tv Bloomberg Real Yield Bloomberg July 21, 2019 11:00am-11:31am EDT
jonathan: from new york city for our viewers worldwide, i'm jonathan ferro. bloomberg "real yield" starts right now. coming up, confusion reigns following the final fed tweak before this month's rate decision. central bank officials emphasizing the need to get ahead of economic weakness with president draghi stepping up. -- stepping up first. looking ahead to the ecb next week. let's begin with the big issue. a polarizing treasury market call. >> all the way down to zero. >> i think that would be pretty extreme. >> we are actually at 2%. 2.5% by year-end.
2.5% and maybe more. 1.5% for the 10 year. >> someone saying we will see tremendous re-inflation over the next 10 years, buy gold. and on the other side, and have someone saying, 10-year yields are going to zero. >> i don't want to think of a world of zero interest rates. >> that is where we are heading over the next couple years. >> 0% for the u.s. treasury seems like an excessively pessimistic forecast. >> we have had the recovery, it's coming to an end. >> if you believe that the business cycle is coming to an end, that call makes sense. >> now the central banks are falling into line and cutting rates, one after another. >> when we start to get this polarization of views, it tend to be close to regime changes. >> i am not saying we will get there right away. >> something is going to give. >> that is the journey we are on until something different happens. jonathan: joining us to discuss -- lisa hornsby from schroders, gershon distenfeld from alliance-bernstein, and noelle from invesco, over in atlanta. it is a big call from bob michele. a multi-year call, looking for the 10 year treasury yield to head to zero. your thoughts, please? noelle: that makes sense if you
think that the recession is kind of looming, but that is not our base case. we are not seeing any signs of a recession. we don't expect the fed to be on a full-blown cutting cycle. we think that we will only see two this year and that will be enough to get growth back on track, which right now we are calling for a modest 2% growth and inflation a little bit higher. i think that is just what the fed needs. jonathan: noel, you touched on something important. it all hinges on where you think we are in the cycle. "as of july 1, we are in the longest economic cycle in modern history, which means you have to pick a camp, either we are headed towards a near-term recession, or we are in a super cycle." gershon, which one? gershon: always hard to say in the short-term. listen to the yield stuff. some of those people calling for much lower rates are those that called for a 3% 10 year a year ago.
i think it is funny where we keep on protecting things. this is the only industry where -- keep on predicting things. this is the only industry where you can be wrong again and again and people still want to know your view. it is really fascinating. the reality is, what europe has taught us is there is no lower bound. in other words, if equities are weak, if the economy is weak, we can go a lot lower, we can even go negative. on the other hand, i'm not sure believed necessarily this will be the equilibrium rate of inflation. inflation will only be 1.5% over the next 10 years. rates probably should be higher in the longer run. jonathan: lisa? lisa: it depends on how you interpret bob michele's call. he says rates are going to go to zero over some period of time, which is probably true. jonathan: a multi-year period. lisa: which is -- lisa: over some period of time they will probably go to zero because in the next recession, they only have 250 basis points of cuts to do, so they will probably end up at zero. that is a fair assessment but i don't think it's happening in the next 12 months. jonathan: i want to view on -- i want your view on something bob michele has also talked about. the amount of money in money market funds right now and the idea that when a rate cut comes, that money will need a new home and that home will be
treasuries. can you walk us through what you think of that particular call? noelle: we think treasuries are largely priced. especially on the front end, we are calling for two cuts, and the market is calling for closer to four. so we really like it a little bit more into the credit sectors. we think a lot of that money is going to go back into ig. valuations have come in a lot, obviously, but we think there is still room to go. and with modest growth at 2%, that's still above potential, and inflation that is not going anywhere quickly, that will keep the fed supportive for some time. jonathan: let's work through this. the federal reserve cut interest rates. there is belief among some people that that money won't go to a riskier home. that money will go to a safer home, perhaps 10-year securities. may further along the curve in the treasury market. how do you frame that for our clients and viewers right now? gershon: if you believe we are going to zero, you don't want to invest anything on the risk side. you don't want to be in
equities, you don't want to be in high yields, you do not want to be in emerging market debt. i don't know that is where people really are right now. again, we have gone so fast. we sat here nine months ago -- how many hikes are we pricing in? i mean, mohammed put out a piece earlier today about how the fed is just caving to what markets want, never going to be happy. i actually agree with that, i don't always agree with mohammed, but in this case i agree with him. the markets are not going to be happy. if they cut 50, i'm not even sure we rally. people are going to say all right, we need to do another 50 in september. so i am not sure how to interpret this. jonathan: let's talk about the guidance that we have had throughout the week, shall we? john williams of the new york fed comes out and delivers a speech about living life in a lower bound ahead of the blackout period for the federal reserve. the market runs up to the races, as you would expect it would. the vice chairman richard clarida follows up by pretty much saying, i agree with the speech from the new york fed president. and then the new york fed tries to walk it back and tells us it is purely academic. how on earth are we meant to interpret that as purely academic? gershon: here is what is going on.
