Speaker 1:
Welcome to TD Cowen Insights, a space that brings leading thinkers together to share insights and ideas shaping the world around us. Join us as we converse with the top minds who are influencing our global sectors.
Jaret Seiberg:
Welcome to Two Cents, the financials podcast at TD Cowen. I am Jared Seiberg, managing director and financial services policy analyst at TD Cowan Washington Research Group. Today we're going to do a deep dive with TD Securities rate strategist Gennadiy Goldberg on the nomination of Kevin Warsh as Federal Reserve Chair and the expected path for interest rates through 2026. Yet as always, we're going to start first with Scott Smith, my partner at TD Cowan and our specialty salesperson for financials. He's going to give us an update on where the market stands. So Scott, what's going on out there and what's interesting?
Scott Smith:
Well, Jared, thanks very much. This has become the year of the banks with regional banks in particular after a very long period of relative under performance, certainly relative to large caps, now actually hitting new highs and continuing to generally trade higher. Some of that is curve steepening. Some of that is M&A. Some of that is also generic positive commentary from fourth quarter earnings about where the loan growth trajectory sits, as well as an overall slightly easier regulatory environment, which I know you've spoken about many times. Elsewhere, it's been much more choppy. Insurance has continued to be a little bit of a challenge. Nothing has been worse year-to-date than FinTech, which has suffered from a number of single stock blowups as well as the more recent blow off in software overall that has been weighing on that space. That move has also crept over into some of the alternative asset managers. And we are now starting to see as well a little bit of questioning on consumer credit. So it is for the moment all about U.S. banks.
Jaret Seiberg:
Scott, within the banks, are we seeing any differentiation between which types of banks are benefiting? Is it the biggest banks, the GSIBs, the regionals, the smaller banks, or is it just a rising tide lifts all banks?
Scott Smith:
You know Jared, it's definitely a differentiation story so far this year. Regional banks, which we generally see as expressed by the KRE up an 11.5% on the year, whereas the BKX, which tends to incorporate more of the larger banks, including names like Goldman Sachs and Morgan Stanley, is only up 4.2%. So people are really looking for those regional US banks that benefit from loan growth and a steeper curve and maybe less from large banks that benefit more from capital markets activity and a broader market view.
Jaret Seiberg:
So Scott, when we had you on last time, we talked about private credit and concerns about private credit. Are we less concerned, more concerned, as concerned a month later? What's the market vibe here?
Scott Smith:
We more or less round-tripped it. We went from less concerned at the closing point of the year and the early part of this year, a little bit less concerned. And then a couple of other of the BDC companies cropped up with NAV write-downs that were significant. And within there, I think what really kind of frustrated investors were some of the credits that were five, six weeks ago carried at 100 cents on the dollar, suddenly showing up five or six weeks later, carrying at zero cents on the dollar. And that sort of uncertainty factor in the group has made it really tough for people to feel like they can get comfortable with where valuations are. So it's not the hysterical level it was in the latter part of last year, but it's definitely worse than it was say right around year-end.
Jaret Seiberg:
Awesome. All right. Well, Scott, thank you very much for the update. As always, look forward to connecting back up in our March Two Cents podcast. Time to shift now to the main event. Gennadiy Goldberg is a chief rate strategist for TD Securities. It's really a good time to be an interest rate guru as the Federal Reserve can't seem to avoid the spotlight. We have the president nominating a new Federal Reserve chair. We have a Justice Department investigation of the existing Fed chair. We have a president who wants rates to be much lower, and we have a Council of Economic Advisors chair who just resigned his seat to stay on the Fed. As I said, there's a lot happening. So Gennadiy, what's going on and what does this all mean?
Gennadiy Goldberg:
Well, thanks for having me, Jared. And looks like, to quote airplane, I picked the wrong week too ... And fill in the blank here. There's a lot happening, you're right. I mean, the nomination of Kevin Warsh here is just kind of the cherry on top of all of it. Look, what really matters for markets is the fundamentals still, believe it or not. There's still lots and lots of noise, but distilling the noise from the macro fundamentals, we're okay here. There's been better macro drivers than I think most folks would've expected. So growth has definitely been better this year than we could have expected. It was definitely better last year, but there's really kind of three narratives that I want to push back on just super quickly. One is the narrative that the U.S. economy is just absolutely reaccelerating. That's not the case. That's really not what we're expecting.
