end of the curve. I'm talking about the 10-year. I forget the exact numbers, but it was really historic. And all the while, we've got the short end holding tight, giving investors a nice return. Are you seeing investor appetite for fixed income remain on the short end or what exactly are you seeing out there? I think the desire does remain on the short end. And the reason for that is that, as you alluded to, there's an anchor.

3:06Investors are thinking about, should I be moving out of cash? Should I go into fixed income? And if you're going into fixed income, what point in the curve do you go? Well, if you go further out, you're probably taking a view on growth of the economy. You're taking a view on will the Fed not only be cutting rates, but are we heading into a recession? As you step out from cash into short duration, I think what investors are thinking about is, should I be locking in higher yields today? And the answer in our minds is yes, we should be locking in higher yields. We think they're very attractive here.

3:39This is way too oversimplified, but it sure feels like for 20, 30 years there, fixed income was pretty simple for most investors. Rates were falling. And so whatever you invested in, the starting rates were pretty high, the yields were pretty high. And then as yields fell, you got the price impact as well. And that situation totally blew up in the 2010s as we went through the 0 % interest rate regime. And then it seemed like, of course, no one wanted to own short duration assets. And now it seems like this decade, it's totally flipped again. And in the 2021, 2022 period, when rates were rising and inflation was rising, people thought, oh, that's right.

4:21There's a reason for these assets. The short duration tends to do better in that type of environment. I'm just curious what you're seeing from fixed income investors who probably have to be a little more thoughtful in how they put together a portfolio of assets now than they've had to in the past. Yeah, I think that's a really great point. And I think, as you alluded to over that time horizon of not just the last decade and a half, but the last two, three decades, the market has evolved. And I think what has evolved is you've had investment-grade corporates triple in size in terms of the size of the market.

4:58If you go back 20 years ago, technology really didn't exist in the investment-grade space. You've had new sectors that have emerged. We had asset-backed and securitized that were problematic in the 2000s before the financial crisis. They went through their own flushing and went into new structures. Today, I think the market is an environment where, one, you have new structures, new participants, both on the issuer side, but also the participant side. Even five years ago, 10 years ago, there may have been 200, 300 investors going into new issues. Now, it's 800. So you've seen the depth and the breadth of the market really expand.

5:41And I think to the point on the short end of the curve, I think there's a lot of uncertainties that are currently going on on a global basis. What's happening with inflation? Are we going up or are we trending down? Well, it seemed like we were trending down pre-tariffs. Now we're talking about tariffs. And we're also, on top of that, talking about globalization, maybe coming back on shore, deglobalization, maybe that puts more inflation into the system over the next handful of years. And I think because of those reasons, because of the depth, the breadth, and uncertainty around inflation trends, front end of the curve is, again, I think the place for investors to be thinking about and anchored in their portfolios.

6:30So Jason, at American Century, you manage a suite of fixed income ETFs across the curve. I just want to clarify one thing because you mentioned that like the idea of locking in some yield on the short end. Isn't that typically talked about at the long end? Because at the short end, you're only getting that for whatever. We're talking about like one to three months, for example. If the Fed were to cut, well, then you're not locking it in. You're just getting the annualized yield for the next couple of months. Right. Okay. So let me clarify and put some numbers behind locking it in and what point on the curve.

7:06I think when you talk about cash as an investment, well, cash could be in money markets, could be in commercial paper that maybe matures in a day, a week, a month. T-bills, T-bills could be anywhere from one month out to three, six months. I'm not talking about that point on the curve when I say lock it in. I'm thinking more short duration, fixed income. And when we talk about that part of the interest rate curve, we're talking really two, three, four years out in maturity. I don't think you have to go all the way out seven, 10, 30 years, right? Because we have an entire maturity profile to pick and choose from.

7:42I'm thinking more between that two and four year part of the curve that we think is really a sweet spot. Got it. So at that point of the curve, you have a product, the ticker is SDSI. What's the case to be made for investing in something like that over, say, an index equivalent? Sure. So I think there's two things. One is what we just talked about, interest rate risk, the duration of the fund, which is currently around two and a half years. So you're getting that type of interest rate risk without having large swings. So if you think about just for a moment, the bond math, if interest rates go up 100 basis points, you'll lose two and a half percent.