this is really unprecedented, at least in my career over the past 20 years. it is not that we have this framework we are working with and we have some slight disagreements on what the next move should be. we are working with different frameworks. there are people in the fed who don't believe the philips curve matters anymore, or at least it should be on a global basis. there are people that think we should pay attention to the global economy and not just the u.s. economy. there is a debate about what is the neutral rate of inflation? one very interesting thing i think, i was always in the camp that if the economy is strong, the fed does not need to cut rates. look at where inflation expectations have gone, it means the real federal funds rate is somewhere around 75 basis points. that might argue that a little bit of a cut might be warranted if we are truly slowing. jonathan: lisa? lisa: the key points -- i agree with gershon. the fed doesn't know what they are doing yet, and that is why we are hearing so many different comments coming out. bullard came out and said i'm not looking for 50, i think we should be cutting 25. the fed has not decided yet, so you are hearing the gamut. the important thing for me is
that we have a fed that is going to support market. -- markets. they are more willing to ease upon signs of lower growth and deflation rather than willing to hike if we get stronger growth and inflation. and that is the most -- whether they go 25, whether they go 50 in the next two weeks, probably less relevant than the fact that they are here to back it up. jonathan: and making the argument much more so that they have limited ammunition, and therefore, they need to do more with less and go early and perhaps go harder. would that be your interpretation of what's about to happen at the federal reserve? noelle: not at all. we think going now with the 25 bits, although it is priced, at least coincides with the data on the growth and inflation side that has come out. 50 bps would get ahead of it. but again, markets are going to price in more and more and they are always going to be behind the market. it is just one of those things that you have to think about
what is priced in over the longer term. and we think it is a little bit too much at this point, given we see no signs of a recession in the near term. all of the macro indicators point to a slowing, slow growth, but with a supportive fed, that is going to stabilize and be a pretty positive environment going into year-end. jonathan: if you look at manufacturing worldwide, it looks like a recession. you look at services in europe and the united states, it looks totally fine. the worry is we bleed from one to another. they are looking to insulate us from that. is that the prudent approach to all of this? gershon: that is what we should be focused on. i think lisa hit the nail on the head. smoke and mirrors here. 25 or 50 is not the issue. the issue is, are we doing this as an insurance cut, or do we truly believe that the economy is slowing and we are going back closer to zero? that is the key issue. jonathan: what is your base case? what do you think it is? because there is a real tension right now between what is priced and this idea of an insurance cut. an insurance cut is not 100 basis points of easing. i mean, can we both agree on
that, that is not what that is? what are you expecting to get? gershon: on the other hand, 25 basis points on the longer end, as we have talked about before, is a rounding error. a lot of lending happens at the longer end. so i am not sure. i don't see the -- the totality of all the data does not seem like we are slowing that much. again, the idea that inflation expectations have come down tremendously, and it is pretty clear at this point the fed is targeting much more inflation than growth. jonathan: can we get higher inflation expectations and lower nominal yield? is that a dynamic that can emerge in the coming months? gershon: it has happened a little bit in europe on a very small scale. jonathan: do you expect that in the united states? gershon: that would not be my base case. remember, we have seen for 10 10 years now very accommodative policies around the world and not much in the way of inflation. so to say that there is a magic pill and all of a sudden we will start seeing inflation is a bit naive. jonathan: lisa? lisa: i would agree and
follow-up on one other point. look at the data that has come out recently. not even recently. nonfarm payroll growth, 170,000 jobs per month. that is a 3-month, 6-month, and the 12 month average. retail sales, consumption growth over 4%. i mean, the economy has clearly slowed from the tax-induced fiscal stimulus of 2018, but it is not in a bad place. for me, these are insurance cuts. i think the fed is much more focused on inflation. jonathan: lisa, don't you find this interesting? you mentioned the data, the data has improved. the federal reserve is set to ease, and ten-year treasury yields cannot get away from 2%. what do you make of that? lisa: $13 trillion worth of negative yielding debt. you look at the high-yield market in europe, some of that -- the high-yield market is negative yielding. that is a joke in and of itself. i think there is a ton of money that is willing to be put to work and the u.s. is the highest yielding market in the world. jonathan: lisa hornby is going to stick with us,
jonathan: i'm jonathan ferro. this is bloomberg "real yield." i want to go to the auction block and start in the united states, where uncertainty surrounding the debt ceiling is weighing on market participants. the $35 billion auction of eight-week t-bills attracted the weakest demand since the treasury introduced the security back in october. over in credit, sinclair dominated junk supply this week, as investors flocked to orders of $13 billion. $4.875 billion offering.