Q3, Q4 growth was quite good. Q1 growth is going to be pretty solid. What we're thinking ends up happening is that growth just remains okay at least for the next month or two and then gradually levels off. So it's not a reacceleration story. It's kind of more of the same, which tells me the markets have already penciled in quite a lot of the optimistic story. And you look at things like data surprises, for example, there's a huge seasonal upside in Q1. You tend to get this upside seasonal surprise. We don't think that lasts for more than the next couple of weeks and you should start to see that reverse, which means rates have probably risen sufficiently to incorporate a lot of this news.
Points two and three that I'll push back on, one is that the issuance patterns in the US are completely unsustainable. Scott Bessent is probably the best friend a bond market can ask for. He will do everything humanly possible in his power and maybe some things outside of his power to get interest rates lower. And that's the important thing to keep in mind. What are they doing? They're tilting their issuance pattern towards the short end of the curve. That's where the demand is. What are they doing? They're in their own little selfie version of operation twist by actually buying back securities with a roughly eight-year duration and issuing with a roughly five-year duration. And you've got the Federal Reserve actually now a net buyer versus a net "seller" last year as they were letting their balance sheet run off. So the issuance patterns are not as bad. Net supply this year is actually declining. So despite all the worries about 6% deficits to GDP, which I agree is unsustainable in the long run, in the next year or two, we can absolutely sustain it and it should be okay for bond markets.
And the third point is the lack of foreign demand. Every time we get more jitters out of Washington or wherever the president happens to be, we get a reassessment of, is the U.S. the dominant flight to safety currency and asset? The currency is still an open question for sure, but at least on the interest rate side, we haven't really seen foreign investors selling. And not only that, we've actually seen foreign investors buying all of last year in the wake of Liberation Day. I think they're going to continue to buy. You've seen domestic investors buying, money funds, ETFs, mutual funds, pensions, banks. Everyone's been buying treasury. So the demand side is actually quite strong. Putting all that together, we still think rates go down towards the end of this year. Obviously it depends on how quickly the Fed cuts. We do expect them to cut three more times.
We're waiting for more economic data, which unfortunately has again been delayed by yet another government shutdown, but thankfully not very long this time around. So putting it all together, we still think interest rates lower. We actually think the curve a little bit flatter as well over the course of this year. We think we've reached basically peak steepness, and that's where we think things stand, I would say, even before the introduction of Kevin Warsh into the equation.
Jaret Seiberg:
Right. So let's get to the soap opera part of this. I mean, the Federal Reserve, we don't normally think of it as an afternoon TV show, but it really does have some great drama. I mean, we have a Justice Department investigation that the Fed chair unveiled in a late night video that he released to the public. We have senators basically holding up all Fed nominees until there's some sort of resolution. We had the chair of the Senate Banking Committee saying the very thing Powell is being investigated for, he doesn't think was a crime. And then on top of it, we have a nomination of Kevin Warsh. We don't really know what seat he's going to fill because we don't really know if Powell is going to leave. So much drama. What do we make of it? Is this normal?
Gennadiy Goldberg:
No, definitely not normal, I would say. This is more an episode of The Apprentice than anything else. But what we're seeing is kind of a, I would say, a politicization of the Fed. We haven't seen the impact of it yet. I will say that. So the Fed is still relatively apolitical. At least for those worried that the decision-making is becoming politicized, it isn't. So there is almost no one at the Fed, and I won't tell you who I think is a little bit more political, but there's almost no one at the Fed who thinks in political terms, whose decision-making process is driven by politics alone. They still want to do what's best for the country, which again means gradually lowering interest rates to neutral, which we think they think is 3%. So we've still got three cuts penciled in over the course of this year.
Now, the introduction of a relatively dovish Fed share, what does that mean? Well, is Kevin Warsh dove? It's unclear. I mean, he's spent basically his entire post FMC career criticizing the Fed in hawkish terms. He's a small balance sheet kind of guy as well. That's what's getting the markets worried. We don't know which version of Kevin Warsh is going to be in the seat. Now, he is between a rock and a hard place. In order to get the job, he had to be dovish. That is beyond measure. And Trump has basically made it very clear that he was appointed for the job to cut interest rates and we think he'll push for that.
Jaret Seiberg:
Gennadiy, I thought I heard Trump say he's going to sue Kevin Warsh if he doesn't cut rates.
