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tv   Bloomberg Real Yield  Bloomberg  May 19, 2019 11:00am-11:31am EDT

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jonathan: from new york city, i'm jonathan ferro. 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's seeing the biggest outflows since december, leaving that treasury market right for rate cuts 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.
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>> soft landing for the global economy. >> big central banks becoming notably easier. >> easier monetary policy. >> help of 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 -- if the trade talks really breakdown. that she will really have a cut if the trade talks really breakdown. >> i have zero doubt in my mind that in that environment the fed is cutting rates. >> it depends on how the growth 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, sir. it is what the markets are looking for. is it going to get it? james: soft landing, john, i'm not so sure. history suggests, looking purely at the odds, it is quite unlikely.
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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 already? 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
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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: let's talk about it. there is always this question that asks, does the bond market know 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 story is whether you think we have already engineered what krishna is talking about. bob: what a great time to be a bond. jonathan: you love it, don't you. bob: 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%.
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jonathan: is the market taking it too far? where you see the yield curve out to seven years? trading below the fed funds rate 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 sitting on these enormous balance sheets, the cash has to be invested somewhere. there is too much money waiting 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? why is this so critical? 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
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steepness of the curve relative to their curve is a signal to them to invest and had 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
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in a period of relative strength, is a solution for treasury yields on a problem for the global economy. savings are 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. two, i would rather see dispersion between 10-year rates and policy rates rather than the two on top of each other.
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that sort of in the bit of an issue more than anything else. 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 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. him this is the reality we are in. what are we supposed to do, sit there and hope for something
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that will 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. him in looking for the dispersion, i'm not looking for tim geithner 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
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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. acts as a 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 fallen unemployment and credit growth. it is when those two dynamics start to show signs of tiring, you have to wonder where is the new line of growth. if you scratch beneath the surface of q1 data in the u.s., you find the internals don't look good.
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domestic demand was 3% year after year. suddenly, that number looks very weak. it is only weak imports because of that 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 stopped. those two dynamics are what concerned me when we look to what is next. without it, we started is of some of those structural issues. jonathan: krishna, this cycle continues a whole lot longer. 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. 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 will remain low. in that environment, fed policy and global central bank policy will remain supportive. chinese desire to maintain their
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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 a general election next 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, the biggest outflows since december. that conversation is next. this is bloomberg "real yield." ♪
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jonathan: i'm jonathan ferro. 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 issuing more than two thirds of its $8.2 billion offering in euros. 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 to million dollar 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
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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
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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 maybe a little bit of a stretch.
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bob: i said low 300's. himbob: i said low 300's. krishna: fair enough. i won't fine-tune it too much. but the point is the underlying dynamic is setting up the right way. bob is right on that. the moderating but these in growth, the policy rates remain relatively low. stable inkets volatility overall, remaining stable. things are going to be ok. if there is a nuance to that, the likelihood of a trade deal is probably smaller in my judgment than what the market is expecting. therefore we may have to deal with maybe half a percent haircut to our growth expectations than we are today. that would be the one reason not to go all in. bob: does that matter? you are a career credit guy. you know the only thing that matters is recession. as soon as you are on the verge a recession, you have to start pricing in much higher defaults him and reprice the market. if you don't have imminent
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recession, every backup is a buying opportunity. krishna: absolutely. high yield is a decent buy if you are looking for income. having said that, if you have to decide between equities and high-yield, i would go with equities. jonathan: would you really? bob: you cannot like the bottom of the capital structure unless you look at top of the capital structure. krishna: you like the top of the capital structure for its fair value, but the bottom of the capital structure can go meaningfully higher. 325 basis point that you. james: i am not a top of the capital structure, bottom of the capital structure expert. i think the way that history has played out, bob is right in the sense that this is a buying opportunity unless and until you can forecast a more meaningful, self-fulfilling cycle of essentially defaults. him him that generally comes him when we are in a downturn. i guess i'm just a little more concerned that we have got less room to run on the u.s. economic
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road. him i want to see the full second quarter of data. but i get the feeling that we have started to see the best of some of these data points and things will not look so rosy in the next couple quarters. jonathan: what we have seen over the last week, outflows in high-yield, inflows into investment grade. what we 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 are like european high-yield and bit 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
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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 -- and him i think is probably -- jonathan: i'm hearing more people signal appetite for him 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. 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 the u.s. the u.s. is going down. europe is increasing marginally,
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but improving rather than deteriorating. jonathan: why did you say this for now? we are up against the clock. james cannot wait to weigh in. let's get a market check. yields heading south down six basis points on the 2-year. just off the lows of 2019. still ahead, the week ahead, including a slew of fed speak, including chairman powell. that is next. this is bloomberg. ♪
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jonathan: i'm jonathan ferro. this is bloomberg "real yield." time now for the final spread. coming up over the next week. monday, 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.
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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 dog contest 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 changes in behavior to get consumption patterns keeping up with where they were. for the u.s., i don't see anything that 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. 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.
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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, has 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 being 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 repair for a hard brexit. jonathan: good point. guys rapidfire round. , three quick questions. three quick answers if possible. china front and center. on the currency, will china engineer, tolerate, or constrain you when weakness? bob: tolerate. krishna: tolerate. james: constrain.
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jonathan: venture back into high-yield or hideout in investment grade? bob: high-yield. krishna: high-yield. james: buy duration. jonathan: have we seen the high for the 10-year yield in 2019? 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. from new york, that does it for us. we will see you next friday, 1:00 p.m. new york time. this was "bloomberg real yield." this is bloomberg tv. ♪
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