tv Bloomberg Real Yield Bloomberg November 19, 2017 12:00pm-12:30pm EST
jonathan: from new york city, i am jonathan ferro. with 30 minutes dedicated to fixed income, this is "bloomberg real yield." ♪ jonathan: coming up, republicans inch towards tax cuts. the plan to stimulate growth fails to fuel the reflation trade. the treasury curve gets even flatter. the difference between short and long-term yields is the narrowest in a decade. and it is a resurgent end for the week for credit. a long correction, at least for now. we begin with the big issue, is there a signal in the treasury market? >> the fed operating on the short end of the curve, global markets operating on the long end of the curve.
i don't think it is that problematic, but it is telling us there are different players in different parts of the yield curve. >> it is not just the shape of the u.s. curve. it is the differentials with other curves as well. that to some degree is a testament to the influence of other central banks besides the fed. >> the rest of the world is still printing money. ecb, bank of japan. the ecb promised they will do that until september of next year. all that money is doing two things, it is hurting duration and credit risks. those two things ultimately end up in the u.s., and that is a very important driver. >> one of the weirdest things about the curve flattening is we are doing it against the backdrop of the fed and potential tax cuts next year. you've got hundreds of billions of extra supply coming into the u.s. treasury market next year. my guess is it will be much more difficult for the curve to continue to flatten in the next year. >> if we don't get some pickup in inflation and the fed stays,
that two years it will go higher and the curve will go flat. jonathan: joining me in new york is vishwanath tirupattur, lisa hornby, u.s. fixed income portfolio manager at schroders, and coming to us from london is iain stealey. we want to go straight to a chart of two's, ten's and the curve rolling over and getting flatter. what you see is how supportive the federal reserve has been at the front end and how the two-year has inched higher and higher. i see how the 10-year has stayed in there as the gap has narrowed. is there a signal in that price action? vishwanath: i think there is something in the price action here. in fact, we expect this flattening trend will continue to be there and extend beyond the 10-year point in the curve is what we think. there is a clear expectation about inflation. the market is telling us that
the market does not believe there will be substantial pickup in inflation over the course of the next several months. that is what is driving the shape of the yield curve. jonathan: is that the signal you take with two's, ten's below 62 basis points? is that what you take away from it, the message? iain: yes. yields are pretty stable at the long end. they are being pulled down by what is going on around the rest of the world. low yields in europe, ecb is still buying a lot of bonds, bank of japan is buying a lot of bonds. treasuries look attractive, yet the front-end is being affected by the fed. the fed will continue this normalization process in december and into next year. jonathan: how important is that? i could bring up the universe of fixed income debts with negative yields of around $9 trillion. i mean, when you really think about that and process it, is it any wonder at this rate weighing down on the long end of the
yield curve in the united states? lisa: no, i mean that is something we have been focused on for many months. it is not just affecting the rates market, it is affecting the credit market as well. credit purchases by nondomestic investors has basically gone up 50% since the crisis. that is all because yields abroad are so negative or so low people have been basically swapping to cash flocking to our markets and have been for some time. jonathan: why haven't potential changes to the tax code done anything? we just erased it all. the tax overall is happening. they are inching forward in bc, yet the treasury market does not seem to be moving the way people expected it would. vishwanath: our expectation is both looking at the house bill and senate bill, we are not going to go beyond the $1.5 trillion deficit number that has been talked about. the expectation that somehow we will have a substantial fiscal
boost coming here is not what is in the cards. absent that, the ultimate fiscal impact is modest. there would be some fiscal impact and you can factor that on credit markets into greater detail, but the expectation is that we are not going to see a truly massive increase in the deficit. absent the deficit financing is what is keeping yields where they are today. jonathan: how much flatter can the curve get? vishwanath: it will get more flatter. meaningfully more flatter. jonathan: what are we talking? 40's, 30's, 20's? vishwanath: it's hard to come up with a number right now but it will be flatter. jonathan: iain, look at what the federal reserve is said to do next year. if i look at the dot plot, they are looking at interest rates, the median forecast, we are at 2.215 for their median end of the year forecast.
