Dave Richardson

Hello and welcome to Download. I'm your host, Dave Richardson. And we are joined by our old friend, although we try not to say that too much. He's a little sensitive to the word «old» right now. We'll get into that in a second. But our good friend, Andrzej Skiba from Blue Bay Asset Management. He is the head of US fixed income, which is a huge job. But according to your kids, you're retiring soon.

Andrzej Skiba

Yes, unfortunately, in their opinion, I'm very old and my days are already numbered. Hopefully, they're proven wrong. But hello, Dave. Always a pleasure to speak to you and to your listeners.

Dave Richardson

Always a pleasure. I'm glad we will set the record straight. You are nowhere near retirement. You are a relatively young man. Any rumors about retirement are likely related to me, if there's any truth to them. And part of that, the fact of this sign of my age, I thought we had you on recently, and we haven't. And you're probably our most popular guest. So I apologize for not getting you on as frequently as we should. With everything that's going on in US fixed income markets, we should probably have you on almost daily. So thanks for continuing to accept the invitation. And let's talk about your area of expertise, which is US fixed income. And Andrzej, where do you think we should start? What do you think the most interesting area of the world that you're responsible for would be right now as we're having this conversation for investors in Canada or investors in fixed income anywhere in the world?

Andrzej Skiba

When we speak to our clients, there are two topics that come up quite a lot. The first one is, are we through the worst? Is uncertainty coming to a level that is tolerable and acceptable? What’s there on the horizon that could spook investors and cause a return of volatility that we have experienced in April? The other question that we get a lot is, we’ve seen US Treasury yields falling a bit in recent weeks, only to move back up in recent sessions, again, with the 30-year close to the magic 5% number. Quite a lot of investors are asking, what is the trajectory from here? What's going to happen to US Treasuries? What's going to happen when it comes to Fed policy? I think those two topics occupy most of our conversations with fixed income investors, and maybe the last one being where to find value within fixed income after quite a rebound that we have experienced in spread products over the recent months.

Dave Richardson

So, Andrzej, why don't we start with the Fed and just get your perspective on what you think they're doing? What they're thinking? What could drive the rate cuts that I've heard someone down in the US is asking for or would like to see some rate cuts? I just read about it in the paper up here, north of the border. And where do you think the Fed is headed and where their mind is right now as they look at all the data that's been coming out over the last few months?

Andrzej Skiba

I think it's a really interesting question because where we've been a few months ago was with a view that Fed might actually not be able to cut rates this year. If inflation remains elevated and you add it to inflationary pressures as a result of the tariffs that are being put in place, essentially Fed might have to decide that this is not an environment where they can help and cut rates. But a few things have changed since then. The first one is the underlying inflation picture. The data that we have seen so far before the tariff impact has hit the numbers has actually been more benign than investors expected. The last few inflation prints gave quite a lot of comfort to investors. It was actually very interesting to hear chair Powell in one of his testimonies confirming that if it wasn't for the tariffs, they would feel like they're in a position to cut rates. That's really important to acknowledge that, irrespective of tariffs, the underlying benign inflation dynamic would help to bring about some cuts. Then you have a question about what will be the end state of tariffs? How aggressively will those be set and what impact on inflation we will see? Our view throughout this process has been that you are likely to settle to see the end state around 10 to 15% tariffs. Some countries will pay more, some will pay less. But what really matters to the market is what's the average end state when it comes to tariffs. We do think that we're likely to end up in this 10 to 15% range. In our opinion, that is not aggressive enough to prevent the Fed from cutting rates when this underlying inflation picture is pretty benign. Our expectation is that between now and the end of this year, you will see one or two cuts, and we will see how data develops over the coming months. But one to two cuts, it's perfectly possible. To see more than that, we find that quite unlikely because either you would have to see much weaker economic development in the US, recession fears coming back or labor market breaking down. Or tariff settling at much more benign level below 10%, for example. We just don't think that that's going to be the end state as part of this trade escalation.

Dave Richardson

So when you look at that, and I think most people are in that one or two cuts for the remainder of the year, a little bit more clarity around tariffs, people with somewhat slightly different views around how inflationary the tariffs actually are short and long term. So we're in this situation where maybe we get a cut or two. What does that do to the longer end of treasury rates? As you mentioned, the 10-year US Treasury has moved around actually quite a bit through the first six months of the year. What do you think the second half looks like for longer dated treasuries?