8:23If they come down 100 basis points, you'll make 2.5%. That's just the interest rate impact. But I think the other way to think about it is if you compare this strategy, SDSI versus peers versus the index, you're earning an extra 100 to 125 basis points over that passive universe. So basically, it more than covers our fees as active managers. You're also picking up incremental carry. And I think the other real interesting component is it's not just carry and earning 5.5 % or 6 % in yield. You're also getting the active management. Active management from security selection from a bottoms-up perspective and then also asset allocation.

9:04Should we be more in securitized? Are there securitized subsectors that are appealing today? How about in corporates? I think there's a lot of talk in corporate credit. Is corporate credit going to have higher or lower default rates here and in high yield? Are there parts of high yield that are attractive or not? And I think that's really where we can sift through the broader universe of credit sectors, construct a portfolio that doesn't have a lot of interest rate risk, again, two and a half years, and then also having an array of credit risk that offers compelling yield above the passives. You talked about the fact that the markets have evolved so much over the years.

9:44Most people, I guess, retail investors would think of short-term investments like this as just T-bills. What is your universe that you invest in in this space and what kind of short-duration assets are you looking at? Sure. I think that's a great point is what does the universe look like? The universe is comprised in our minds of investment-grade corporates, again, five years and shorter. High yield corporates, short duration, high yield. That can range from double Bs down to triple Cs, although we're focused today more on double Bs and some select single Bs. Could include bank loans. Bank loans currently are really a minimal component of the portfolio.

10:23And as you move away from corporates, there's securitized sectors and subsectors. It could be mortgage-backed securities to more esoteric parts of the securitized market like rail cars, data centers, et cetera. The last component is emerging markets, both sovereigns and corporates. So we think about those credit sectors in five years and shorter, there's really a whole lot of security selection and asset allocation to be had in our universe. Let me ask you a two-parter. In the high-yield space specifically, are you seeing less opportunities as companies go the private credit route? And then number two, again, within that space, assuming that, not assuming, these are lower quality companies.

11:08Do you have to do an added layer of risk mitigation analysis as you start to think about what impact the tariffs might have on these companies? So sorry for the two-parter. It's private credit and it's credit quality. I think those are great points to dive into. So I think just taking the first point first, first question first. Let's frame the overall size of the market. 1.3 trillion in US high yield, 1.3 trillion in US high yield bank loans. So combined, we're talking about an asset class of just shy of$3 trillion. The size of that market has not grown or shrunk all that much. Maybe it's decreased a little bit through some rising stars as we exited the pandemic.

11:52But I think what we're seeing is, and you're sort of alluding to it, is that deals are being reconstituted, restructured in securitized or in private credit. There are deals like data centers or Fiverr, for example, that maybe traditionally is in high yield that's being done in special purpose entities that are away from the public markets. Are we finding opportunities in a$3 trillion asset class? Absolutely. I think when we look at the second part of your question, which I think is really critical and what we're laser focused on in short duration is our credit work, making sure that we get paid back par or 100 cents on the dollar at maturity.

12:38That is really what we're focused on is the credit quality, the borrowers that we're investing in. Because my point before about earning 100 to 125 basis points extra in carry, well, that can quickly erode if we're wrong. So I think it's important as active managers that we have a team of experts who do that extra layer of due diligence on the credit work. And I think we take it even a step further. We're not only engaging with borrowers and underwriters, as many do in the active fixed income world, we're engaging with them to actually help refinance their upcoming capital structures to basically incentivize the borrowers, hey, take us out, take us out at par.

13:25We'll help you extend maturities, extend that runway. If you think about the asset class broadly, this year, next year, there are no major maturity walls. That's typically what happens and gets investors into a problem or a default cycle is hitting maturity walls. This year and next year, 25, 26 are not big maturity wall years for high yield. So I think if we can pick our spots, not go too far out into the future, go out to 2026, work with borrowers this year so that those liabilities do not become current. I mean, that's a real easy way to lose your job as a treasurer or a CFO. It's to let an obligation become current and then ultimately default your business.

14:14We're working with high quality borrowers to ensure that that does not happen. Michael and I always talk about the fact that anytime there's an asset class someone is talking about, the easiest risk to ask someone is just like, well, what happens if there's a recession? Which is obvious. There's a lot of asset classes that have some risk of a recession. In the short duration space, call it one to three years or whatever, how much risk is there actually of some sort of credit event from a slowing economy? Is there less risk in this end of the curve than there is in sort of intermediate term or longer term duration fixed income assets?