we are 20 basis points north of that on a 10-year treasury, right here, right now. can you try to make sense of that for me? iain: you say take it with a pinch of salt, but that's exactly what they have done this year, what they said they were going to do. they wanted to raise rates three times. we think they will do that in december. they will continue to normalize rates, continue to take rates, real rates, close to zero. the long end continues to be anchored by those forces around the rest of the world. they also say on the dot plots, say 275 is where they think the terminal rate is. a 10-year treasury at these levels is not one million miles away from that. maybe that is right. jonathan: if you get that dynamic where they go with a cash where they say they are going to go and treasury yields do not push higher, is that a policy mistake? is that something they can ignore? iain: the reality is treasury yields will move higher. i just don't think they will
move dramatically higher. in reality the curve will continue to flatten. when you look at what happened in previous cycles, 2005, in april of 2005 we were around these levels. 60, 65 on the two's, ten's. it took us until december to get down to zero. then two years to go to recession. we are long way from the recession fears people say it is indicating. jonathan: lisa, your thoughts? a policy mistake from the fed? lisa: one interesting thing i was going to point out is we are looking at the dot plot, but the fed composition in 2018 is going to look dramatically different than it does today. on the fomc, of the five voters, we know dudley is retiring at the end of the year, richmond has to replace lacquer. there is a significant change in the fed. i don't know that looking at these dots tells us a whole lot. they will continue hiking rates but may be the composition of the fed will be very different next year. jonathan: does that mean the fed
will change at all? lisa: it could become more hawkish. that is a possibility. especially if data comes in the way that it has. i don't think they are going to try and be a aggressive unless inflation picks up. that is the question. if you see inflation here or abroad, that is the end of this bull run in risk assets we have had. jonathan: i've heard a lot of people talking about the competition of the federal reserve. from the names you hear, jay powell is set to be the chair, mohamed el-erian could be considered as the vice chair. these are the kind of things people are comfortable with. it is not the john taylors of the world that could populate the ball of that board, is it? vishwanath: they really don't --if you look at the debate that preceded the nomination of powell -- john taylor was very much on the boat and till the
last moment. we don't know what the composition is going to be of the fomc. i agree with you on this. the composition -- we are thinking of what the fed is saying, what the fed will be doing in the future. based on the fed, the future plans will not necessarily be the fed that we have. lisa: there is some speculation that one of the first orders of said willf the powell be looking at the inflation target. seeing if 2% is actually the right place to be or maybe a little bit higher. that could introduce term premium to the curve. a lot of people are positioned and flat because they affect the cycle that produces flatteners. vishwanath: in terms of term premiums, the significant difference between the term premiums at the long end of the curve and the short end of the curve. the very positive term premiums
for the long end and negative term premiums the flat of the curve. it makes sense to exploit that by continuing to flatten absent a big change in the direction of the fed. jonathan: guys, you are staying with me. vishwanath tirupattur, lisa hornby, and iain stealey. coming up on the program, the auction block. canada taking advantage of its own flattening yield curve. the two's, 30's are the tightest since 2008. from new york, this is "bloomberg real yield." ♪
this is "bloomberg real yield." the united states not the only one with a flattening yield curve. over in canada, taking advantage by selling ultra long bonds for the second time in three months. $392ountry optioning million worth in 1964. an allocation yield of 2.25%. spain sold 1.4 billion euro bonds sold in 1966. despite -- they came in with better demand from the previous auction as well. despite the volatility in high yield, weight watchers at his first sell in five years. still with me, vishwanath tirupattur, lisa hornby and iain stealey. can we just have a conversation this year about what is happening with high-yield?
if you look at fund flows, it looks like money going into investment grade and it looks like a flight to quality to some extent. is that what you see? is that the right trade? vishwanath: we have been advocating this for some time, what we call the up in quality trade. we see several challenges on the lower end of the credit spectrum. we think the challenges are numerous. for example, the buildup of leverage over the course of the last several years has been enormous. it has not been in any one sector. it has been across many sectors you have seen enormous buildup in leverage. compensators are getting paid for taking on the leverage. it is nearly at an all-time low. we think it makes sense to keep going up in the quality spectrum at this time. jonathan: j.p. morgan asset management for a while have stayed bullish high-yield.
the message from bob michael is don't get greedy. is that something you guys are still thinking about as you look at this situation? is this just a buying opportunity for you? iain: definitely. when we look at yields, when we were down a month or so ago, 5.4% on u.s. high-yield, it was probably a little too low. we have seen a decent backup. we are now yielding around the 6% level. spreads are about 40 to 50 basis points wider. we see this as a great opportunity. we see default rates remaining low. we see corporate health very strong and the u.s. economy looks great to us. the time to buy high yields. jonathan: i want to use sprint as an example. the deal breaks down for a merger, the debt breaks down. i have brought it up on my bloomberg very quickly. we've traded north of 110 and then we dropped below par. the question i want to ask you is whether a company north of $30 billion worth of debt in a competitive sector, whether you
are compensated with a yield north of 6.5%? iain: i think when you look at companies like that we have seen profits improving. we have seen the overall state of the economy should be good for this sort of company. the thing that happens to these big, large issues with the big components of indexes, when you see the sort of inflows -- or outflows, i should say, that we have seen from the etf's, they are going to take some pain, but for us, it creates opportunities to go into them, pick them up at higher yield and get better returns. jonathan: you could have had this debate throughout the year and so far in 2017, iain would have been right. we can bring up the two previous bouts of the correction we have seen in high yields in 2017. we have seen this movie twice before. we saw it in the spring, spreads widened and then tightened. and we saw it through august. spreads widened and they tightened. we are seeing it again. why is it going to be different this time around?
