If you’re wondering what the Federal Reserve will actually end up doing with interest rates this year, Larry McDonald advises ignoring what economists say.
Instead, it’s best to focus on credit risk, according to the founder of the Bear Traps Report and former head of macro strategy at Societe Generale.
Even after just one increase to the target for the Federal funds rate, credit markets are signaling that it’s “highly suspect” that the central bank will lift rates by the equivalent of seven 25-basis point hikes this year, let alone the eight or nine increases that some economists are predicting, McDonald said in a recent Bear Traps Report video.
McDonald pointed to the iShares CMBS exchange-traded fund to make his case. The $753 million ETF tracks commercial mortgage-backed securities, a critical lending tool for banks. The 10-year-old ETF is experiencing the second-largest ever drawdown, behind only the 2020 Covid-19 market crash. It remains mired in weakness even as benchmark equity indexes have recovered much of their year-to-date losses.
“Economists are looking at economic data, they’re not looking at credit risk,” McDonald said. “And at the end of the day, as we’ve seen over the last 10 years, credit risk will veto the Fed, will veto the economists. That’s why you have to spend more time looking at credit risk and not listening to economists.”
When it comes to what areas of commercial real estate are riskiest, Bear Traps suspects that it’s the CMBS tranches that are most-exposed to major U.S. cities --- risk that is also being flagged by the municipal bond market, McDonald added in an email Thursday.
“We are seeing a corresponding surge in muni credit risk in some of the large U.S. cities,” he said. “NYC spread vs. Austin and Miami widening a lot.”
This article was provided by Bloomberg News.