this month is on track to be the busiest july for high-yield insurance in five years. and in europe, the corporate primary market has broken 900 euros of sales for the year, reaching a landmark. it took until mid-september in 2018, while the current rally has pushed even some junk bond s into negative yielding territory. sticking with europe, jay pelosky looking ahead to new leadership at the ecb. jay: we are setting up particularly in europe for a transition from complete dependence on monetary policy to joint monetary and fiscal policy. and i think the new leadership in europe is going to be on board with this. the big opportunity is setting up for this risk asset melt up outside of the u.s. particularly in europe. jonathan: still with us are lisa hornby, gershon distenfeld, and noelle corum. let's begin with you, noelle. this relentless rally in europe on the periphery and in credit. what is your exposure right now in europe and how are you managing it? noelle: as a usd investor, we like europe right now, not only
is there value still left in asset prices, but you could also make money on the hedge, when you hedge it back from the euro to u.s. dollar. so we like investment grade in europe, a little bit at the periphery. for now, we are staying away from italy, though. jonathan: look at the nominal yield right now that you pick up in italy before that fx hedging, it is 50 basis points. fewer than 50 basis points on investment grade in europe. is that sustainable? gershon: you can't take out that one you just try to delete before hedging costs. that matters. the fed has not cut yet. it is still 300 basis points. so to the u.s. investor, it looks pretty good. and i agree with noelle, the economy is weaker, but what causes problems is not just economic weakness, it is leverage. on average, european companies have less leverage on the balance sheets than the u.s. companies. -- than their u.s. counterparts. jonathan: that is a really interesting point. lisa? lisa: i would agree with some of that, although, at the end of the day, base rates in europe
are still so low. yes, 50 basis points -- base rates are so low, i would rather invest in the u.s. at this junction. jonathan: what about the periphery? you and i have gone back and forth about btp's in the past, the italian 10 year is week after week, the yield keep s coming lower. the back end of this week, the politics just came back on the table, just a touch. are we willing to put aside the italian political situation and just keep buying one of the only real places left to get positive real yield in europe? lisa: the structural issues in italy have not gone away. the debt burden is still huge, low tois still way too support that type of debt burden. however, to the point we are making now, italy yields significantly more than you can get in any other part of the european market. so you are seeing investors piling into it, and they are seemingly ignoring some of these structural issues. this could go on a while a little longer. they have a budget coming due in october. we know what happened the last time around. the market starts to get skittish when the italians say
hey, we are actually not going to comply with those european set limitations. and that is where you see italian btps come under pressure. i think that could happen again, although we do not have a position at the moment because the technicals are still very, very powerful. jonathan: gershon, we have talked about the bulk of negative debt around the world. 25 trillion, here or there about. the number is massive. is that the attraction with italy at the moment and over the last month, just clamoring for anything that is left with a positive real yield on the continent? gershon: yeah, i think that italy is suffering from these false lines we've drawn in markets. italy is behaving like an em bond, and it should. it is riskier than many things in em. but the problem is, the way that markets are set up, investors look at things in the developed world and then the em world. i can guarantee you if it was an em credit, people would not be
buying it as much. the market is oscillating here between, is this a risky asset, which it clearly is, or is it more of a risk-free asset because it is a government bond? jonathan: hasn't that been the last story for the last six or seven years for italy, that it has been trading like a credit, not a sovereign? do you think that people will start to look at it differently now? gershon: some people are looking at it differently. the point that you started the conversation with, people need yield. people are going to convince themselves that yeah, these are all long-term problems. by the way, the u.s. is the same way. at the end of the day, put aside trump's tweets today about how we should be paying much lower s, that is always fun to talk about, but the reality is, you look at unfunded liabilities, somewhere around 100 trillion. jonathan: 35,000 years to get to a trillion seconds. gershon: 100 trillion is a pretty large number. jonathan: pretty big number. gershon: so we are all convinced that the dollar is a safe haven, the u.s. will find a way, but we are setting ourselves up.
