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tv   Bloomberg Real Yield  Bloomberg  August 25, 2018 9:30am-10:01am EDT

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jonathan: from new york city, 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: fed chair jay powell forging ahead with interest rate hikes. president trump telling italy that america is willing to buy italian debt. one of the best-performing - pockets of fixed income this year. fed speak in jackson hole. >> we ought to be moving towards neutral, which means three or four increases over the next nine to 12 months. i think at this point moving in september and december is
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consistent with that path. >> from my point of view, i would rather not be calling rates accommodative right now. i think the whole structure of rates is lower and therefore we are at neutral or close to neutral right now. >> i agree the economy is doing well. based on what i see today, i think two more rate hikes could be appropriate. >> the case for raising interest rates is pretty compelling. we have an economy growing above trend. we have low unemployment and inflation that basically our goal, at 2%. >> there is no reason to challenge the yield curve. >> i would remind you, this is not our objective, to manage the yield curve. we use it as a signal for what it tells us about a policy path. jonathan: joining us now is bloomberg's international economic policy correspondent, michael mckee. what have we learned from chairman powell today?
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michael: we are going to seek the fed raise rates in september and probably in december. he made the case there are people arguing the fed should move faster because the economy is picking up speed. there are people who make the case that with no inflation, that could move at a slower pace. he picked the middle route and says gradual rate increases is justified at this time. no indication he would change. no list of problems out there that we saw in the minutes that might influence him. it was this is what we are doing. jonathan: a beautiful jackson hole with michael mckee. thank you for joining us. joining me in new york city is matt hornbach, subadra rajappa and coming to me from atlanta is rob wldner. great to have you with me.
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it seems like it is chairman powell saying more of the same at the same pace. subadra: the message was one of caution and gradualism. thus far they have been hiking once a quarter. there is no rush to squeeze in the a lot of hikes over the next coming year. i think they will be very cautious. they will proceed as required -- if more hikes are warranted, and proceed as required. jonathan: matt, they are trying to link it back to jackson hole, wyoming. forget the dollar just for a moment. there is nothing that is changed from jackson hole and there is no difference i can see from chairman powell today from the month before that, and the month before that, and the month before that. matt: the market probably got ahead of itself trying to make up the story the fed needs to accelerate the pace of hiking. you can see the market is disappointed he was not super hawkish. when you look at what he's
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telling the marketplace, he is saying we are going to continue to gradually raise interest rates. there is no reason for them to change course at this point. jonathan: rob? what was your take? rob: our take on chairman powell's speech is he will continue with this gradual rate increase. what i was surprised by is that he did not really talk about yield curve at all. he highlighted the difficulty of understanding economic data and how unemployment is related to inflation and how difficult it is to measure that. the yield curve, you could argue, is easy to measure. it's a good signal and he did not address that at all, although other speakers did. jonathan: where should he be looking on the yield curve? the fed funds rate? what is the most important part of the curve that gives you the most information on what they should be doing? rob: they are very correlated, but we have reached new flat levels today.
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if they continue with their steady rate increase, we would expect that to continue to flatten. subadra: i think the market with -- will either tend to look at two 10's or five 30's. it has generally been a good indicator of whether it will be a slowdown in growth. you are after that part of the curve. matt: there is an interesting fed study out a couple months
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out a couple months back to the fed said the two ten's part of the yield curve is not the best leading indicator. you were supposed to be looking at the front end of the yield curve. that does better job of foreshadowing the next recession. at the end of the day, the yield curves are correlated. we should be watching everything. jonathan: it seems there is you also have the dynamics where there is a lot of demand coming for the backend. it will be somewhat range bound. a lot of the pressure is going to come on the front end. this dynamic with the flattening led by the front end will persist for the remainder of the
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rob: the flattener will continue. breakevens have been steady for a number of months. at the fed raises rates, the flattening will continue. matt: one of the things that was interesting about powell's speech is he told us he was not worried about upside risk, yet he would continue to raise interest rates. that is a recipe for a flatter yield curve. we will invert some point next year. jonathan: in focus, and he keeps talking about it as it comes up again and again, it is not upside inflation risk. it is financial instability and financial excesses. is that what is driving the federal reserve chair? matt: i don't think so. if they were worried, they would be hiking more than once a quarter. they are just not there yet. it is unlikely we will get there. jonathan: when they move into the neutral rates, they are about to move into the range of what the fomc considers neutral. what is neutral to you? how close are we?
