Fed could ‘preload’ rate hikes then ‘go to its balance sheet’, strategist says


Kevin Flanagan, head of bond strategy at WisdomTree, joins Yahoo Finance Live to discuss Fed Chairman Powell’s remarks to Congress, March interest rate hikes and inflation.

Video transcript

KARINA MITCHELL: We’ll keep him in the markets and bring in our next guest. Kevin Flanagan is WisdomTree’s Head of Fixed Income Strategy. Kevin, thank you very much for joining us today. I want to start with the testimony from the Fed and what Powell had to say. Do you see his comments as maybe a little less hawkish, a little more accommodating at this point?

KEVIN FLANAGAN: Yes, to a very, very small extent. I think the markets have been waiting for news from the president for some time now with all the headlines we’ve had, with the markets pricing in seven rate hikes, a 50 basis point move for March. So it was nice to hear from the president himself.

And I think what’s more important is that he knew the markets would focus very carefully on his wording. So for him to say he’s 25 bps inclined in March, you have to take that for what it’s worth, that’s for sure.

KARINA MITCHELL: And how many rate hikes do you see coming over the course of the year? And then what about his comments on tightening and shrinking the balance sheet? Is it more or less in line with expectations, in your opinion?

KEVIN FLANAGAN: Yeah, I think at this point in the game, even with the bad news of what’s going on with Ukraine and the Russian-Ukrainian crisis, I still think the Fed is where we should stay focused – the Fed and inflation. So I could see the Fed doing some early feeding here and raising rates at the March, May, June and July meetings, maybe for a total of 100 basis points. And then they move on to their balance sheet in the second half. Remember that a liquidation of their balance sheet is equivalent to another quarter point rate hike. That may be how you come up with five, six or more rate hikes – some the traditional way and some via the balance sheet.

KARINA MITCHELL: I wonder how far do you think the Fed is marching right now, going up to higher energy, inflation is skyrocketing. How worried are you about them sticking the landing? They just said… Fed Chairman Jay Powell said they can hold the landing, but how concerned are you about stagflation and potential recession?

KEVIN FLANAGAN: Stagflation, I don’t think, is really on the radar. I think if you separate the word from the flation – the inflation part, I think it’s going to continue to stick. It will be difficult for the Fed to lower inflation at any time in the short term. There’s not much they’ll be able to do by raising rates, as we just said, even their balance sheet.

On the deer side, I think the good news is that the Omicron variant really didn’t hit the economy like some expected. So we are, I think, in a better position to move forward, as we might not have expected had we had this discussion a few months ago. So I think we can have some nice, solid growth, let’s call it maybe around 3% or so. But it is this part of inflation that will remain sticky.

KARINA MITCHELL: There has been a monster bid on bonds recently. I mean, today the yields are higher. But what about returns? What are you reporting – what is it reporting to you and where do you think they go from here?

KEVIN FLANAGAN: Well, the drop in yields this week was really, I think, a function of the news over the weekend, what we saw with Russia’s withdrawal from the SWIFT system and other types of financial sanctions against the central bank in Russia, which there are worries at all times. You know, whether it was the March 2020 financial crisis when COVID first created the lockdowns – there are concerns about the funding markets.

Will companies and banks be able to finance themselves? And we have yet to see any red or even yellow signals appear in these markets. But there was enough caution that it was kind of a good student body mentality, a flight to quality in obligations. And now we’re coming back with focus, right? We come back to the Fed, to inflation, powell speaking.

And the next thing you know, you have, as you just pointed out, a 10-year Treasury yield up 15 basis points today. So I think that’s the direction. A see-saw trend, some volatility, but we still think rates will continue to rise later this year.

KARINA MITCHELL: And what do you hear about your customers’ concerns? And what would you advise them to do to protect their wallets right now?

KEVIN FLANAGAN: Yeah, well, I mean, the focus was on rate hedging. Rising rates have been our main theme for some time now. And when the chairman of the Federal Reserve tells you he’s going to raise rates by 25 basis points, we should listen, right?

It’s not often that the chairman of the Fed somehow explains what’s going to happen. So what we’ve done is talk about a floating rate treasury strategy, where you have floating rate treasury bills that are 100% treasury. They adjust each week with the weekly auction of three-month Treasury bills.

And it’s a good complement for the core part of your bond portfolio. And there is no credit aspect, is there? There are other instruments that may have a credit or concentration in financials. It’s 100% Treasury. So as the Fed raises rates, it should keep moving, adjusting and floating higher accordingly – and the duration is one week.

KARINA MITCHELL: And, Kevin, what is your opinion–I’m interested to know–about the energy issues that are happening right now and the news that OPEC-plus will hold production steady–400,000 barrels will be issued in April, no more despite an ongoing conflict. And then, of course, the IEA releases all 60 million barrels of oil from its reserves – just to fall into the bucket, which really equals six days of Russian production.

It’s not going to do much. One analyst said if the number was 200 million barrels of oil, that could make a significant difference. Do you think we need to drill more in this country at this point?

KEVIN FLANAGAN: Well, that will definitely be the argument from the Republican side of the aisle that we’ve already started to hear. I’m not entirely sure the Biden administration has entered that camp yet. But what we see, of course, with energy prices, affects us. And that’s something that obviously was mentioned in the State of the Union address as well. And that’s something the Fed can’t really do or the central bank can’t really do, right – higher energy prices.

And the question becomes, is it inflationary or is it more of a tax on the consumer? I think as long as we keep pushing it forward and it’s not a major consumer tax, it’s the status quo. I think if we get to the point where it starts to affect economic growth here at home, then maybe you’ll see that the Biden administration will look at other aspects of how to increase production here at home.

KARINA MITCHELL: Well, investors are definitely taking all of that into account today, as the benchmarks are currently at session highs. We will have to leave it there. Kevin Flanagan, Head of Fixed Income Strategy at WisdomTree, thank you very much for your insight today.


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