tv Bloomberg Real Yield Bloomberg January 21, 2018 4:30am-5:00am EST
jonathan: from new york city for our viewers in new york and around the world, i'm jonathan ferro, and this is "bloomberg real yield." ♪ coming up, investor shakeup in , the d.c. drama, and the potential for a government shutdown. the treasury selloff continues. 10-year yields break post-election highs. and signaling the end of qe. we begin with the big issue, the slow-motion treasury selloff. >> it could be a bond bear market. i think it is more of a teddy bear market than a grizzly bear market. >> we don't need to worry about
the 10-years getting too expensive until 3.5%, quite frankly. we've seen 3% in the past few years. our work suggests the sort of positive effect on the financial sector of the 10-year moving higher right now overwhelms the potential negative effect of the valuation compression as rates rise. >> we have been talking about this rate rotation for years. people are going to go out of bonds into equities. it is pretty high right now. bond returns, we are only three weeks into the year but they are not very good. maybe you start to see as rates move higher and and returned to start to deepen in the bond market, people moving equities and supporting the equity market. >> at some point, when the bond yields get up to 2.85%, perhaps it will get to 3% in the 10-year, i don't think so but perhaps, the equity market is going to pick up and take notice. i think it will be to the benefit of the bond market. >> with these higher rates, we think the economy will slow a bit, but ultimately the spreads are tight in corporate bonds
right now. we have been de-risking. within the markets, we are favoring more investment grade rated companies, and we have been producing our high-yield exposure. jonathan: joining me is robert tipp, chief investment strategist at pgim. jack flaherty from gam. also from london is marilyn watson, the head of the fundamental bond strategy at blackrock. for a long time, 260, was a line in the sand post elective. how significant is another we have breached it? marilyn: when you look at what is coming through in terms of the tax reform plan and overall growth, and a think it is necessarily that significant. where we like at the moment in terms of the u.s. treasury curve is the front end. we think you are not being paid
at the moment to take duration risks. i think when we are looking at the concept of a normalizing economy, growing economy in a , and a synchronized global growth, you could see it move quite a bit higher. jonathan: if you look at the motivation for the move, according to mom el-erian's recent -- thomas, el-erian's el-erian'so mohamed recent "bloomberg view piece," basically it is economics and it makes sense. it's not just about removing stimulus. the nature of the move has not been violent. it has been gradual. is there anything to worry about? robert: i think gradual is what -- jack: i think gradual is what it will keep doing. the momentum is still there. i agree this is driven by fundamentals. the economics, the synchronous growth, you are going to see more issuance. that is a big part of it. until we breach 3%, i'm not too worried about risk assets, but i think the momentum is still higher yield. jonathan: take a listen to this.
>> we are not ready to tear up and reverse all of the views we have had the past five years. the dynamics behind this inflation idea, people have -- there is a reason for inflation. the graphics, ai, all of the reasons we discussed regularly. they have not suddenly gone away because we started in the year. as far as i'm concerned, i do the opposite of the bearish people. jonathan: robert, we might be in the buy zone for pgim. are we? robert: i think is right. i agree the momentum is negative here. i disagree in terms of where the value is on the curve. that is a tougher call. the market is somewhere around 3%, probably below 2.75% on the 10-year. the selloff will run out of steam. jonathan: have you been buying through the week? robert: for us, the main thing
in terms of positioning on the treasury curve has really been the shape. if you look at the bonds, it hasn't hit new yield highs this year. the performance on the back end of the curve has been solid. you have growth, a strong stock market, therefore you have a fed that is likely to keep moving. jonathan: marilyn, let me come to you on that. on the front end of the curve, what you see value there? pgim and robert tipps have been sure the two-year, and that's where a lot of money has been made. why do you see the value on the front end? marilyn: there is a lot of uncertainty out there. we are not being paid for the inflation risks going on down the curve. the moment, what you are getting is much better versus taking that duration risk further down.
jonathan: does that resonate with you, robert? because there is also a massive short position built up at the front end. it could make it vulnerable to repricing. does any of that resonate with you? robert: the spread product is attractive. i definitely agree with that. but i think the value on the back end of the curve is very difficult to judge. you have to look, you know in a , global context, you have an 83 basis point year, we are at 90 plus percentile of relative value relative to europe on the back end of the curve. the capital markets are really global. a lot of the investment flows, i think the marginal pricing mechanism for the united states are coming from abroad. i think that is why the back end of the curve is actually running out of steam and resisting the selloff more than the front end. jonathan: the president of united states could have a meeting with chuck schumer at the white house as the shutdown
deadline nears. that headline is crossing the bloomberg at the moment. does any of this play in? the shutdown, this dysfunctional washington, d.c. story? the way you view the bond market, or are you just looking the other way? jack: the brinkmanship, that's what it is. in the short-term, it could be a wobble. but think about this. they need to come to a deal. the problem i have is that this congress and this government is incapable of cutting spending. they are incapable. we know we are going to have a larger deficit next year. whatever deals they are going to come to will mean greater spending. that puts pressure. jonathan: where do you see that funding coming from? that story was true all of last year, and 10-year yields managed to kiss almost 2%. jack: think about the treasury issues. i think they should be issuing on the long end. jonathan: they are doing mostly in the front end. they're going to keep
issuing out to three years to years. that is it, they don't really go out with extending further. that's were pressure will stay. jonathan: that plays into the idea, robert? robert: shortly and in the intermediate. i think the fed will keep a lid on the front end of the curve. there is less impact on the front end of the issuance than on the back end. the back end is benefiting from discussions on deregulation. that would make it easier for dealers to carry inventory of long treasuries, since you are seeing pressure on swap deals rather than treasuries as treasuries become easier for dealers to hold. jonathan: i want to get your thoughts, robert, on what has been happening with inflation linked securities. you now see the breakeven spread between the 10-year and 30-year go to negative. what does that mean when the spread starts doing that? what happens if that break goes negative?