Gennadiy Goldberg:
Well, I believe the initial line was, "I'm not going to tell him what to do, but he knows what to do." And then he promised a lawsuit. This is one of these good news/bad news situations. As Governor Miran put it, the worst part of it being on the Fed, you're one of 12, which for markets, the best part of Kevin Warsh or Steven Miran being on the Fed, there are one of 12. They have to convince the rest of the committee to do what they think is right. And they're going to start from, I would say, a low point. They need to build up some credibility. They need to convince the committee that we need a smaller balance sheet or we need sharply lower interest rates. I think a lot of the things that markets are worried about will play out over time, not necessarily day one.
So is Kevin Warsh going to push for interest rate cuts? Yes, most likely, within reason. I also think he doesn't want to let inflation run away. So if there are inflation worries, he's going to have trouble convincing the rest of the committee that cuts are necessary. The point about the balance sheet and him not liking large balance sheets directly contradicts the administration's goal of getting interest rates lower and Scott Bessent's goal of getting interest rates lower. How is that going to play out? Over a very long period of time. And you and I have talked about this before. They're going to have to cut banking regulation, which incentivizes banks to keep a large amount of reserves on their balance sheet, and that's going to take at least a couple of years. And only then can they actually try to get the balance sheet lower as a portion of GDP or bank assets.
That's the only real way to go. I doubt there's going to be a massive U-turn on the balance sheet. We still expect the Fed to keep buying for reserve management purchases. We do expect them to slow down in April, but purchases are going to be the thing for the next year or two at the very least. We don't think there's going to be a big U-turn. What does it all mean for markets? You have somebody on the FMC who's arguing for more rate cuts, so you have another dove. But if you look at the rotation of the rest of the voters, your Lorie Logans, your Beth Hammacks, you've got a lot of hawkish voters coming onto voting rotation. You are going to have to convince the rest of the committee, and it's really the committee that makes the decisions and it's going to take a while to convince them.
So I don't know. It's just going to create more chop in markets. So it really brings us back to what do the fundamentals do? That's really what matters. If it's fifty-fifty, that's where Kevin Warsh can really make his bones and push for the rate cut and push that through. If it's very obvious the market doesn't need a rate cut and the economy doesn't need rate cuts, it's going to be hard for him to push that through. And the markets are actually going to like that because they like an independent central bank and they like long-term inflation expectations under control as they currently are.
Jaret Seiberg:
So Gennadiy, let's talk about one of Trump's big priorities, which are mortgage rates. We hear often from either the president or the treasury secretary, the significance of getting mortgage rates to start with a five handle rather than a six handle. It's certainly part of the messaging going into the midterms. There's two things that maybe Warsh could do as Federal Reserve chair. He could move more quickly to cut rates at the short end of the curve and hope that the long end of the curve follows in step, perhaps even maybe starting with a 50 basis point cut, which could be possible out of the gate and then stand pat for a while. They could talk about what they're going to do with their GSC MBS holdings. Do you see any of this in play or how should we be thinking about mortgage rates with Warsh?
Gennadiy Goldberg:
Part of the goal in getting interest rates lower is to get mortgage rates lower as well. And unfortunately, this is where internal consistency is not necessarily a strong part of policymaking at the moment in the White House. You've got the announcement that Fannie and Freddie are going to buy 200 billion in mortgages followed by threats over Greenland, which basically wiped out the entire benefit for Fannie and Freddie that we've seen so far play out in market. So mortgage spreads, the mortgage basis, so the spread between mortgage rates and tenure treasuries, tightened after that announcement, roughly around 20 basis points or so. And then the threats over Greenland started and that basically wiped out the entire benefit. So for a brief moment, we had mortgage rates below 6%. They got exactly what they wanted. The 50 base point rate cut is probably not in play unless something goes terribly wrong, in which case it's the rest of the committee. The curve will certainly steep it, but we'll see a bolt steeping in rates, which means all rates will go lower, the curve will steepen. That wouldn't be the worst scenario.
The issue is right now, I actually see Scott Bessent as having more impact on interest rates than the Fed. Now, the Fed can cut three more times, two are already priced in. It's not going to make that much of a difference. What Scott Bessent can do, and they've sort of hinted at this at the last refunding meeting just yesterday, they can come in and threaten to cut back 20 and 30 year option [inaudible 00:15:49], and that would help. So one of the ways you flatten the curve, one of the ways you're getting longer-dated interest rates lower is you bring down the amount of issuance you do in the 20 and 30 year space. They can very easily threaten that.
