tv Bloomberg Real Yield Bloomberg August 24, 2019 10:30am-11:00am EDT
♪ lisa: from new york city for our viewers worldwide, i'm lisa abramowicz. bloomberg "real yield" starts right now. ♪ lisa: coming up, move over, jackson hole. tariff fears dictating markets with escalating trade fears extending the rally in treasuries. chairman powell saying the u.s. economy is in a favorable place but faces significant risks, reinforcing bets for another rate cut in september. and zero rate 30. germany regarding the size of its bonds that pay nothing as the auction flops.
fed officials at jackson hole grappling with how the trade war is impacting the u.s. economy. >> trade uncertainty is sort of a fact of life now. >> trade policy uncertainty has been weighing on the outlook. >> business investment is not held back by the cost of capital. >> we have seen already some business spending be weakened because of the tariff situation. >> what is holding it back is trade policy uncertainty. >> the uncertainty of the trade situation. >> the center of gravity is u.s. economic policy, not monetary policy is trade uncertainty. >> i don't think there is likely a resolution soon. >> trade uncertainty will be with us. what i see some businesses do is become more cautious. >> this trade war is triggering other actions around the world, other countries thinking about reevaluating their own trade relationships. this could easily get out of control and easily feed back to the u.s. lisa: there should be a little ding every time they say "uncertainty." joining us now is matt toms, luke hickmore, and here in new
york, jim keegan. i want to start with you, jim. one thing i'm struck by, yes, we are seeing bets for a rate cut being priced into markets but it is not giving a boost to risk assets. what do you take from this? jim: you have to look at how risk assets have performed. if you look at 2018, it looks like we had a peak in growth rates, inflation, interest rates, and risk assets. if you look at stocks for instance, globally, stocks peaked in 2018 and the s&p is up very little from where it peaked initially at the end of january 2018. you have basically collected the dividend. at the end of the day, i think fed policy has just created asset inflation, which is why you have this divide on the fed where there are several people concerned about financial stability risk. if you look at asset inflation, it leads to asset bubbles. if we mean revert -- which the laws of mean reversion have not
then repealed yet -- it tells you where assets could head. lisa: the concern for asset bubbles has been persistent for a long time, has not stopped the fed from pursuing easy money policies. how concerned are you about matt and how many times do you expect the fed to cut rates? luke: i think the market pricing around four cuts seems right. we are only expecting 25 basis points in september but the risk of a 50 could be centered around how risk assets move here on out. the move into q4 this year seasonally could be pretty tough for risk assets. equity markets in particular, the set up right now feels quite
shaky for equity markets coming into the end of this year, and that could be what pushes the fed into upping the pace of their rate cuts. it does feel hard at the moment to see rates much below three quarters of a percent or 1% in the u.s., but we could get there quicker if equity markets selloff. lisa: matt, do you think the fed will cut four times? matt: we think three more gets you to 1.5%, however a feedback loop on growth expectations is not there, and that has historically increased asset prices, that stimulative product. that is not being questioned by the market, and that is why the yield curve has flattened. we have also had fixed income assets not selloff. so there is not a trade to bounce back in high-yield when you're already off 6%. lisa: i am glad you brought up the yield curve. st. louis fed president jim bullard keeping a close eye on the yield curve, telling bloomberg he is not shrugging
off the inversion. mr. bullard: if you have a recession prediction model, it will use the yield curve to predict that. our job is to get the yield curve to be un-inverted, so those recession probability models probably do not work anymore. i am not interested in testing somebody's theory about this time is different about the yield curve. lisa: jim, how many times does the fed have to cut to avoid a yield curve inversion? jim: depends on which part of the yield curve you are looking at. lisa: let's say 2/10. jim: 25. more than that, they would have to do 50 or more. lisa: luke? how much to avoid inversion in the 2/10? luke: at the moment, that is difficult to say. the market is really pricing in, moving toward recessionary probabilities being very high. what they do now may not change that yield curve move in the short-term.
almost if they cut four times before the end of the year, we think we could be inverted because the market would then panic, what does the fed know that we don't? lisa: luke is suggesting that markets are going to invert the yield curve regardless because people are feeling pessimistic about the economy. do you agree? matt: i disagree without. the market will not assume that the fed knows anything more than it does a day or two ahead. a proactive fed helps the market and yield curve, does not instill fear for more than a short-term amount of time. in our opinion, three extra cuts allows the 10-year to steepen, if some of the trade uncertainty goes away. it is hard to see below 1.5 on the 10 year when the inflation expectations have a hard time getting below that level. that would mean a negative real
yield on 10. 1.5 is a key level on us for cash and on 10. lisa: it is interesting you say you don't think the market is thinking, what does the fed know what we don't know? certainly, the fed is wondering what the market knows what we don't know. loretta mester telling bloomberg, she may not agree with the signals from the bond market but they cannot be ignored. ms. mester: there is no doubt bond investors have a more pessimistic view of the u.s. economy than perhaps the economists and i do. we have to take a signal from that. we cannot just ignore what is happening there. lisa: jim, do you think the bond market is appropriate in sending a signal that is basically telling us there will be recession within the next 12 months? jim: if you look at various financial markets for instance, the three-month 10 year, the new york fed recession probability
model is telling you on a normalized basis, 72% probability. five year treasury is saying it is in the 50% area. if you look at investment grade corporate, 13%. high yield, 10%. equities about 8%. historically, the bond market has been much a more accurate reflector of inflection points, so it is reasonable. global growth has clearly slowed and there is elevated global recession risk. china is in a secular slow down. not a cyclical slowdown. they don't have the current account reserves that they did have previously to stimulate. they have a debt problem. germany looks like it is going into recession. it is totally tied to trade and exports. 47% of germany's economy is exports. 18% of those exports go to asia and most to china. 9% of germany's gdp is tied to chinese exports. lisa: we will see how that plays out. of course, we have the trade wars heating up, which is interesting to watch the price action. markets somewhat calmed after what jerome powell had to say, but less so after president trump tweeted out, writing, my only question is who is our bigger enemy? jay powell or chairman xi?
