tv Bloomberg Real Yield Bloomberg May 18, 2019 11:00pm-11:30pm EDT
>> bloomberg real yield starts right now. coming up, trade tensions simmering. chinese estate media is not interested in talks. investors turning increasingly cautious. high yield bond fund seeing the biggest outflows since december, leaving the treasury market primed for a rate cut with yields near 2019 lows. we begin with the big issue, the market looking for the fed to nail a soft landing. >> we think we will have a soft landing. >> pretty soft landing. >> soft landing for the global
economy. >> big central banks becoming notably easier. >> easier monetary policy. >> it has to help all financial assets. >> i think they are in a good spot. >> i think they are in a good spot. >> u.s. economy seems to be in pretty decent shape. >> what is the fed going to do in a different circumstance which because of the trade issues, actually the economy starts slowing down? >> the fed could start to cut rates. >> you will have it capped if trade talks break down. >> i have zero doubt in my mind in that environment the fed is cutting rates. >> it will really depend on how the gross data comes out. jonathan: joining me to discuss is bob michele of jpmorgan, krishna memani, and james athey of aberdeen standard investments. james, let's begin with you. it is what the markets are looking for. is it going to get it? james: soft landing, i am not so sure. history suggests, looking purely at the odds, it is quite unlikely. i think if you scratch a little further beneath the surface you find actually the circumstances that we are likely to be facing
in the next weeks, months, quarters, and beyond don't really compare that closely to the possibly two or three other occasions where we have been able to engineer a soft landing by easing rates previously in the midcycle. we are too late cycle. there are too many imbalances, too much of a weight off burden of debt, too many structural issues around the global economy really for me to believe that the fed can cut a couple of times and we can get back to everything is fine and don't need to worry. jonathan: you think we have engineered one. krishna: to some extent, the fed in 2018 effectively engineered a soft landing. tightening rates when growth was high, and then pivoting down to a more easing policy. they have done that. whether that gets into a risk on or not is an open question that
we have to ask ourselves for the second half. trade issues raises the issue. having said that, the fed has engineered a soft landing. jonathan: always this question, is there something bond market knows that the equity market does not know? that has not been the story of 2019. they are trading on the same thing, which is the fed has backed away, cutting rates aggressively, and the equity market is comfortable with that story. the real question is whether we can engineer or have already engineered what krishna is talking about. bob: what a great time to be a bond. everyone loves you, you can do no wrong, you have no inflation. central banks have backed off of raising rates, running down the balance sheet. money is trapped on the sidelines. i think the fed has done it. they have full employment, inflation as they are now saying close enough to the target. why not stop here and enjoy it? i'm not worried about credit. default rates are less than 1%. jonathan: is the market taking it too far?
where you see the yield curve out to seven years? is that the market taking things too far? bob: i don't think so. i think the market is genuinely distorted. as long as the central banks are going to sit on these enormous balance sheets, the cash has to be invested somewhere. there is too much money waiting domestically and internationally to get into the market. it will buy every backup. that is the new reality. jonathan: this is the chart that you have brought to us. let's talk about it. it is absolutely fascinating. this is the 10-year rate, treasuries, bunds as well, minus the local policy rate. we have converged on the policy rate on the 10-year. why is this so strong and important? bob: it tells you that any market where there is a steep curve, with the amount of intervention by central banks, money will flow into the long end of the market. we have seen that repeatedly. we have seen that out of asia, in particular where the relative steepness of the curve relative
to their curve is a signal to to them to invest and hedge back to their base currency. jonathan: james, what do you think about that? i find it fascinating. your thoughts. james: it tells us we are running out of road, i suppose. i agree with bob to the extent that financial markets have essentially been driven by almost entirely central-bank policy, liquidity provision, and the cost of money. the traditional connections we expect between asset classes and between asset classes and underlying economic fundamentals, things like inflation, have been broken for many years now. the reality for me is that process has to continue seeing flow in order to continue working, but it also is only as strong as the weakest link. if you start to look elsewhere, the saving glut that we know about coming from asia, a part of the reason you see treasury bond yields going so low, even
relativeod of economic strength, is a solution for treasury yields on a problem for the global economy. you withdraw from the flows. if they are not borrowed and reinvested, they are a drag on economies. it is that process which ultimately requires us to keep feeding the machine. when we stop feeding the machine, we stop facing up to the economic realities. they don't look quite so good. equities are priced to perfection. credit spreads are priced to something close to perfection. emerging market spreads are probably priced close to perfection as well. i don't with the triggers are, but i know the vulnerabilities are numerous and everywhere. jonathan: krishna? krishna: two takes on that. first, what this is telling us more than anything else is that this is a disinflationary trend in the world. that is why we are aggregating. two, i would rather see dispersion between 10-year rates and policy rates rather than the two on top of each other. that indicates an issue. having said that, the risk with