we kind of miss the point when we talk about what is going to happen in two weeks with rates. it is, we have a long-term debt problem around the world. we will be talking about that a lot more in the coming decade. jonathan: we are going to be talking about the ecb as soon as --t week, and ecb decision an ecb decision just around the corner. our guests will be sticking with us. let's look at where bonds have been this week, 2's, 10's, and 30's. two weeks of losses in treasuries, followed by a week of gains. u.s. yields lower. down by eight basis points. still ahead, the final spread. the week ahead featuring u.s. gdp and the ecb decision. that is next. this is bloomberg "real yield." ♪
its new prime minister. wednesday, pmi numbers from france and germany. thursday, rate decisions from the ecb and turkey's central bank, too. that one could be interesting. and the weekend, with second-quarter gdp right here in the united states. still with me, lisa hornby, gershon distenfeld, and noelle corum. so noelle, let's look ahead to the ecb, shall we? a really interesting meeting that many people expect the president, mario draghi, to be teeing up a rate cut in september. what is your base case? noelle: our base case is that we get a little bit of that. he is probably likely to leave the door open, but we think we are calling for a q3 cut, and qe, too. we might get a little bit of details on the asset purchase program. that is where we would be focusing as he comes up. jonathan: any idea on what they might buy? is it the same stuff as before, or do they broaden the parameters a little bit? noelle: i think they will broaden them a little bit, because there is only so much
they can buy without significantly moving markets. but in terms of the underlying details, that is still yet to be seen. jonathan: what do you think, lisa? lisa: i would agree with that broadly. i think that they open the door next week to the september meeting, where they unveil bigger policy. i think there is probably going to be some kind of tiering of deposit rates, could be an expansion of their programs, additional assets added to that, as noelle alluded to. now, i think that they realize they have to do something, and they are the ones that are actually out of ammunition. the fed talking about near the zero bound -- ok, the fed has 250 basis points. the ecb is definitively below the zero lower bound. so they are the ones who the pressure is on and the economy there is still very weak. jonathan: gershon? gershon: draghi is the master of keeping his options open. i think that chairman powell should hire him maybe to do the press conferences. maybe as a consultant. [laughter] gershon: we are going to sit
here and say, we are not sure what he said, because he is really, really good at that. but i think lisa is exactly right. the issue is, whether they cut the near term or not, are they going to have the wherewithal to if we show signs we are going through a recession, do they have enough firepower left, enough tools at their disposal to actually make an impact? jonathan: here is a question for you. just a think this out loud with you. if they cut interest rates, if they tee up another round of qe, the objective is to get inflation expectations up, it is ultimately to shake you out of those 10 year bunds in germany. are yields going lower on 10 year bunds, or are they higher if qe restarts and rates could cut? gershon: that will be dependent on how risk markets react. if we see a big global selloff in equities, you are going to go lower. what is the reason we went from zero to where we are now? it is because you had a lot more fear in the marketplace. that is going to be the determinant, more so whether it -- more so than whether it should or not. jonathan: how do you think this
market would respond, bunds specifically, to a rate cut and the restarting of qe? noelle: we think it's -- we have more of a longer-term view. we think that bunds will be going higher toward the end of the year. that is because we think growth expectations for europe have gotten too dire here. as lisa and gershon have alluded to, the ecb doesn't have a lot in their toolkit. so they are not going to be as responsive as the market would have liked them to. so we think we will get into a scenario where growth is not as bad, ornot looking that at least not as bad as markets are anticipating in europe. and the ecb is reacting to that and they are going to disappoint a little bit, and that will move bunds higher. jonathan: guys, let's wrap things up and get to the rapidfire round. you know how this works, three quick questions, three quick answers. first question for you, total returns to year end, you have to hold one asset class, u.s. high yield or euro-denominated high-yield? which one, euro or u.s.? gershon: i assume you mean
hedge. i will do euro. jonathan: i knew you were going to say that. noelle: agreed. hedge, euro high-yield. lisa: u.s. jonathan: 10-year italy. in and around 1.50% on the 10 year at the moment. what is next, 1% or 2%? lisa: 1%. noelle: 1%. gershon: 2%. jonathan: interesting. federal reserve month end, 50 basis point cut, 25, or nothing at all? gershon: 37.5. [laughter] noelle: 25. lisa: 25. jonathan: there we go. why do you misbehave on every show we do? gershon: you keep on inviting me back, jon! just stop. [laughter] jonathan: i have no idea why. we will keep inviting gershon back, alongside lisa and no well -- noelle. this is bloomberg. ♪
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