Andrzej Skiba

To us, it's really a question of what will be the growth outlook over the coming quarters? Because at the end of the day, and that is something that we mentioned before, the key concern for investors was the level of US deficit. When you have an avalanche of treasuries coming to the market where the treasury Department needs to fund, that is an environment where investors might demand for extra compensation to move further out the curve, whether that's a 10- or 30-year point. That was really our concern, particularly when growth fears were acute and at the same time, deficit expectations were high. Because this is really a toxic formula where bond vigilantes could be coming out of the woodworks and saying, hey, this deficit is unsustainable, and so we will not buy treasuries unless you pay us more, which would put additional pressure on treasury yields further out the curve. One of the ways we've seen in the past you can address some of these concerns is by having more robust growth than expected. It feels at this stage that Trump administration is really focused on re-accelerating growth, that a lot of the decision process that has been taken recently is about re-accelerating growth, and by doing so, addressing some of these concerns about elevated deficit levels that the budget bill that just passed is doing nothing to reduce. From our perspective, the key question, therefore, will be if growth outlook is pretty robust and inflation continues to behave, then market is unlikely to put further pressure on treasury yields. If, however, inflation remains elevated but growth falters and treasury still has to fund so much in the market, then we could see upward pressure on treasury yield. So across our portfolio, the way we are implementing this view, and we've been doing that for quite some time, is by being long risk—so positive on two-year treasuries, because that is almost like your safety valve in the portfolio. If things go wrong, two-year treasuries will protect you while we are negative on the 30-year treasuries. We're essentially expressing a view that the curve will continue to steepen between the 2- and 30-year point. Right now, it's around 100 basis point steepness, but we see multiple scenarios where that number needs to be higher. For us, that is the right way to play this theme, this narrative. Generally, we would be avoiding long-duration treasuries at this stage. But then we also recognize there is a fair amount of investors out there in the market when treasuries hit 5%, they're happy to start nibbling on treasury risk. From our perspective, we prefer to stay away until that clarity on growth and deficit is with us.

Dave Richardson

Let's dig into that because I did want to check in with you. Perhaps more than any other subject we're covering today, I wanted to check in on your thoughts on the one big, beautiful bill. Not the one big, beautiful plant, which is behind Andrzej in his office as we're taping this podcast. By the way, if you don't just want to listen to us, if you actually want to see the one big, beautiful plant, which I think is a man-eating plant—this is pretty exciting as Andrzej is doing the podcast—you can subscribe and watch us on YouTube. Most of our episodes are now in video, along with the audio version, which you can also subscribe to anywhere that you get a podcast. So Andrzej, one big, beautiful bill. When you look at your world—which apparently you're going to be in for a while now, you're not retiring, we've established that—what do you think the next 5-10 years looks like after the passing of this bill with the tax cuts, with the projections for growth that are going to be generated out of, which comes from more the supply side economics folks, and that you can cut tax and raise revenue, and what happens with the deficit. From a bond market perspective, and someone who is an expert and works in that space, what do you make of that piece of legislation? Is this a good or bad thing long term for bond investors?

Andrzej Skiba

Sure. It's important for us to separate what we think about the contents from emotional perspective or outside of the markets from the reality that this bill augurs for fixed-income investors. There's a couple of things worth highlighting here. The first one we've noticed that one of the reasons why we have not seen a very negative response from fixed income investors is because the final version is a little bit less egregious in terms of adding to deficit compared to the initial house version. This is one of our core views that markets often trade on marginal changes in uncertainty, marginal changes in the end state of things rather than the final destination. Because here we've seen some improvement in terms of a bit less added deficit compared to the initial house version. It was relatively uneventful from market's perspective when the final bill got signed into law. The other thing worth highlighting is the simple truth that this bill does very little to address the deficit outlook, that the rollover of the tax cuts, which was widely expected, has been funded mainly by a combination of cuts in some social safety net programs, but also pretty rosy growth projections within the bill, something that happens in many countries when it comes to passing budget. US is not unique in that respect. That's why for us, the key question going forward is, well, this bill is not helping to reduce deficits, can help to stimulate some economic activity, and at least is closing the period when investors, companies, struggle to make investment decisions, whether that's to do with capital expenditure or M&A expenditure, now you know essentially what the playbook is going forward, and that is likely to be supportive for growth. Therefore, the key question for us is, back to the point I made earlier, how will the growth outlook evolve over the coming months? If growth is faltering, if the tariff trade escalation is not resolved, that will be a tricky mix of having high deficits and weak growth. If, however, US again somehow manages to pull the rabbit out of the hat and have growth outlook that seems to be ahead of many other places in the world, then I think investors will forgive the deficit-inducing nature of this bill and manage to stay calm in the context of our markets. Having said that, though, it's very difficult to see a scenario where in absence of some dramatic recession risk coming back, treasury yields would fall meaningfully from here. We might stay with these somewhat elevated, by historical standards, yields for quite some time, especially when treasury issuance continues.