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subadra: it is hard to know. if you look at the fed's forecast of where we should be, the committee members at of between 2.3% and 3.5%. we will not know until well after the fact where the neutral fed funds rate is. it is safe to assume given the median expectations, it is somewhere between 2.5% to 3%. rob: we believe the neutral fed funds rate is probably below that. i think what was interesting is chairman powell today talked about how difficult it is to determine what that is. i think if we look at the risk-reward for the fed, it favors letting the economy run a little bit to try to find out where the neutral rate is rather than hunting for the neutral rate before you hit inflation. matt: one thing i picked up from his speech is that he seems to be more focused on the unemployment picture than the
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inflation picture. that is where i think it will probably leave him to determine where neutral is at some point. they need to see it flat line for a period of time. the unemployment rate still seems on a downward trajectory. they expected to continue to fall. they will wait until that stabilizes before they peel back. jonathan: they talked about the removal of accommodation. they were about to consider what restrictive policy looks like. what does it look like for the treasury market? matt: what the fed is telling the marketplace they are likely to do, in this is where the dot plot comes into play, is it is an important signaling mechanism for the marketplace. in september when they gather around the table and come up with their dots and release them to the marketplace, the market will look at the 2020 dots. where are the 2021 dots? that will be important in that regard. jonathan: everybody who came on this program got excited about guidance around the balance
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sheet. subadra: for the first time i would think in my career we saw reference from the chairman in the minutes calling for having to look at the balance sheet. i think that will be at the top of their agenda. i think what really changed is the fact we will go from the autopilot mode that has existed over the last two years to being more careful about what the size of the balance sheets should be. what should the size of the excess reserves be? given the fact we are in a completely different regime right now, post crisis. maybe it warrants a much larger balance sheet and higher excess reserves given the fact there is regulatory demand for excess reserves. those are the kind of discussions we will get from the fed in the fall. jonathan: subadra rajappa from societe generale sticking with me alongside matthew hornbach and rob waldner. coming up, the auction block.
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regular u.s. visitors to european bond market have been absent in 2018. we will talk about that next. this is "bloomberg real yield." ♪
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♪ jonathan: i am jonathan ferro. this is "bloomberg real yield." we want to go to the auction block now, where we start in the united states. the treasury selling $14 billion as demand rose. relative to the last auction, the sale marks the highest heels for competitive bidders since 2009. in europe, daimler issued its second round of pound bonds, bucking a near 40% slump in sales and corporate debt sales in 2018.
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the maker of mercedes-benz, --, $640 million of five-year notes. staying in europe, u.s. companies have cut down on investment grade euro notes to 80% this year to 9.5 billion euros. this comes after the president's tax reforms removed an incentive to issue debt in europe. while we are speaking about europe, i want to get to a fascinating story. we have a mention of a report that president trump told the italian prime minister the u.s. is willing to help the country by buying government bonds next year. still with me is matt hornbach, subadra rajappa and rob waldner. i think that everyone has read that story. they started by laughing. how can this happen? if at all? subadra: they can't. as far as i know, the u.s. government doesn't have the ability to go out and buy sovereign debt from other countries. even the federal reserve has a limited capability of buying securities. they can't go out and buy
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equities. they do have in japan but the u.s. mandate is very limited. matt: the only thing i would say is if it actually happened, it would be a great deal if they swap back the currency. you can get great deals and italian debt these days. jonathan: rob, your thoughts on this? i think most people's base case, it doesn't happen. the interesting part of this story is quite clear. united states is willing to back italy at a time when italy is pushing europe to allow them to spend more money. rob: i don't think it will happen. i think what is kind of ironic about this story is he is offering help at a time it seems to us the fed tightening policy and the u.s. administration really pushing hard on this trade. we saw other stories about renewed tariffs. all of this will make it much more difficult for italy and for emerging markets. on the flipside he's talking about buying italian bonds. typically the u.s. offers help
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through the fed put, which is far away from where we are now. it is interesting we have this dichotomy. jonathan: in the european bond market right now, i want to ask you how wide italy stays relative to germany. and certainly relative to spain. yields have really blown out and they stayed blown out. for most people the extreme tail risk, the base case is the increase in supply. is that your base case? rob: we have to get the budget negotiations in italy. i think there will be continued noise from italy as we come back from summer vacation. that is what is keeping spreads wide. we don't see the redenomination risk propagating at this point throughout the eurozone. as you point out, the pressure is really on italy. the pressure is really on italy. if it impacts other more vulnerable countries like spain then you start to think about redenomination risk.
