tv Bloomberg Real Yield Bloomberg May 21, 2017 12:00pm-12:31pm EDT
jonathan: from new york city, i am jonathan ferro. with 30 minutes dedicated to the fixed income, this is "bloomberg real yield." ♪ jonathan: coming up, the biggest crisis of the trump presidency breaks the calm on wall street. for the one south -- for the 1000th time investors ask, is , the trump trade dead? treasury yields grind down. will the chaos in washington throw it off course? is it a wake-up call for em? if you don't one impeachment in brazil was dramatic, markets break for three in a row. we start with the big issue.
a week of messy politics finally breaks the calm on wall street. >> ultimately, you want to have a functioning washington. we are still the most important government and economy in the world. if that all comes to a screeching halt because of these issues, that is not good for anyone. >> that is the thing we have to gauge. do people have confidence that this administration will not only get the big themes out there, but deliver on them? >> if you want to keep everyone happy, he has to do real policy stuff and not just send out tweets. >> this trump trade that we have embraced and that has driven the market to new highs in equities is coming to an end. >> the trump trade is great for news and is like reality tv playing out in politics. reality tv tends to have a short-term nature in terms of politics. i think investors will take this in stride. jonathan: joining me around the table today for the next 30 minutes or so is matt hornbach,
lisa abramowicz, and jim barrineau. great to have you with us on the program. matt, i want to begin with you. how much of the trump element in the reflation trade has brought -- has drained out of the markets? >> if you are looking up at the 10 year treasury yield, y'll find that it has come down a b from the postelection highs. one of the ways i like to look at it is by looking at term premium. i think it is a nice measure of how people are thinking about the trump presidency and its effect on markets. when we do that we find that , quite a bit has come out of the treasury market. a little more than you would suspect if you just look at the 10 year treasury yields themselves. one of the things i like to do is looking at our 10 year treasury premium measure. this is mttpus10 on the bloomberg. what you can see here is we have taken out quite a bit of the postelection jump in term premia.
i do think quite a bit has come out. lisa: you can look at the two-year tenure spread and see the narrowing. it is at the narrowest since the election. that is a good way of looking at how the trump trade has been evaporating. bond markets have not bought into the trump trade as much. jonathan: we will get to the spreads and the curve in a moment. for me, fading the fed seems to have been the story. we had the odds of a move in june it rolling over. we had the odds of a move in september rolling over. is fading the fed the right thing to do on the back of political drama through the week? matt: i think it is too soon to say for sure. stories are hitting the tapes with a frequency we are not used to. i think it is probably too early fadehe fed. our theory is the fed will hike rates in june, and continue telling the markets that they will probably try to get another one in this year. jonathan: for em more broadly,
what we have seen as a fair a favorablet, -- market is it a favorable , environment from the federal reserve? when you factor in your view on the federal reserve, looking at em specifically, do you see a complacency? jim: no, i do not. the key asset price for us in emerging markets is the u.s. dollar. when you take the reflation trade out of the treasury market, we have also done so aggressively in the u.s. dollar. a weaker dollar historically is always great for emerging markets. this is actually a virtuous cycle kind of period in emerging markets where inflows are coming in, currencies are appreciating, central banks are lowering interest rates, growth prospects are improving. we are in a pretty good spot, actually. lisa: i am struck by the optimism not reflected in some of the numbers we have seen in
the first quarter. i am looking in particular at some of the household debt numbers we saw out yesterday from the new york fed that showed consumer debt has reached an all-time high, $12.7 trillion that you can see on this chart. i think this is important, especially at a time that we are seeing increasing delinquencies in auto loans. even if it does not signify some kind of broader economic demise, it certainly will signify slower growth going forward. this, i think, should factor into people's expectations. jonathan: let's get to what the president of the st. louis fed said earlier this morning. the financial readings since march moved in the opposite direction, and this may suggest that the contemplative path is too aggressive. is there something in that argument? i know a lot of viewers will be thinking, he doesn't have a vote and doesn't set the tone anymore. can that argument bleed through the rest of the fomc?