robert: the difference in the drivers whether are short-term or long-term. on a long-term basis, there are global dollar precious on prices that are likely to keep inflation under control for the foreseeable future. in the near term, commodity prices have been strong, they've been the biggest driver of in the near term of breakeven risks. that is why you see commodities prices going up, more of an adjustment in shorter maturities than longer. jonathan: what have you been doing on the tip side of things? robert: the tips have been unattractive on the margin, as result of this headline inflation increase. but come up big picture, they have been very range bound. it is definitely a tactful market where 10 or 20 basis points cheaper, they are attractive, but by the time commodity prices have run up and the breakevens have wound out,
it runs out of appeal. relative to the other fixed income. jonathan: marilyn, have you been buying inflation protection at blackrock, and should people continue to do so, even at these levels? marilyn: yes. for quite a long time, we have been issuing protection. as we have approached these levels, we have been taking profits but we retain the front end of the curve. we retain holdings, but we have reduced retainings marginally. jonathan: marilyn watson from blackrock in london, around the table with me, robert tipp from pgim, and jack flaherty from gam. next up, the auction block, the riskiest bonds far outstripping returns. the safest high-yield debt. that conversation is next. this is "bloomberg real yield." ♪
jonathan: i am jonathan ferro live in new york city. this is "bloomberg real yield." i want to head to the auction block. the rise in rates, investors are eating up risking debt. 2018 was europe's most popular bond this week. investors bidding for a time for notes on output from an austrian lender. elsewhere, investor euphoria is still unshaken in the united states. we saw orders of about five times the size of this offering. ,eanwhile, a $13 billion sale the highest since 2014 left primary dealers with their smallest share ever. everyone is back with me. in new york with me, robert tipp and marilynrty,
watson with blackrock. what does it say that the most popular issue in europe this week was the first issue of cocos? jack: people still believe that risk on is a thing. i think that is really what it comes down to. people believe in growth. you are seeing growth throughout the world. jonathan: even with the conversation, robert, you think the ecb will pull back? you still have this tremendous resilience and credit even though the ecb are buying corporate debt, as well. robert: they are. but there is a real thirst for yield. as i was saying, the demand is strong in europe. the ecb has been crowding out, but they have been winding down the amount they are buying. some of the things that would indicate that they were supporting the market, where sovereign bonds were trading relative to cbs, for example, those relationships have indicated the market isn't leading that much on the qe buying at this point. there may be surprising resilience in the markets as we go forward.
jonathan: marilyn, they don't buy financials in europe, but the spillover has been pretty clear, the reach for yield has been clear. can you remain constructive on financial credits, hybrids, contingent convertibles, at a time when the ecb is set to pull back even further and on qe and potentially end it altogether? marilyn: as was just said, there is insatiable demand for yield. there is a huge amount of demand particularly in the eurozone, where the ecb is still buying bonds. even though it functions at a lower rate. i think we have to be a lot more careful and selective in the names that we buy. where in the capital structure we buy. we have seen huge amounts of compression. overall, if the ecb does starts to wind down its qe program, we will see a lot more dispersion. it will be harder to find value, but i think overall, as long as
you are very selective, then there is still some value to be found. jonathan: jack, are you comfortable going to the bottom of the capital structure and buying more cocos? considering the year cocos had last year? jack: cocos is not something we like. the legacies are being taken out. the old tier one, the things that had favorable status, and then they lost it. the banks are incentivized to take it out. they will take it out at higher levels. they will be taken at a higher jonathan: there is a broader question here. robert, the federal reserve has managed to hike interest rates gradually. is president draghi going to have the same luxury here? that he can remove stimulus, maybe even talk about hiking rates at one point, and still have these loose financial conditions? robert: we will have to see. already the euro is up 20%. their economy, like myself, i am choking right now. we will have to see whether that takes a bite out of growth. jonathan: we'll give you a chance to take a drink.