respect to that is relatively modest because it is the level that matters. the point that james is making is a point that everyone, every bear makes. at some point, it is going to blow up. at some point, it is going to blow up, but if that happens five or 10 years from today, you would have missed out on the grand opportunity, as many have missed out over the last five years. this inflationary trend trend makes whatever growth you have far more sustainable in the long run than a growth spurt and inflationary trend. that has been what is supporting the global economy, and i think that will support the global economy for the next five years. bob: but that is the problem. i, too, would like to see some dispersion of yields between official policy rates. i would like to see the 10-year at 4%. i'm just not going to get it. this is the reality we are in. what are we supposed to do, sit
there and hope for something that won't happen for maybe the next decade? i pulled up a chart on money market fund assets. this is the other thing that is alarming to me, not that we are dropping to 2%, but that we may go lower. money market fund assets are 3.1 trillion. they are normally about 2.5 trillion. money is piled up internationally, as james talked about, domestically. it was also simple. the fed would stop raising rates toward the back end of the year and you could invest higher. that is not happening. what do you do now? krishna: you are making the point that i've been making for the previous five years. in looking for the dispersion, i am not looking for a 10 year rates being meaningfully higher. i would rather have that dispersion as being policy rates being somewhat lower than where they are. with the lack of inflation, for the fed to be on the verge of making a policy mistake, they
came to their senses at the right time. jonathan: james athey, weigh in. james: to some degree, krishna is saying, if we were to grow, it would be a mistake to worry about the potential for what happens when the growth stops. if you look at the drivers of growth globally, essentially what you are talking about is a bipolar world, where the u.s. world's consumer of last resort and china acts as the world producer of last resort, which means it is a demand are in a lot of those inputs and processes. the u.s. economy has been driven essentially by falling unempolyment and credit growth. the chinese economy has been driven by falling unemployment and credit growth. it is when those two dynamics start to show signs of tiring, you have to wonder where is the next leg of growth. if you scratch beneath the surface of q1 data in the u.s., you find the internals don't look good. domestic demand was 3% year after year. suddenly, that number looks very weak. it is only weak imports because
of that weak demand that has seen the headline number pop higher. if you look at china, when they stopped stimulating in the second half of last year, essentially, the economy just stopped. those two dynamics are what concerned me as we look next to global growth. without it, we started is of some of those structural issues. jonathan: krishna, this cycle continues a whole lot longer. krishna: five more years. jonathan: we have not reached the limits that james just painted. krishna: five more years. jonathan: why five more years? krishna: do i know whether it is five or not? the point is, the end of the world that people were expecting in december did not materialize. in the same way the end of the world that people are expecting in 2020, 2021 will not materialize for two central reasons. one, inflation globally is low and going to remain low. in that environment, fed policy and global central bank policy will remain supportive. chinese desire to maintain their
growth through credit growth is actually in place as well and will remain for an extended period of time. jonathan: final word here, bob. bob: i don't know about five years. i'm good for two. i would like to see what happens in the general election in next november year. you are right. expansions don't die of old age. australia is proof of that. jonathan: great to have you with me. coming up on the program, the auction block. investors turning increasingly cautious. high yield bond funds seeing the biggest outflows since december. that conversation is next. this is bloomberg "real yield." ♪
i want to head to the auction block where u.s. companies are heading to the continent, europe, borrowing at the fastest rate in years. cheap funding cost lured them across the atlantic. fidelity national lead the surge, issuing more than two thirds of its $8.2 billion offering in euros. in a broadly risk off markets through the week, quality was the place. investors absorbing just shy of $30 billion worth of investment grade supply, including dow chemicals $2 billion offering, the deal to refinance new two maturities was nearly five times covered. the junk revival challenged by the biggest weekly outflows since december. six new deals coming to market including barrett global. that $2 billion offering needed to be cut in half amid rising trade tensions. bob michele, krishna memani, and james athey is with us. bob, your view on high yield? no drama compared to what we saw at year end. how do things stack up at the moment? bob: they look pretty good to
me. there is a bit of a binary outcome here. if there is some sort of trade agreement or framework and it gets pushed off, the weight of money coming into a market with default rates below 1% pushes high-yield to the low 300 over the spread. over the next six months. certainly by year-end. if trade disintegrates and escalates, sure, high yield will widen out. i think it trades either side of 400. i think you get 375-425. i think it looks great. jonathan: what you think of that, james, tightening back up to over 300 again? james: to some degree, i agree with bob, in that it feels a little binary. the news stories out there, the market dynamics out there that could shift things on to the downside are probably more numerous than just the trade debates. i look at commodity prices, oil prices, and i think, are those truly reflecting all the new information we have in terms of
underlying supply and demand dynamics, notwithstanding the short-term disruptions and tensions we are seeing in the middle east? i'm not sure that is necessarily the case. we know the high-yield market is pretty heavily skewed toward energy names, we know there can be weakness there. to me, the more important, the more interesting dynamics are the psychology of markets, structure of markets, and the extent to which markets can cope in a calm an orderly fashion with potentially some of the drawdown we may see in the near term from this escalating trade tension slowing growth, slowing manufacturing globally. we are seeing horrific data in asia. i'm still cautious and concerned. i don't discount the fact that bob may be right if we get good news. i think the risk is more skewed to the downside in my opinion. jonathan: krishna? krishna: i think bob is right, but 300 may be a little bit of a stretch.