vishwanath: we probably did have this debate with iain on this particular topic. i would say our conviction, looking at the fundamentals and how much you are being compensated for taking on this leverage, and we don't see the corporate fundamentals in the same manner. we think there is a tail that continues to deteriorate. say, for example, if you look at the year to date, triple c bonds the riskiest part of the trade spectrum, have underperformed than double b bonds. , thee total return space year-to-date the terms are lower. that is basically what the market is telling you. you are not getting paid to go down the triple c end of the spectrum. jonathan: the message in the previous segment was about sovereign debt and the weight on the long end of the yield curve. does the same apply for corporate credit? do you have to think about of the amount of foreign flows
coming into the united states spurred by action from the ecb and president draghi? lisa: absolutely. that has been the story of the last several years. 40% of the ig market is now owned by foreigners. at least corporate credit. any change in the dynamic, the relative value dynamic, whether because of the cross currency basis or because of spreads in the u.s. no longer offering value have to be watched closely because we could see an exit of demand. jonathan: goldman sachs in their top 10 themes for 2018, late cycle imbalances. they are not talking about leverage this time. they are talking about illiquidity. how much concern do you pay to illiquidity in spaces like high-yield, and do you promote a more active approach with these kind of things going forward from here for what is for many the late-cycle story? iain: i think this is the perfect environment for credit analysts to do their homework,
make sure you are in the right credits. we are not daytrading these bonds. we are long-term investors. we want to buy companies we think are going to give a return to capital and income over the next five to 10 years. depending on the life of that bond. i think there are some worries out there. there are definitely some names you want to avoid. we like the market overall. again, credit selection, absolutely critical late cycle. i completely agree with that. vishwanath: i agree trade selection is critical. i think it is important to note the market we think has not appreciated how much the fed's qe program has enabled credit. we have just embarked on a -- if you take that precept, the qe health credit, we are are embarking on it because of qe. there has to be some extent an opposing effect. we think the liquidity in the market where tremendous liquidity has been infused, it
that aggregate liquidity remains pretty substantial. we begin to see some of that liquidity taken out of the system by the fed. lisa: we completely agree with your view. we just did the back of the envelope numbers. if you look at the difference between the purchases by the central banks this year and by the central bank in 2018, there is about $1 trillion in debt more to be absorbed by the market from what there was 2017. that have to have an impact on valuation. jonathan: you guys are sticking with me. vishwanath tirupattur, iain stealey, lisa hornby. i want to get you up to speed on the market action this week in treasuries. two's, tens, and 30's. it is a much flatter field curve. up at the front end by six, down at the long end by 10. still ahead on this program, the final spread of the week ahead. chatter from the ecb and the fed. this is "bloomberg real yield." ♪
jonathan: i'm jonathan ferro. this is "bloomberg real yield." it is time for the final spread. coming up over the next week, it will be a shortened trading week in the united states with the thanksgiving holiday coming up. we will have details of the recent meeting by the federal reserve and the ecb. plus, fed chair janet yellen will be speaking, and the u.k. chancellor of the exchequer philip hammond makes his budget statement and the holiday retail shopping season kicks off in the united states with black friday. still with us, our guests. lisa, i want to wrap things up with you and get your idea of where you think the opportunities are right now. we have seen a little bit of a bounce back. is there anything else you would be looking at the pickup? lisa: we are cautious on risk generally. right now, it is about balancing, taking risk down and having some carry on in the portfolio. some areas we find value are in the securitized space. you can get relatively short
dated security bonds pick up 89 basis points over treasuries. there's in other area we think, it is idiosyncratic. vishwanath: i agree with lisa. both of those things are the trades we have been recommending our investors. jonathan: i imagine iain might disagree with you both. where are the opportunities? iain: i agree on em local side, there have been decent real yields across a lot of countries there. some names are causing headlines at the moment, but overall looks good. i've got to take credit. there is a buying opportunity to pick up some bonds, 6% yields trading 60, 70 basis points lower couple weeks ago. jonathan: what do you say we still have the hunger to buy. you can still see where the force in the market is whenever you get the widening is. vishwanath: i look from the world of portfolio managers, the index to the benchmark indices.
you see that what has happened over the last several years has been the all weight credit, underweight mortgages. that has been mainly because mortgages could not have been bought by them. the fed was buying them. that is changing now. we think, forced to reallocate. jonathan: we will wrap things up with all three of you with the rapid fire around. you know the drill. three questions, short answers if you can. two's versus ten's. do we see zero before 100 again? vishwanath: yes. lisa: no. iain: yes. jonathan: long credit risk or long-duration risk? credit risk or long-duration risk? vishwanath: high quality. credit risk. lisa: high-quality credit risk. iain: definitely credit risk. jonathan: ok, final question. we have a bit of a selloff in high-yield, and a bit of a bounce back as well. i've picked out two credits that have taken a bit of a beating over the last couple of weeks. and bit of a snap back as well. i want to know what you pick up.
pick up the pieces of sprint or tesla? vishwanath: tesla. lisa: tesla. iain: i will take the sprint. jonathan: there you go. great to have you with us. you are selling and he is buying on pretty much everything. vishwanath tirupattur, iain stealey, lisa hornby. that does it for us here in new york. we will see you next friday at 12:30 new york time. 5:30 p.m. in london. this was "bloomberg real yield." this is bloomberg tv. ♪
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