>> bond market is pricing a pretty gradual rate as it is. i do not think james bullard has much to worry about from the bond market perspective. if the fed continues to hike rates at the pace that the median participant is suggesting, he may not be happy with that. but the bond market is on his page. jonathan: what is the message in the yield curve right now? we have broken 100 basis points. we are going down toward 90. is there a message in the curve for the fed? lisa: yes, it is that the more they hike, the more long-term growth will come down. it is going to be a problem if the economy is not accelerating right now. jonathan: why do you see a steeper curve evolving from here? matt: part of it is the idea that the more the fed hikes interest rates, the closer they will come to the point that they will have to start cutting interest rates again. this is exactly what they are telling us they will do in the face of another downturn, they will lower interest rates. lisa: are you saying the yield
curve will steepen because the fed will soon have to lower interest rates again? matt: it will keep the intermediate sector of the curve much richer than you would expect. lisa: you think there will be a downturn in the near-term that will cause the fed to have two -- matt: absolutely not. define the near-term. when you look out a year or two, it is reasonable to expect there is some probability of a recession. the markets will always put some probability on recession when you look two, three years out. if you look at the new york fed survey, that is primarily what -- that is exactly what primary dealers are telling to the new york fed. in two and a half years, there is a 20% probability that the fed will have to revisit the lower bound. this is not news to anyone. jonathan: i was speaking to an investor on the advisor -- on the investment advisory commite at the new york fed earlier this week who said that they made the phone call. they wanted to know why this week was so different and why the market was reacting to the drama in d.c. what was your view on that? matt: at the end of the day,
there are stories coming out that are making people question the longevity of what the administration is going to be able to put through. keep in mind, we are expecting and hoping we will get progress on health care reform. we are expecting and hoping to get progress on tax reform. i think all of these complications may just extend the timeline. investors get worried when you talk about extending the timeline. jonathan: with the inflation trade -- we have seen fading in the reflation trade for quite a while. breakevens have been rolling over. spreads are getting flatter. there is a story there, away from whatever is happening in d.c. we are fading a lot of it. i think the opposite should apply. at the beginning of the year, i was told that the trump trade did not begin reflation trade. it did not begin until the middle of last year. therefore, actually the trump trade is not what is ending here, it is the reflation trade, isn't it? haven't we reached peak reflation already? matt: when you look at the fed's
five-year reflation index since the election, we go back a year or so, you can see that there was already a ramp-up in these break-even reflation rates. here, we have optimism building in. then you saw the election, and a big jump in the five-year inflation rate. since then, it has gone sideways. jonathan: if i asked people about inflation trade, they would have pointed to china. this very constructive view on china. they would have told me to look at chinese tpi's. things are starting not to roll over dramatically, but flatten out. for our viewers and listeners, looking at the reflation trade, give me the view on china. jim: china had a great first quarter, but china's overall objective is stability in the economy. they have their hands in so many levers in the economy to target -- two toggle credit growth --
to toggle credit growth. they had a good first quarter, now they are scaling back credit growth. they are very focused on stability, and they have done a great job. you can see that through the currency action. jonathan: can you have that reflation trade, that steeper curve still on without a buoyant china? matt: absolutely you can. part of it is thinking what will -- what the fed is going to do with its balance sheet. let's face it, when the fed starts to reduce its balance sheet, the treasury will have to make up for that lost funding. they will have to increase issuance. coupon sizes are going up, and that could cause premiums on the back of the curve to rise. lisa: i think it is consecrated. -- complicated. i wrote a story saying that and i got a lot of valid arguments about why that will not lead to higher yields. it is not so clear, i would say. jonathan: what are theasic arguments? lisa: first of all, you have an aging population that is piling more into longer-term debt. the second is it is political to increase the deficit.
the third argument is that, in general, any rolling off the balance sheet would have no effect. these things coming together lead to not a big move. matt: don't get me wrong, i think we are talking about two different time frames. over the long-term, interest rates will find it harder to move higher. our forecast for the 10 year yield is 250. that is below consensus. i'm not looking for much higher interest rates myself. jonathan: i keep asking this question. have we seen it yet? matt: it depends on what the administration can get done by the august recess. jonathan: jim barrineau sticking with us, alongside lisa abramowicz and matt hornbach. coming up next on this program is the auction block. investors in brazil are bracing for impeachment the sequel. , this is "bloomberg real yield." ♪
♪ jonathan: from new york for our viewers worldwide, this is "bloomberg real yield." i want to head to the auction block where apple had its first euro debt sale since 2015. it marks seventh in the currency from a u.s. firm this month alone. the tech giant in the oversubscribed offering rates -- raised $2.8 billion to fund share buybacks and expansion plans. over in sovereign, $11 billion of 10 year tips in indirect bids marking the biggest share of data since 2003. in brazil, the political drama surrounding the president causes -- pushed the treasury to delay an auction and caused problems
in bond sales. surprise, surprise. for months, investing in brazil had been a breeze, but it changed abruptly following reports that president temer approved illegal payments of the man who impeached his predecessor. investors are now gripped by chaos. back with me are my guests. jim, this is your world. you talked about what a surprise this was. jim: the market reacted like it was a shocker. but this is brazil. there has always been a bit of a taint around it, and there has always been this massive uncertainty since the corruption scandal, which is now about two years old. it began to engulf different people in congress. so, there is always a suspicion that it might reach up into temer, and now it seems like
potentially it might be confirmed. lisa: you talk about the market reaction, and i am struck by the sudden spike. take a look at the bloomberg. you can see the blue line is the cost to insure against a brazilian default in the next five years. it is jumping up towards the white line. the white line is argentinian credit default rates. this is shocking to me. argentina has defaulted seven times on its external debt, and five times at its local debt. now we have brazil jumping up to nearly the same levels as the cost to protect against a default in argentina. it seems like a marked and important move. jim: if you look at my screen, you can see what the currency did. it was limit down for the most of the morning. we think it is overdone, because of the point that lisa made about credit default probabilities being priced into the market. secondly, local rates essentially wiped out a cutting cycle by the central bank. that was a key indicator.