bob: i said low 300's. krishna: fair enough. equity markets stable, volatility remaining stable. things are going to be ok. if there is a new wants to that, the likelihood of a trade deal is smaller than what the market is expecting. therefore we may have to deal haircut percent to our growth expectations. matter -- the only thing that matters is recession. as soon as you are on the verge of recession you have to start pricing how your -- default.
if you don't, every backup is a buying opportunity. >> absolutely. high-yield is a decent by if you are looking for income. if you have to decide between , i wouldand high-yield go with equities rather than high-yield. unless you can forecast more meaningful self-fulfilling cycle of essentially default, that generally comes when we are in a downturn, i guess i am more less roomwe just got
to run on the u.s. economic road again. i want to see the full second order of data, but i feel we have started to see the best of these data points and things rosy in thek so next few corners. jonathan: what we have seen over the last week, outflows in high-yield, inflows into investment grade. walk me through the appetite for investment for the foreign buyer where they are willing to be unhedged and come in and pick up the income. bob: what they look at is the yield they can get and the cost of the hedge back to the currency. it has pushed them into government bond markets with steeper yield curves, has pushed them into credit, it is one of the reasons, for example, they like european high-yield more than u.s. high-yield. they are at the point now where they have a lot of capital, have to get it invested. the cost of the hedge back to their base currency is not what it used to be, so they are willing to take dollar unhedged. krishna: there are some people who will take dollar unhedged,
but the majority of large institutional buyers would probably look at it on a fully hedged basis. on that front, the reverse yankees are telling you where things are from a valuation standpoint. the dearth of supply in europe, demand for credit in europe, relative to what you can get on a hedged basis out of the u.s., i think is probably -- jonathan: i'm hearing more people signal appetite for european high-yield credit. is that the right approach? krishna: european high-yield, depending on the sector is perhaps cheaper than what it is in the u.s. valuations are certainly better. i think the direction of the economy -- and this will create a lot of ruckus here -- the direction of the economy in europe is probably better than it is in the u.s. the u.s. is going down. europe is improving marginally,
but improving rather than deteriorating. jonathan: why did you say this for now? we are up against the clock. we have to come back and talk about this. james cannot wait to weigh in. let's get you a market check on where treasuries have been. yields heading south down six basis points on the 2-year. just off the lows of 2019. still ahead, the final spread. the week ahead, including a slew of fed speak, including chairman powell. that is next. this is bloomberg. ♪
jonathan: i'm jonathan ferro. this is bloomberg "real yield." time now for the final spread. the next week is a busy monday, one. kicking off in japan with first-quarter gdp. tuesday, mark carney testifies to parliament about his may inflation report. wednesday, the fomc releasing the latest minutes from its meeting. plus plenty of fed speak with the spotlight on chairman jay
powell. background table, bob michele, krishna memani, james athey itching to weigh in on the eurozone call. james, your view? james: this is the least ugly contest globally at the moment. we have had lots of cyclical strength, decent reasons why that's been able to occur. when unemployment stops falling, you need big changes in behavior to get consumption patterns keeping up with where they were. for the u.s., i don't see anything that intimately tells me it's about to fall off of a cliff. trade tensions is a huge current trade deficit account country. this is not the policy that is going to hurt the u.s. too much. when i look at the eurozone, it's a different story. it has essentially been a model which has gotten to where they are come excessive eurozone support. fiscal stimulus at the margin more recently. realistically, it's been trade, exports. specifically, exports which start first and foremost in china. if you see trade tensions and domestic policy choices in china which are beginning to slow
things at the margin, the eurozone manufacturing industry stops dead. when that percolates through the system, there is really not a lot left. domestic demand with a few notable exceptions, have not been sufficient, given the current size of the economy. i think the eurozone has some serious challenges to face up to. jonathan: really quickly, your thoughts? bob: i'm not worried about europe. you have to go back to monetary policy is excessively accommodative. we thought they would be raising rates and running down the balance sheet. they are not. they are backstopping the bond markets. brexit is not much of a concern. companies have spent the last three years preparing for a hard brexit. jonathan: we will do the rapidfire round. three quick questions. three quick answers if possible. china front and center. on the currency, will china engineer, tolerate, or constrain un weakness? bob: tolerate. krishna: tolerate. james: constrain.
jonathan: venture back into high-yield or hideout in investment grade? venture back into high-yield or hideout in investment grade? your advice? bob: high-yield. krishna: high-yield. james: buy duration. jonathan: have we seen the high in the u.s. 10-year yield in 2019 already? have we seen the highs, yes or no? bob: yes. krishna: absolutely. james: absolutely. jonathan: great to catch up with you. what a conversation, james athey, bob michele, krishna memani. that is it for us. we will see you next time. this was "bloomberg real yield." this is bloomberg tv. ♪
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