Dave Richardson

Yeah. And Andrzej, I think there's a whole wave. We've talked about this with Eric Lascelles, who I know you know, who has been a guest on the podcast many times about a new monetary theory, this whole idea that debt just really doesn't matter. This is a school of thinking which I'm going to guess is not a school that you belong to, but nevertheless, that debt levels can just go on and on and don't really matter that much. I suspect that a certain debt level does matter. Do you ever think about what that debt level might be in the US because we're in around 100% of debt to GDP. Or is that the wrong way to think about it? How do you put in your mind as part of your role is to protect investors from the bond vigilantes and what can happen when debt gets to an unsustainable level? How do you manage all that and think about it in managing portfolios?

Andrzej Skiba

Well, look, one thing that we need to highlight is that a lot of major developed market economies have, over the recent years, moved up their debt to GDP to around 100% levels or close. Something that was anathema to the markets not that long ago—and Japan was sticking out as a sore thumb compared to other developed economies—is no longer the case. Almost like normalizing these elevated debt levels and making markets and consumers used to governments bailing out everyone when trouble hits, seems to be the tune that's been playing globally, not just in the US. In a way, the fact that everyone's in that boat makes it less potent as a fear on a day-to-day basis. Having said that, one of the aspects that we are looking at quite closely is the funding cost, because it's one thing to focus on the level of debt to GDP—how much indebted government is—the other one is actually to focus on what portion of your spending will you have to devote to servicing interest costs on that debt. For the US, those numbers are actually ramping up quite a bit and are getting into a territory where further meaningful increases will be difficult for the markets to stomach. I think almost some of the narrative could be shifting from debt to GDP level into what portion of your spend has to be devoted to servicing this massive debt load over the years to come, which is one of the key reasons why a combination of elevated debt with weaker growth is a toxic combination. Even if growth remains better than expected, while we don't think that bond vigilantes are likely to win in the near term, and we don't think that global investors will stop looking at dollar assets as a core part of their portfolios, you can easily see scenarios where while you don't see an earthquake, you can see tremors. Those tremors will be individual treasury auctions where the outcome of a particular auction might actually be disappointing to market participants, resurfacing some of these fears. We need to be vigilant. We need to be careful. That's also one of the reasons why in this elevated deficit world, we just don't see a scope for an aggressive rally in treasury yields from here. One way or another, this needs to be addressed, and fixed-income investors will be very focused on that trajectory and funding cost trajectory going forward.

Dave Richardson

Does the weaker US dollar concern you in any way? We've seen a significant weakening this year in the US dollar. Many analysts expect that it will continue to be weak as we move forward. Does that factor into your thinking around what you're doing in US fixed-income markets?

Andrzej Skiba

Well, I could almost turn the question to ask, from the perspective of this administration, what were their goals? Actually, when you speak to many administration officials, their feedback early on was, we want a weaker dollar and lower treasury yields. They got one out of the two. But they were very happy seeing a weaker dollar as a way to support US economy going forward. There are not many tears shed for the weaker dollar here. Whether that trend continues, given the magnitude of the move we have seen so far, I would ask our friends on the FX strategy side instead. But it was definitely not an undesired outcome, but clearly, it's a bit more of a complex picture when it's a weaker dollar and higher treasury yields at the same time.

Dave Richardson

It was a somewhat rhetorical question, Andrzej, because we talked earlier and I wanted to highlight why you want to listen to podcasts like this. One of the main things that we can contribute to you as an investor, if you're listening to us regularly, is give you some of these insights. I hope what you sense just from this conversation, in particular with Andrzej, clinical, analytical, objective, unbiased view. I'm interpreting this. I'm not getting emotional about it. I'm going to do what's best for my clients, given all of my expertise and how I piece all of this together. You might have heard a lot about tariffs. You might have heard a lot about other policies coming out of the US economically. You might have heard about the big, beautiful bill. You might have heard about inflation, but there was no US government representative standing out there going, we want to weaken the dollar. If anything, we were hearing the opposite. Yet very clearly, we were hearing Andrzej very clearly that part of the objective was to actually weaken the US dollar. Again, it's more important for FX and maybe it plays a bigger factor in some other thoughts around your portfolio as a Canadian investor. But knowing that is a very important part of putting together an investment strategy. Different things happen in different markets, and we talked a lot about it in the podcast. We'll continue to talk about that when you have a weak US dollar. In fact, we'll have Laurence Bensafi, who's part of our emerging market equity team. Emerging market equities love a weak US dollar, and lo and behold, emerging market equities are the best performing stock area in the world this year. So this is how all this stuff connects. So, Andrzej, I just wanted to highlight that you had mentioned on your last appearance, or actually, I think all the way back in October and last year, anticipating a Trump election and that would lead to a weaker dollar. So all of this comes into play. So, Andrzej, that looks at the treasury side of things. Anything else interesting in investment grade or anywhere else in the US market in terms of where you're positioning the portfolios? Or is this just as a lot of people have described a dull bond market where you sit at the shorter end, around two years, you stay away from the long end and just do okay. Which is fine. That can deliver you a mid-single-digit returns, which is never disappointing for a bond investor in this environment. But anywhere else that's interesting to you?