clearly, inflation is on a structural decline in brazil. it is going to take a pretty negative series of events and a lot of noise over a long period of time to get the central bank to markedly change their cycle. -- there rate cutting cycle cycle. -- their rate cutting cycle. so, all of a sudden, we got a little bit of value opening up in brazil. jonathan: we have seen the flows rush in. one of the most popular etf's for emerging markets. we see money going in, and i think the question for many people, for the nontraditional investor aka the tourist in this market, whether it becomes a story. jim: i think what happened yesterday is all of the tourists in brazil see a headline like that. they do not want to explain to their investors while they have 1% or 2% of their portfolio in
brazilian assets. it is better to sell the assets and ask questions later. dedicated guys who are looking for relative value, some real value started to open up because currencies have been a one-way ride for about 16 months. lisa: you say that some opportunities open up. not that many, because flow out of the emerging market have not been so severe. if you take a look at the bloomberg, this is the gap between yields on emerging markets versus u.s. investment-grade debt. it has collapsed. people are getting the smallest amount of premiums to own emerging markets debt versus comparable debt in the u.s. since 2013. matt, in your world, does this sound alarm bells? does this mean you're not getting paid? matt: what i find alarming about that chart is we find u.s. -- we think u.s. investment spreads are already too tight.
you're talking about a double whammy. from my perspective, we focus on the u.s. we think, at some point, the bell will toll for u.s. investment-grade credit. jonathan: investors in the u.s. think dm is too tight. what do you think about em? jim: there is not an asset class on the planet that is really cheap here pretty much. we still have a relatively robust spread to the global government bond. it is not just treasuries. you have an awful lot of em buyers from there. currencies were down on a nominal basis by 50% in the 2013 to 2015 period. we wiped out a lot of currency overvaluation in em. now we have cheaper currencies, and we look at real yields in the emerging markets versus developed markets.
there is a tremendous gap there. local currency investors still see value in emerging markets. jonathan: i keep hearing the year 2013. back to what it means for em. can they really get on a balance sheet reduction path on the federal reserve without seeing significant trouble? matt: i think the fed's view of the balance sheet is a tool they want to use in a passive way. i want to set it and forget it. if they get a couple more rate hikes this year, that is what they will start doing in 2018. i think the fed will be able to get the balance sheet moving lower. jim: it always depends on market expectations. if they begin to unwind it come -- unwind it, signal to the market in a rational manner and treasury yields don't jump, it has the potential to be a somewhat nonevent. jonathan: sticking with us. coming up next on the program, let's get a market check for
you. 2, 10, and 30 grinding lower. we are down eight on a 10 year. down eight basis points on the 30 year as well. we are back from that 3% handoff on 30 year treasury. ahead on the program, it is the final spread. we also have the week ahead with trump talks in europe. opec meets and the federal reserve release its minutes. 's --. you're watching and listening to "bloomberg real yield." ♪
♪ jonathan: from new york city, i'm jonathan ferro. this is "bloomberg real yield." time for the final spread. president trump makes his first overseas trip, which includes nato and g7 meetings. the fed will come out with meeting minutes from its last meeting, and we will of course get a g-7 summit a little bit
later in the week as well. back with us for our roundtable, matt hornbach, lisa abramowicz, and jim barrineau. next week, opec meetings, the fed minutes, what are you looking for from that. matt: we are looking for more details on how the fed intends to wind down its balance sheet. are they going to go with treasuries and mortgages? will they cease reinvestment on only mortgages? we will get more details. hopefully, we will get more details on the pace at which people are expecting that balance sheet to come down. lisa: everyone is focused on the balance sheet. perhaps they will be looking at risk factors, though they come too late on some risk factors. jonathan: how much time is left before they need to provide an exit plan? matt: if you read the march minutes, what they tell you is that they are looking to get information out as soon as they have it. i think they want to avoid another taper tantrum. they will have to give us some clue of where things are heading by the june meeting.
jonathan: there seems to be a consensus on rates. where do you think there is a consensus on the exit strategy of the balance sheet? matt: ultimately, it is the size they want to get it to. it is a large range. you could go from $200 billion reduction in 2018 all the way up a $600 billion reduction in 2018. lisa: it is also about the political backdrop. jonathan: let's get plans here with the rapidfire. we have some quick questions. one word answers only. for the first question, will the fed back off from a june hike, yes or no? matt: no. lisa: no. jim: no. jonathan: flatter or steeper? matt: steeper. lisa: flatter. jim: flatter. jonathan: where is the best insulation from a storm in d.c., e.m. or europe? matt: europe. lisa: europe. jim: e.m. jonathan: a little provocative. long president trump fiscal
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