They can flatten the yield curve quite substantially. The reason I think Scott Bessent is keeping that in his back pocket, I keep saying it's his final trump card effectively, is rejigging the issuance is because he wants to wait until we really, really need it. If interest rates look like they're running away, that's really kind of the card he'll play. But he can threaten it and he can hint at it in his interviews with the media, for example. So I think Scott Bessent probably has more ability to get interest rates lower just by changing the cadence of issuance and just changing things at the margin than the Fed at this moment. I don't think they're going to do QE, but you've already got, as I mentioned earlier, the treasury doing their own little selfie version of Operation Twist. I don't think the Fed's going to do their own version of Operation Twist because it's a big lift at the moment, unless again, something goes terribly wrong, which is not our base case scenario.
So they're stuck between a bit of a rock and a hard place. As you've mentioned it before, the administration's throwing everything they can against the wall and seeing what sticks on the affordability side. Hoax or not, they are trying to address this issue and they're trying to be seen addressing the affordability issue. I really think Scott Bessent has more tools than the Fed at this point to get interest rates lower and he's going to try to use them.
Jaret Seiberg:
All right, Gennadiy, last question. At the end of the year, what's the 30-year mortgage rate?
Gennadiy Goldberg:
I think by the end of the year, we get into the low fives, probably around 5.25. Now that's predicated on our view that 10-year rates go down to about 3.5 We're well below market consensus there. We will review that as we review our Fed calls, as more of the data comes in. We could be closer to 5.5 potentially. It's not a lot. Five handle is great. I will say that. I think it'll encourage a little bit more activity in housing, but you've still got 55% of the country locked in with mortgage rates 4% or lower. So it's really a psychological thing at that point. Somebody with a 3% mortgage, are they willing to move? Are they willing to move on with life for a 250 basis point increase in mortgage rates? Every basis point you can get closer to narrowing that differential helps. So I'm hoping for low fives, mid-fives would be okay. And I think you could declare that a bit of a victory in this environment.
Jaret Seiberg:
Awesome. Gennadiy, you're wonderful as always. Thanks for joining us today. Much appreciated.
Gennadiy Goldberg:
Thanks for having me.
Jaret Seiberg:
Let's wrap up our podcast today with catch up on the news out of Washington for financials and housing.
In the last couple of weeks, the president has revived his call for a 10% cap on credit card interest rates. I don't see the legislation as likely, though I am watching if banks roll out balance transfer offers or similar products to provide credit card borrowers with similar interest rate relief. At a minimum, this is something that the market is looking at and something that we're going to be focused on going forward.
On the credit card interchange front, Senator Roger Marshall tried to add a provision to the Crypto Market Structure Bill as it advanced through the Senate Agriculture Committee. Although he pulled the amendment in the face of Republican opposition, I expect this fight will continue with Senator Marshalls and Dick Durbin trying again with pretty much any other bill that it looks like the Senate is going to pass.
And then lastly, on the housing front, this is still a priority issue in Washington. The President has ordered Fannie Mae and Freddie Mac to buy 200 billion of their own MBS in an effort to bring down mortgage rates. I expect the president to push for additional policies to boost housing as we head toward the midterm election. I think his State of the Union address in the end of February is likely to be a vehicle where we're going to get more details on those other policies. I do think the overall goal here is to try to reduce monthly payments and thus expand the ability of average buyers to afford a home.
As we look forward on the calendar, it's going to stay very busy on the financial policy front. We have a number of House hearings through the end of February focused on housing, as well as oversight of the SEC. We're especially looking at a February 11th hearing on the secondary mortgage market, given the importance of that in housing finance. We also are watching the U.S. Court of Appeals in a case involving the president's efforts to effectively shut down the CFPB. This could really tell us what consumer finance enforcement at the federal level will look like through the end of the president's tenure.
We are also awaiting a potential decision from the Supreme Court on the Lisa Cook case. Governor Cook is on the Federal Reserve Board. The President has tried to fire her for cause, and the Supreme Court needs to decide exactly whether the President has that authority, and if he does have the authority, do allegations involving a mortgage application, give him enough grounds to remove her for cause.
And then lastly, I do think the House and the Senate are going to pass a housing bill that should boost manufactured housing. Also have some language in there to push zoning reforms. Looks like the House is probably going to act first with the Senate following suit at the end of February or in March. So with that, we're going to wrap up the February edition of our podcast. Thank you very much for tuning in and please make sure to look for us next month around this time for the March version. Thank you. Have a great day, everyone.
Speaker 1:
Thanks for joining us. Stay tuned for the next episode of TD Cowen Insights.
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