my question for you, and it comes from a viewer, jack, what is the argument for a december 18th ecb rate hike? does one exist? if qe ends, is there an argument you could get a rate hike by year end? jack: i think it is a small argument. i think they want to give time to after the purchases stop. you could see the purchases go on until december. september, december. i think they want to see time as to how that will go about. however, you still have pressure in general. growth is strong. my guess is a little argument, but the timing is suspect. jonathan: marilyn, you are close to the heart of the matter in london. as you look across europe, is a conversation in frankfurt emerging slowly that we are going to have a real conversation about rate hikes, even with core inflation where it is at? marilyn: yes, i think that is the key issue. core inflation is still very low. we had disappointing data out this week as well.
while the conversation is turning, and you can see it even in the pricing of bunds, you can see the markets are going to focus on not only when the qe program will end, but thinking about changes to invest apology and investment rate. it is going to be a much slower burn and it will take some time. even if the ecb were to finish with the asset purchase program in september, i agree that it will take some time here it probably will be next year when the ecb starts to increase rates. tipp,han: robert your view. robert: i think there will be a lot of pressure for them to raise rates. they signaled end of september on the buys, but there will be internal pressure to stop sooner and i don't think they will do that. the trail in growth is 2.8%. we saw this with the fed, they were nowhere near hitting their inflation target, but the pressure was there to move.
, for example, the bond purchases. in the case of the ecb, they have been doing massive purchases that are not popular. but they are at a negative interest rate of -40 basis points. mario draghi has said the inflation risks are over. they are in an extraordinary emergency type condition right now. i think the pressure will be there to stop the buying, and there will be a consistent chorus that will not stop until they get to zero. and i am not even sure it will stop there. jonathan: jack, we have another question from a viewer. coming across the bloomberg terminal. it is a multipart question. the german 10-year and u.s. 10-year, the federal reserve produces its balance sheet and the ecb takes a step back from qe, the spread is still really wide. how is that going to evolve over the coming year? jack: it's interesting, in our portfolio, we are running a short duration in general. jonathan: interesting. jack: if you look at the valuations on the european side, the german valuations argue they are too low.
i would say that relationship could converge a bit. we would rather be short in germany. to the longer end of the u.s. curve, you see factors as to why there is demand. jonathan: are you more comfortable being short in germany then you would be, say, on treasuries in the united states? robert: in europe, i think there will be a convergence. the spread between the two is too wide. we are likely to see a bit of increase in europe, we get a safety margin in the market, maybe another 20 basis points or so back up in bunds. over the next several months, and lower end long treasury yields. jonathan: robert is going to catch his breath and have a drink. jack flaherty and marilyn watson also staying with us. the front end up nine on a 10-year notice. we take out some of the postelection highs. from new york, still ahead, the final spread. the week ahead featuring
♪ jonathan: i am jonathan ferro. this is "bloomberg real yield." it is time for the final spread. coming up over the next week, you have rate decisions from the bank of japan and the european central bank. the world economic forum in davos, switzerland opens on tuesday. a big highlight being president donald trump, who gives a keynote speech on friday. also next week, another round of earnings, massive talks and gdp rates from the united states and the united kingdom. everyone is still back with me. we have robert tipp from pgim, marilyn watson of blackrock, and jack flaherty of gam. something we have not talked about much is credit.
robert, you mentioned to me, the small widening we have seen almost across the board in the united states. is there a signal there at all? robert: i don't think so, i think the markets are digesting the fact of the budget battle, supply and earnings. there is a lot to work through in terms of the impact with the changes in the tax law. jonathan: broad strokes are difficult to do, but looking at what we have learned so far on a tax bill, and what it means for companies, are you able to establish a view on what it means for investment grade and high-yield? jack: the piece it really affects is the lowest rung of high-yield. that can be hurt. what is interesting is what has rallied the most. the very lowest rung of high-yield. jonathan: could it mean less duration? given that the tech is bringing us cash back and it might not be issuing as much? jack: i think on the margin that is a good point. they are bringing money back, and that is a good thing. jonathan: guys, you're sticking with me, we will wrap up with a rapid fire, looking back at the last 25 minutes or so and trying to push things forward and establish what your view is on individual markets. i am going to begin with the treasury selloff in the last
couple of months. we have a 2% on a 10-year in september, all the way up to 264, up 20 basis points in the space of a couple of weeks. the treasury selloff now, is it a buy or is 3% coming? robert: buy. jack: 3% coming. marilyn: 3% coming. jonathan: ok, next question. european cocos had an enormous year last year. german bunds are anchored on a 10-year. do you buy ten-year german bunds or european cocos? robert: stay with the spread. jack: i guess i would take the cocos if i had to. marilyn: it is a tough call, but i will go with the cocos. jonathan: the federal reserve, we know sometime soon they will hike and probably hike again. next week, decisions from the european central bank and the bank of japan. the ecb starting to scale back
qe. some conversations in japan about the boj scaling things down there as well. who is the first to hike? the boj or the ecb? robert: that is -- jonathan: we have to go. boj or ecb? robert: ecb. jack: ecb. marilyn: ecb. jonathan: guys, it has been great to catch up with you all and get your thoughts on the market. jack, robert and marilyn. from new york, that is it for us, we will see you next week. this was "real yield" and this is bloomberg tv. ♪
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