14:49I'd argue that potentially there's more risk if you don't have your eye on the ball in terms of the credit quality of who and what you're investing in. What I mean by that is owning triple Cs here, one, they typically have a much higher probability of default, right? One in five chance of default. Whereas you don't have that same type of probability in double Bs. It doesn't mean that double Bs can't deteriorate. They certainly can. Short under the curve, you have to be really careful because as your prices start moving closer to par, your risk is potentially 100 cents on the dollar. So you could actually twist this around and say, where is the biggest risk?

15:32Well, it could be in price appreciation. It could be price deterioration if you're not careful on credit quality. It's not to say that when companies default, you get zero. There's typically some recovery. What we're trying to do is really avoid a bankruptcy. And I think you have to think about it from a bottoms-up perspective. Does this company have the wherewithal financially to pay off their obligations? Coupled with a top-down perspective, are we going into a recession? What happens to some of these companies in terms of their cash flows? Are they cyclical? Do they come down during times of recession?

16:10What did they look like during the financial crisis? What did they look like during the downturn in 2015 and 2016 in oil? We do have past periods you can sort of home in on by sector to stress test borrowers. And I think that's really what the key is, is stress testing your cash flows for the downside. Do these companies exist? Can they pay off their obligations or generate cash flow to service all of their obligations? Jason, I know we've spent the bulk of this conversation thus far talking about the short end of the curve. if these tariffs stick and we are in a slowing economy and on the one hand, it's like a push pull of, well, higher prices, higher inflation.

16:53But if the slowdown swamps higher prices, then ultimately you would expect lower rates in a slower economy. Is there an opportunity? You might have to live through some volatility as we've seen, but is there an opportunity for people that are of the view that the economy is going to be weaker six months, 12 months from now? Let me lock in these. I don't want to say artificially. Let me lock in these high rates today to get ahead of that. Yes. And I think the opportunity there is what happens with the Federal Reserve. I think we go back a couple of weeks ago and I know a lot of people are cringed when they say this word, transitory.

17:28Jerome Powell used this in the end of November, 2021 and said, we're no longer in a, yeah, we're not in a transitory environment anymore. Right. And that's when we went off to the races and raising rates. He used it again during his last speech. So I think we have to just take that word with a grain of salt and ask ourselves, okay, are tariffs inflationary? Well, okay, there's a one-time readjustment in price, but to me and to those who consume, that's inflationary. After we get through that point, does inflation continue to rise or is it controlled? And I think really the Fed needs to think about what are they trying to control?

18:08Is it bringing down rates and lock-in rates today, as I mentioned earlier, because the economy is starting to not only slow, go into recession, unemployment's rising, or are they thinking about the other part of their mandate and thinking about taming inflation? So I think it's very questionable what the next 6-12 months look like in terms of inflation, the reset from tariffs, for example, higher prices, and how the Fed plays the economy's hand. Right now, there's three or four rate cuts being priced in. Let's see what happens as we get to the middle of this year, towards the end of this year, with inflation, the impact from tariffs.

18:51And also, who knows? I mean, we had on Saturday this past weekend exemptions from technology, and we had this following day another maybe walk back from that. We seem to be in this like one step forward, two steps backwards environment, and it makes it very difficult to say there's going to be three or four rate cuts this year. There may be one. We just don't know yet because we're not quite sure what the next zero to 90 days look like in terms of tariffs. One more question for me on your process. Do you become more active in an environment like this where it is so hard to navigate and it seems like there is this back and forth between what comes next?

19:31In short, yes. We do become more active. We look back over the last two weeks. I mean, this is really as uncomfortable as it is to see prices, whether it's in treasuries or corporates or securitized moving at 3, 5, 10 points at a clip. It's actually a great opportunity. That's when we start to see dislocations, particularly in the front end of the curve. The word dislocation, let me explain what that means in our minds. It means that you see indistinguishable selling. And what do investors do in fixed income portfolios? They sell front end bonds because they have to fund outflows. Well, guess what?

