Thank you know, let's get to our guess. Nancy Davis is founder and ce IO of Quadratic Capital, joining us on the line from Greenwich. So we're saying that two year yield in near full percent for the first time in fifteen years. Nancy, you say, the last time the curve was this inverted, Gorbachev was sitting in the Kremlin. What kind of opportunities are there for investors, Well, the rates market is definitely expecting the FED to hike more UM.
The you can see on your Bloomberg terminal, we have a hundred and eighty seven basis points of additional hikes just this year alone, so in two thousand and twenty two. So even if the Fed um you know, there's very little expectation about twenty that they're going to hike a hundred tomorrow. But even if they hike a hundred, there's still another you know, seventy five plus basis points eighty
seven basis points baked in. And so I think what you're seeing right now is a lot of people speculating that the number of FED hikes is going to increase UM using FED fund futures or treasury options or other derivative contracts, and the speculation has actually gotten I think a little bit too high um and that has really inverted the yield curve. Guield curve is the most inverted
um over you know, for for for decades um. Currently you can see the two year swap rate on your Bloomberg terminal is four thirty four, so it's almost four thirty five already, and the level of the ten year yield is seventy two basis points lower. So it's a really odd time for the rates markets because they do believe the FET is going to hike. I think the question is whether these hike expectations are realistic or whether the FET is going to hike seventy five and maybe
another seventy five this year and then hold um. So, so there is a lot baked in, yeah, And how much more painful could it get if we continue to see the Fed really try to tame the inflation. You say inflation potentially could have paked, but even if it remains above two percent, we're going to have to continue to see these behinds. Well, It's interesting because the five year break even, even the Fed Zone calculation of it, currently the five year break even is two point one
one per cent right now. UM, So even though the last CPI print was eight point three, the inflation protection market is saying inflation is going to fall dramatically. Um the two year break even for instances two point three right now on your Bloomberg terminal, the ten years two point three nine. So there's very little priced in that the Fed is going to lose control over the inflation markets. In fact, the inflation markets are priced dramatically to have
falling inflation expectations. And so that's where I think the opportunity allies for investors because like all markets, it's um it's all about what's priced in, and the market is expecting that these rate hikes are going to get the
job done and inflation is going to fall dramatically. And I think taking the other side of that trade, where you say, look, does the Fed's rate hikes really impact the supply side issues or does it solve the labor market crisis, It doesn't really solve any of the bigger issues, which are more geopolitical and pandemic related. And I think that's an opportunity for investors to add inflation protection in the future because it is so cheaply priced relative to
where it's realizing. What as well, does it mean in terms of movement to risk assets, Nancy. When you've got the likes of Ray Delio predicting that you could see a decline in Stokes and Neural Robani warning that the FED could drive the US into a stagflationary dit crisis, well we we definitely have a lot of commentarators and
a lot of positioning that are quite bare as Shaun markets. So, I think, you know, as a contrarian, whenever you have everyone expecting one outcome, you know the other side is usually um, probably right. So I think the FED could really avoid, you know, the rate hike tomorrow. I think
they'll probably hike seventy five. But if they hike and then hold to allow the raid hikes to ease their way through the economy and also do more with the balance sheet reduction, they really haven't been talking a lot, even though the caps have doubled in the month of September. They initially started in June with the quantitative tightening. I think they could be doing a lot more with the balance sheet to ease off hiking rates. Um. So I
do think, yeah, go ahead. I was just gonna say I've asked you this before, and I'm just curious to get your thoughts, considering things have changeds we last book. But but the sixty forty portfolio is that now? Is that now a dead way of looking at investing? You know a lot of people still have it, so it's not dead because it's definitely alive and well, and in most institutional as well as retail portfolios have something that
looked like a sixty forty portfolio. I do think it's time for investors to really be looking at the fort in bonds because a lot of the passive indusseries don't have any inflation protected bonds in it, and that's because they were created before these The Treasury even invented the inflation protected bond market in so I think the challenges is a lot of people in this very high realized inflationary environment have been looking at things that worked in
the seventies and the rates market, even the inflation protected bond market didn't exist before the late nineties. So I think it's really a time to just be adding inflation protection into your portfolio on the fixed income side, because so much of the benchmarking in the indusseries has moved to nominal treasuries or mortgages, and it's a really dangerous time to be just owning that traditional sixty forty for sure.
So let's tokyobok a little bit. How how is the a t F going amidst the recent scenarios that we are facing in the global economy? Well, are are depends which et F are. Deflation in ETF has been doing quite well. UM deflation is really being priced in. A lot of people think the Fed hiking rates is going to, you know, cause a slowdown in growth and a slowdown in economy. Our inflation to e t F UM i've all which is the larger and older e t F is UM definitely UM not been performing very well because
the yield curve is massively inverted. So before Jackson Hole, we had about ninety two basis points of additional hikes priced in before the end of the year. After Pal's eight minutes, you know, mega, you know, screaming match about inflation, the rates market, the hikes went up. They more than doubled, and we have over you know, hundred and eighty seven basis points of hikes priceton, even though we still haven't had actual FED meeting, So I do think the inverted
yield curve is not a normal environment. UM investors are not being very rational, in my opinion, when you can own, you know, the two year swap is four thirty four, why would you go by uh, you know, a ten year bond for instance, seventy basis points you know, lower what meaning less yield and more risks. So inflation expectations have been falling dramatically, and that is a lot of confidence that the Fed hiking policy rates is going to really kill inflation. But like all markets, they move off
of expectations. So I do think it's a good opportunity for investors to buy future inflation expectations because they are so cheaply priced. Um the five year break even you can see it on your Bloomberg terminal, it's two and a half right now, the ten years to thirty nine, even the two year is to thirty three. So UM inflation is very much on sale alright now, So we're
gonna have to leave it there, unfortunately. Always a pleasure of Nancy Davis is found in ce io of Quadrantic Capital on the line from Greenwach Forest