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jonathan: the ecb has not finished qe, yet we have concerns about btp's. matt: one of the focused areas will be through the summer commitment on interest rates. how can we talk about raising interest rates at all or even ending qe when you have these things happening in europe? people will give italy the benefit of the doubt for now. clearly spreads have widened, but i think next year it will be very interesting when we talk about ecb policy, how they will be able to manage the situation. jonathan: the reports coming from germany that chancellor angela merkel is pushing for the top spot of the european commission to be filled with a german, and not the european central bank. i'm sure there are some bulls happy with the situation. matt hornbach, great to have you with us. subadra rajappa and rob waldner. i want to get a market check for you. let's bring that up for you. 10 year yields looking like
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this, on the week down by four basis points. two-year grinding higher by a single basis point. coming up, a fresh china data on the global trade war. this is bloomberg. ♪
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♪ jonathan: i am jonathan ferro. this is "bloomberg real yield." i want to head into the final stretch to get you up to speed on what's coming up through the rest of the week. there will be trade data from the united states as we get insight into how the tariffs between china and the united states might be affecting the numbers. u.s. trade data coming on tuesday. we get some u.s. gdp on wednesday. look out for that as well, and some housing and personal
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spending data. the u.s. personal income data dropping on thursday. i want to get to a debate that's happened in the fixed income market throughout 2018. two pockets of fixed income have outperformed. one has been high-yield, the other has been leveraged loans. leveraged loans have been outperforming high yields. i was happy to catch up the two people on very different sides of the trade. we asked them whether either side has room to run. listen to what they have to say. >> i think the leveraged loan trade is not because you will make a lot of money. you will get decent income. if you are wrong and it turns south, the protection will be very significant. i think it is fair to say that the supply of loans has been somewhat of a problem, where you see lots of issuers coming into the marketplace who would not have come in normally.
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if you have an actively managed fund where you pick the right securities, in a down cycle they will not really this thing was themselves. >> how did that work out in 2008? not very well. high-yield was down 26%, loans were down 31%. we are seeing the pattern we have seen over the last few years. companies that should be coming to the high-yield market and issuing at 6%, 7%, 8%. they go to the low market because the financing is much cheaper. people think we are talking about the same universe of countries. we are not. two out of every three loan issuers don't have any bonds under them. jonathan: going up in quality is not what you think it is? >> he mentioned 2008. loans came back a lot faster. that is precisely the point. you can have a drawdown but because loans are senior and because you have significantly lower losses in good loans, for sure.
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jonathan: the high recovery rate? >> higher recovery rate and the fact that you have companies that are issuing the loan markets that might not be able to issue in the high yield market at all. >> i don't understand that argument. from 2008-2009 they killed loans by 1000 basis points. two years ago we debated this point hundred 10-year was below 1.5%. let's not cherry pick. this is the second year out of 13 they have beaten high-yield. what are they done since two years ago when the 10-year was under 1.5%? high-yield returns 7%, loans 4%. following this advice continually loses you money versus alternatives. >> i think we should not cherry pick the last two years. let's go back to when loans
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--when we had downturn. where the driver of the downturn was problems in the high-yield market. let's look at the recovery. the performance of the high-yield market in that timeframe was significantly worse than the performance of the loan market. if you're not going to cherry pick the data, let's not just take the last two years. it's also fair to say the most ardent high-yield investor today is surprised by these performance of high yields this year. that is absolutely clear in the market. the upside in high-yield is relatively modest. having said that, i think the debate between loan and high-yield is somewhat irrelevant for this reason. the real opportunity is not between picking between high-yield and loan. the real opportunity is the emerging market local debt. if i had money to put to work today for significantly better returns, it would not be because i wanted to devote money to loans or high yields. it would be buying emerging-market local debt, which is extraordinarily cheap
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at the moment. >> that is something we can definitely agree on. jonathan: i finally caught you on the right side. we will go back about. >> it is relevant. the past year loans have edged up a small win. pick any year you want, high-yield killed loans. there is a structural disadvantage in the loan market. you have no upside like you have in the high-yield market. jonathan: we will get to how you part of your position in the u.s. why do you think most people are under -- duration now? >> european high-yield, bank loans, emerging-market debt. those are highly qualified equity markets. there is nothing in the portfolio for a rainy day. jonathan: a debate on two areas of fixed income that have really outperformed this year. leveraged loans outperforming high-yield. two people i have a lot of respect for.
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i can tell you because i was there that they shook hands after that. from new york city, that does it for us. we will see you next friday at 1:00 p.m. new york time, 6:00 p.m. in london. from new york, this is "bloomberg real yield." this is bloomberg tv. ♪
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