Andrzej Skiba

When you say dull markets, I always get scared. Be careful what you wish for, because normally people say that just before volatility hits you. But look, from our perspective, credit markets, whether we're looking at investment grade or high yield, a lot of value has been taken out. With the rebound in spreads, tightening of spreads that we have seen in recent weeks, we're coming close to multi-tight in spread terms. So it's very difficult for me to sit and tell our investors that it's an amazing time to get invested in credit products. However, what we are confident about is that it's definitely a much better time for an active investor than a passive investor. Because if you are a passive investor, then you accept the entire market at its expensive valuations. Whereas for an active investor, it's a great time for us to actually highlight our skill and ability to find pockets of value and still squeeze some performance from this market and deliver returns for our clients. So this is really a challenge for active investors like ourselves to actively look, to find those pockets, to benefit our clients when generic spreads, whether it's in high yield or in investment grades, are not particularly appealing. That's exactly what we've been doing across our portfolios, helping clients on a global basis. We will see whether that picture will change as we come closer to the autumn. Autumn always is a very heavy issuance period in credit markets, so that could bring quite a few opportunities for investors to gain exposure to interesting assets at better entry points than it currently might be the case. In some ways, we're suggesting a bit of caution across many of our strategies after the rally we've just had. We've taken some chips off the table, and there's nothing wrong about booking profits. There's nothing wrong about saying, hey, it's not a sin being closer to home in terms of overall risk positioning. We're just watching as the markets evolve. If we were to see any meaningful shifts, whether that's to do with macro or the credit cycle, absolutely, we're ready to step in, take advantage of dislocations. But for the time being, we feel that credit does not offer an amazing upside opportunity away from the pockets of value that we're trying to identify as active investors.

Dave Richardson

Whereas I, or more accurately, my kids or your kids would walk away from a dull program, a fixed-income investment manager never walks away from any market, dull or exciting. You're always looking for opportunities. Then I think one of the big advantages that you have as a professional investment manager is not just your ability to understand where the market might move, but to actually act and act quickly and take advantage of those opportunities that the market presents to you, which is in the end, as you suggest, what is actually exciting about where we're sitting and where we're going to be over the next several months.

Andrzej Skiba

Absolutely. Look, the other thing worth highlighting is that while spreads might not be the most exciting by historical standards, yields at which you gain exposure to fixed-income assets are quite elevated by those same standards. We see a lot of investors, both here in the US, but also amongst global investors looking at the dollar market saying, I just want some of these yields. I'm a bit less bothered by the level of spread valuations as long as I get exposure to credits that are solid, that I can sleep at night and not lose that sleep over. They're focusing on locking in those yields rather than chasing specific level of spreads. It's important to understand that dynamic because it means that often your marginal buyer of fixed-income assets cares more about the yield than the spread, and that's driving markets day to day.

Dave Richardson

Absolutely. People like me who are moving towards retirement need that income and that yield.

Andrzej Skiba

You know where to find that.

Dave Richardson

Exactly. The readjustment that we had back in 2022 as inflation hit, has created a bond market that is really overall healthier. Again, maybe not the credit side, and you've covered why that is. But as you say, the yields that you can generate if you're looking to generate income are quite attractive, and that's a nice place to be.

Andrzej Skiba

I absolutely agree.

Dave Richardson

Well, Andrzej, you're certainly on top of your game. Always great to catch up with you. Always lots of valuable information and insights on what's going on in fixed income. I can't thank you enough for your time. That was a fantastic update. We covered a lot of ground. So thank you.

Andrzej Skiba

Always a pleasure, Dave, and good luck steering through these markets to all of your listeners.