Fixed-Income, Banking Stress and the Fed

Romaine Bostick: Let's get right to our next guest, Bonnie Wongtrakool joining us right now, portfolio manager and head of ESG investments over at Western Management, Western Asset Management, excuse me, which oversees $402 billion in assets. And Bonnie, I do want to start off with the economy and the momentum in this economy and whether you anticipate that there is still momentum there or are we just sort of waiting for that cliff that had been priced into this market earlier this year?

Bonnie Wongtrakool: Right. So the economy definitely does have momentum still. We saw that in the first quarter economic data came in a little bit stronger than many expected, as did corporate earnings, which were still coming in right now. But we do think that the economy is starting to lose momentum. A lot of those forces that pushed growth above trend after COVID. So the fiscal stimulus and the excess savings, the pent up demand supply chain bottlenecks, we see those as dissipating. And you're seeing signs of cooling in growth, which we really do think is going to eventually lead the Fed to be able to take a pause and reassess as these forces come down, which is really pretty constructive actually, for fixed income, which tends to outperform as you get towards the end of a hiking cycle and definitely should do well if growth moderates and inflation comes down.

Romaine Bostick:Okay. Well then elaborate on that. I mean, I assume you're still liking fixed income in this space. You still see opportunities in there?

Bonnie Wongtrakool: Yeah, we do. We think that bonds have good total return potential here. You know, when you look at the level of yields that they're starting from, they're higher than we've seen in many years. And the spreads are reasonable, especially in light of the fundamental picture. So we think that it does make sense to be in bonds. We do like staying in higher quality in terms of credit quality given the relative valuations. So some of the areas that we have favored are investment grade corporate credit on the shorter end of the curve. So 1 to 5 years. And we also are starting to find agency mortgage backed securities pretty interesting here. They have cheapened up a lot in light of the volatility and in light of potential bank selling, which we think could be should be orderly. But we are looking to add to that sector on weakness.

Scarlet Fu: So let's talk a little bit more about the financials. We were just mentioning how First Republic, the trade today is painful to watch because it's halted from trading. When it resumes trading, it goes down, then it's halted once again. There is this assumption that it's, you know, an isolated case. It's idiosyncratic. This is no longer a systemic issue or the contagion might be limited. How are you thinking about this in just the most conservative way?

Bonnie Wongtrakool: Well, I think it's like Romaine said, it's a tale of two cities. Our US banking analyst likes to say that as well. You know what's going on within the regional banking sector, the mid to small banking sector, is quite different from what's going on with the bigger banks, the money center banks, and the latter is a sector that we do like that we're overweight and that we continue to favor. But the two of them are quite different in terms of their risk profiles. The bigger banks have much more diversified revenue mix. They're not as reliant on that net interest income as those smaller banks, which they will see that margin get squeezed, whereas the bigger banks have other revenue mix, other fee income to rely upon, and they are already being very highly regulated, they're very strictly regulated, unlike the smaller banks which need to go through that, as we are told today by Barr. So we find that the money center banks are in an extremely strong position, very good liquidity. It's a great place for bondholders to be. Of course, the rest of what's going on in the banking system we need to keep an eye on, I think the Fed also and will give them, I think, more reason to be cautious going forward and making their policy more restrictive.

Scarlet Fu:I actually wanted to ask you about that. How much do you think that factors into what you expect to be a pause in the in the Fed's movement on interest rates? This idea that we have to see the fallout in the banking sector, especially with these smaller regional banks.

Bonnie Wongtrakool: I think the Fed, you know, before this, they recognized that their monetary policy has long and variable lags. And what's going on in the banking system simply increases the uncertainty around how that monetary policy will play out. It's very hard to gauge and say, well, it's equal to a certain number of hikes. I don't think anyone knows. And the Fed recognizes that they don't know. So I think it really does lead them to be a little bit more biased to pause rather than keep on going.

Romaine Bostick: All right, Bonnie, great stuff. Always wonderful to talk to you, Bonnie Wongtrakool, there over at Western Asset.