20:08Last week, there was one of the largest outflows on record. What was sold? The front end. What does that do for us? So short duration is the ATM. That's right, which is great because then we can go out and find opportunities, the QSIPS, the bonds that we really like, and buy them on sale. So it's also another way of saying it's a good idea to have some dry powder and be ready for the volatility that we've seen over the last few weeks, but probably what we'll see in the coming few weeks and maybe a few months as well. Jason, for listeners or advisors who are listening that want to learn more about American Century and your suite of fixed income ETFs, where do we send them?

20:48You can certainly send them my way. I think we have some great professionals who can assist as well. We can certainly start with AmericanCentury.com, our website. There's some great information on there that we publish in our fixed income section. But we can certainly field calls beyond that with your local wholesaler and they will get your questions directly to me. Awesome. Thanks very much, Jason. Thank you, guys. Okay, thank you to Jason. Remember, go to AmericanCentury.com to learn more about all their funds. And now here's our talk with Christian Hoffman from Thornburg Investment Management.

21:32Christian, welcome to the show. Thank you. Happy to be here. So today we're going to be talking about opportunities in global credit markets, inflation, interest rates, bonds. I already said that. All right. For our listeners who are not familiar with Thornburg, I have to be honest, I was looking at your mutual funds and the size impressed me. A lot of assets in there. Maybe just a quick intro on the company. Sure. We're based in Santa Fe, New Mexico. We've been doing this for 43 years. We have roughly 47 billion under management. And I've been here 13 of those 43 years. So a historic week in the bond markets.

22:12Last week, we're recording on April 16th. So the last week was a historic week in the bond market. The 10-year rose, I forget the numbers, a lot, the highest in a decade, 30-year went up highest since like the 80s, I think, or some outrageous activity. And interestingly, you also similarly saw wild action in rates overseas and some of the differential and spreads between what our government bonds trade at versus the comparable maturity in other countries, the gap is narrowing, which is fairly concerning. So what's your take? Is this a basis trade blowup? Is it inflation? Is it margin calls? Is it people raising cash?

22:54What is happening inside of the bond market? How are we supposed to make sense of it? I think it's all of the above. And parsing out the contributing factors will become much clearer over time. But when you're living right through it, it's fairly unclear. Obviously, the historically inverse correlation between equities and fixed income broke down in 2022 and stayed broken for several years. And really, in this last sell-off, you saw that historic relationship really come back into focus, where you saw a flight to quality in people buying treasuries, as you saw a lot of equity turmoil and money flowing out of that asset class.

23:30So, money flowing out of U.S. equities, flowing into international equities, and also chasing safety in U.S. treasuries. That started to change, I want to say, on April 4th. It was Friday, right around midday, where you continue to see equity volatility, I think, swinging from positive to negative territory. But bonds just lost a bid and started to sell off. And really, from that point on, the correlation's been much weirder and more broken. My colleague on the desk to say, you know, treasuries again today doing their own thing. Not great. Exactly. Some of that is unwind. Some of that is, again, I think money shifting around.

24:12I think there's also some industry relationships where gold has certainly caught a bid. And I think that internationally, the safe haven of US treasuries has been called into question, I think with very good reason. So there's some of that going on. There's a conspiracy theory that maybe China or China with other actors maybe has been dumping treasuries to do some behind-the-scenes negotiation or threatening. I think that's very possible, although I haven't seen a lot of evidence to suggest that's true. You could also have something like China selling to support the currency, which I think is less troublesome, but has the same outcome in terms of what you're seeing in the markets.

24:58So it's really all of the above, and it's certainly a fascinating time to be investing. Michael and I talk a lot about how most of the bond stuff really just comes down to positioning, which is kind of obvious. But people always like to look at the yields to figure out what does this mean that the bond market is saying about inflation? What does it say about growth? And I think the really scary thing this time and why this has perked up a lot of ears is because the dollar was falling while rates were rising. Um, does that, does that make it more concerning to you that those two safe havens are going in seemingly the wrong direction?

25:31I think as a U S citizen and someone who manages primarily U S money and someone who primarily owns U S dollars, uh, it is, it is concerning. Also, I think calling into question, some of our historically, you know, very strong relationships with, you know, international trading and diplomatic partners. Like I think these things are all concerning, not just us, but really the global world order. And, you know, when Howard Lutton goes on TV and you see markets go down, you know, 300, 600, you know, a thousand basis points, that's concerning to me. Look, Trump 2.0 is quite a bit different than Trump 1.0.