Higher Bond Yields To Wreak Havoc In 2025 | Jonny Matthews

Episode Summary

Executive Summary: Johnny Matthews argues the U.S. economy remains unusually resilient despite aggressive Fed tightening, with productivity, strong household balance sheets, and durable labor demand reducing recession risk. He sees inflation settling closer to 3%-4%, rates staying higher for longer, and bond yields vulnerable to more upside. He is cautiously bearish on equities, constructive on EUR upside, and expects immigration, deficits, and sticky services inflation to keep policy restrictive.

Main Topics: No recession in sight for the U.S. economy (Priority: 5/5): Matthews reiterates his view that recession risk remains low because the economy has absorbed prior rate hikes without breaking growth, supported by jobs, incomes, and balance sheets. Fed policy and the December hawkish pivot (Priority: 5/5): He argues the Fed’s hawkish shift mainly aligned policy with market pricing rather than shocking markets, and that the initial 50 bps cut was reasonable given prior tightening and falling inflation. Productivity-led U.S. outperformance (Priority: 5/5): The U.S. has outgrown peers because of labor market flexibility, sectoral reallocation after the pandemic, and heavy investment in IT, AI, and business equipment. Inflation is sticky and likely normalizes higher (Priority: 5/5): He expects inflation to remain above pre-pandemic norms, with fading goods disinflation, rising food costs, and only gradual cooling in shelter and services. Labor market resilience and immigration effects (Priority: 4/5): High-frequency labor data suggest a still-healthy job market, while immigration is helping raise labor supply and may be lifting the unemployment rate without signaling weak demand. Higher-for-longer rates, term premium, and bond risk (Priority: 5/5): Matthews thinks long-end yields can rise further as markets reprice the policy path, with deficits and reduced confidence in low inflation adding risk to fixed income. Cross-asset positioning: cautious on equities, constructive on FX (Priority: 4/5): He is short duration, wary of repeated equity multiple expansion, sees TIPS and possibly gold as attractive, and thinks the euro may rebound while the dollar looks stretched.

Key Arguments: The U.S. likely avoids recession because growth, jobs, incomes, and household/corporate balance sheets remain strong despite Fed tightening. The Fed’s December hawkishness largely reflected the market’s own reassessment after stronger-than-expected GDP, inflation, and labor data. Post-pandemic U.S. productivity gains were boosted by labor reallocation and stronger investment, making U.S. growth structurally better than Europe/UK/Canada. Inflation is not beaten: goods and energy disinflation are fading, food is firmer, and services/rents remain sticky. The labor market is improving at the margin, with quits, job-finding sentiment, and claims data not consistent with imminent recession. Immigration has expanded labor supply and likely pushed up measured unemployment, but it does not signal a collapsing labor market. Rate cuts may be overestimated; higher nominal rates and possible term-premium increases argue for higher long-term yields. U.S. equities may struggle to repeat the prior two years’ outsized gains because valuations have already expanded significantly. Alternative stores of value such as TIPS, gold, and potentially non-dollar assets may benefit if inflation stays above target. The euro may be oversold, especially if ECB hawks respond to firmer European inflation data.

Data Points: U.S. growth average: ~3% for the last ~2.5 years - Matthews says the U.S. economy has averaged about 3% growth and sees no clear recession trigger. Fed funds rate peak: 5.25%-5.50% - Referenced as the level from which the Fed began cutting. Initial Fed cut: 50 basis points - He defends the first cut as a reasonable starting point for easing after a long hiking cycle. Cumulative Fed hikes: 425 basis points - He says the policy tightening had been in place long enough to test the economy. Private sector wages and salaries growth: 5.5% YoY - Cited as evidence of strong household income growth. Real income growth: 2.6%-2.8% - Referenced as the recent six-month pace supporting consumption. Average existing 30-year mortgage rate: ~4% - Used to argue households are insulated from higher rates due to locked-in low mortgage costs. Interest costs as % of corporate profits: Lowest in decades - Used to show corporate balance sheets remain resilient. U.S. household debt to disposable income: Back to start-of-century levels - Chart discussed to show household deleveraging. Household debt service ratio: Lowest in decades - Shows principal and interest burdens are historically light. Household wealth: Up about 50% over the last four years - Supports the claim that high-income households have strong spending power. Top 40% of income distribution share of consumption: 72% - Used to explain why upper-income households drive the macro consumption picture. Lowest income quintile share of consumption: ~5% - Used to argue lower-income distress has limited aggregate impact. Secondhand car prices: Year-over-year increases resumed - Cited as evidence goods disinflation is ending. Monthly rent inflation print: 0.2% MoM recently, vs. 0.3%-0.5% prior months - Used to question whether shelter inflation has truly reset lower. Average hourly earnings growth: More than 4% - Referenced as still-strong wage growth supporting services inflation. S&P 500 EPS: 228 to 272 - Year-ahead EPS rose from end-2022 to end-2024/this year in his chart discussion. S&P 500 valuation multiple: 16.8x to 22x - He attributes much of the index’s rally to multiple expansion. S&P 500 total return drivers: ~20% earnings growth, ~30% multiple expansion - Explains the roughly 50% index rise over two years. 10-year Treasury move: Up about 100 bps - Since the Fed meeting / over recent months, illustrating bond repricing. SOFR-implied lowest policy rate over next 2.5 years: Up 120 bps - Used to show markets repriced the entire expected path of Fed cuts. JGB 10-year yield: 13-year high - Signals global upward pressure on yields, in his view. Payroll outlook: ~200,000/month - He predicts a return to stronger job growth over the next few months. Current unemployment rate: 4.246% (rounded to 4.2%) - He notes the last print was just below the rounding threshold. BLS establishment survey sample: 120,000 businesses / ~600,000 workplaces - He uses this to argue payroll data are more reliable than household survey unemployment. Household survey response basis: ~42,000 households - Derived from a 70% response rate on 60,000 households. Short-term layoff claims: ~211,000 - Most recent weekly claims level cited as near a half-century low. Top-end income growth: Lowest-income quintile had the highest percentage income gains - He notes lower-income groups improved proportionally, even if spending power remains concentrated at the top. Rate expectations: Only about 2 cuts priced for 2025 - Discussed in the context of the SOFR curve and reduced easing expectations.

Pivotal Quotes: "It takes a lot to put the U.S. economy into a recession." — Johnny Matthews: His core framework for why recession risk remains low despite tighter policy. "The Fed really brought its expectations in line with the market." — Johnny Matthews: On the December hawkish pivot and why he did not view the Fed move as a major policy mistake. "Inflation hasn't been conquered." — Johnny Matthews: His summary of why long-term yields and policy rates may stay higher for longer.

Implications: Listeners should expect a higher-for-longer rates regime, persistent inflation above target, and continued U.S. outperformance versus peers. That favors short duration, selective inflation hedges, and caution on richly valued equities.