Podcast Summary: Thoughts on the Market

Episode: Market Outcomes of Fed’s New Course
Date: August 29, 2025
Host(s): Matthew Hornbach (Global Head of Macro Strategy), Michael Gapen (Chief U.S. Economist)

Overview

This episode dissects the market’s immediate and forward-looking reactions to the Federal Reserve’s new trajectory signaled at the recent Jackson Hole meeting. Matthew Hornbach and Michael Gapen discuss shifts in treasury yields, implications of a potentially more inflation-tolerant Fed, the projected path of interest rates, and expectations for the U.S. Dollar over the next 12-18 months.

Key Discussion Points & Insights

1. Immediate Market Reaction to Jackson Hole

[00:30-03:51]

• Chair Powell’s remarks surprised investors, leading to significant moves in treasury yields.
• Short-term interest rates, particularly the two-year, dropped sharply.
• The yield curve steepened:
  • Short-term yields fell more than long-term (10- and 30-year) yields.
  • Investors are reconsidering their "love of duration" — with concern that a less inflation-focused Fed may prompt them to demand more compensation for long-term bonds.

"Perhaps this is a Fed that does have slightly more tolerance for above target inflation..."
— Matthew Hornbach [01:41]

• Classic dovish response: Investors interpreted Powell’s tone as more accommodative than anticipated.
• Aftermath:
  • The following Monday saw no major follow-through: yields stabilized, indicating market optimism about the economy and no fear that the Fed has negative inside information.
  • Ongoing data releases will continue to drive investor attitudes; weaker data could spur more treasury rallies, whereas rebounding data might pause year-to-date gains.

"Investors aren't worried that the Fed knows something that they don't."
— Matthew Hornbach [03:19]

2. Market’s View on the Fed’s "Trough" Rate

[03:51-05:52]

• Market pricing of the cutting cycle: Hornbach and Gapen discuss how investors assess the likely end-point (“trough”) of the Fed easing cycle.
• If the Fed is seen as more tolerant of above-target inflation:
  • Markets may price in a lower policy rate at the trough than previously assumed.
  • This is balanced against ongoing economic data—rebound or weakness in labor and economic activity will shift these expectations over time.

"The way that the market would price a central bank's likely policy path... is going to depend on how investors are thinking about the reality reaction function of the central bank."
— Matthew Hornbach [04:29]

3. Implications for Treasury Yields and the US Dollar

[05:52-08:50]

• Treasury Yield Path:
  • Morgan Stanley maintains its year-end target for the 10-year yield at 4%.
  • Minor tweaks may occur to the quarterly trajectory, but not to the broad outlook.
  • Looking ahead to 2026, election cycles, a change at the Fed’s helm, and investor anticipation for 2027 complicate forecasting.

"But it's also about by the time we get to the end of 2026, what are investors going to be thinking about 2027? That is really the trick to forecasting."
— Matthew Hornbach [07:16]

• US Dollar Outlook:
  • Morgan Stanley has been bearish since the start of the year; dollar down ~10% YTD.
  • Expectation is for further depreciation over the next 12-18 months.
  • The dollar’s path is interlinked not only with U.S. policy but also ECB, Bank of England, Bank of Japan, etc.

"The big picture is that the dollar should continue to depreciate in our view."
— Matthew Hornbach [08:33]

Notable Quotes & Memorable Moments

• On market behavior post-Jackson Hole:
  "What we saw on Friday was a pretty classic response to a Federal Reserve speech... much more dovish than investors had anticipated going in."
  — Matthew Hornbach [02:45]

• On policy forecasting challenges:
  "Of course the end of 2026 is a lifetime away it seems, from the current moment."
  — Matthew Hornbach [07:08]

Timestamps for Important Segments

• 00:30 – Gapen recaps Hornbach's immediate impressions post-Jackson Hole
• 01:41 – Discussion on Fed's possible higher tolerance for above-target inflation
• 03:19 – Market reactions and lack of continued rally after the weekend
• 04:29 – How markets price the Fed’s path beyond the short-term
• 05:52 – New baseline for Fed policy and effect on treasury yields
• 07:08 – Challenges and uncertainty in forecasting into/after 2026
• 08:33 – US Dollar outlook and international policy interplay

Conclusion

The episode presents a nuanced analysis of how a perceived policy pivot by the Fed is moving markets, stressing the significance of both the central bank’s tone and economic data in guiding investor expectations. Morgan Stanley remains consistent in its overall outlook for treasury yields and expects further depreciation in the US dollar, albeit with ongoing adjustments as more information becomes available.

Listeners are advised to keep an eye on key data releases and central bank communications, as these will shape both short-term and long-term asset price behaviors.