i have to wonder, luke, what would president trump like to have seen out of this meeting? how much does this risk the fed's independence at this juncture? luke: you wonder whether he would like an intrameeting rate cut. jay powell saying we will do everything it takes to get inflation back to 2% and support growth, a very draghi approach. but that is not going to happen. trump will continue to lay on the pressure. it has been a fascinating move away from a completely independent central banks, to ones that are getting increasing political pressure. still independent but that political pressure has to weigh on them over the long-term. lisa: everyone will stick with me and we will talk more about this coming up. the auction block. the world's first 30-year bond
♪ lisa: i'm lisa abramowicz. this is bloomberg "real yield." i want to head to the auction block. let's begin in sweden where the country's oldest lender tapped the market for so-called additional tier 1 bonds for the first time in three years. the bank received orders for more than nine times, yielding just over 5.6% as record low interest rates continue to lure issuers. in the u.s., $7 billion at 30 year tips.
0.5%, the lowest in nearly seven years. primary dealers took home the smallest portion of the auction on record, with demand the strongest since 2017. where is inflation? the world's first 30-year bond without coupons struggled to find buyers, prompting a germany debt agency to admit the sale may have been too large. signaling that negative yields across europe may finally be taking their toll on demand. bunds rebounding since that auction, so maybe not. increasing uncertainties. credit suisse saying there may not be too many alternatives to negative rates. >> clearly, yields are not attractive, they are very low, but they are reflecting a reality. institutional investors of today are worried about the economic outlook or perhaps risks that are more broadly around. they do not have much more alternatives than piling into already unattractive government bonds.
lisa: matt toms, luke hickmore, and jim keegan still with us. what is your take on negative yields and the attractiveness? do you take a signal that reaching peak negative yields from the german bond auction? luke: i don't think we are, bearing in mind september ecb, we are looking for a 20 basis point cut. that will take us to a 60 negative depo rate. getting into a negative 70, 80, 90 number for the german ten-year could be quite easy from here. you think, a lot of people are buying these assets for capital appreciation and direct appreciation in their portfolios. if you are u.k. investor buying euro assets, you get a positive pickup from the foreign exchange as well. there is still plenty of demand
around. we will get a wave of new issuance from corporates in a couple of weeks. it will get taken down very well. lisa: matt, what is your perspective when we look at the incredible amount of negative yielding debt out there? are you finding it attractive, are you going into those areas that have negative yield? do you view this as a bubble? how do you reconcile this with the history books? matt: basically, if you need to own it, you need to own it. if you can swap back into another currency and still have a positive yield, it makes sense and we do that. ultimately, we think the experiment has a problem with the outcome mechanism. we have not seen growth or inflation revised. we think you'll see a bottom to negative yields, how far they can go negative, because there is a cost in the banking system, savers, ultimately investment. the end will be when people realize there is an offset.
there is a benefit but there is an offset to negative yields. lisa: president trump reacted to the german bond auction, tweeting, "germany's 30-year bond fell. our federal reserve does not allow us to do what we need to do. they put us at a disadvantage against our competition. strong dollar, no inflation. they move like quicksand. fight or go home." do you expect to see negative yields in the united states within the next few years as the u.s. faces a slowing economy and perhaps a downturn. jim: at this point, i don't, and i sincerely hope not. you can look to japan and europe and they have not worked. we talked about they have not increased growth, they have not increased inflation, they have not increased credit. they have increased savings rates. they have created more zombie companies. that is deflationary. we have an excess capacity issue globally. all of these easy money and negative interest rates does is increase the ability of these companies that should be out of
business to stay in business. lisa: which raises an interesting question -- if there are all of these zombie companies are getting fuel and being kept alive by the negative rates, what is your perspective on buying corporate debt in the eurozone in a time of a slowing economy? at least we can pick up some extra yield and there is a buyer of last resort, the ecb, or are you staying away? luke: the landscape is changing pretty rapidly over here. that whole zombie argument has been around a while and i'm not sure it applies anymore. the kind of company struggling to get financed at the moment, b, ccc, are struggling to find assets. these are not businesses that can go to the market and get lots of new debt. the place that we think is interesting is the investment grade in the bb area. if nothing else, the ecb will be buying 20 billion of that possibly as early as january next year, every single month. if you have that kind of big buyer in the market, there is lots to go for still in european credit. sterling credit works as well. i think actually, even in the
u.s. market is a haven asset which still has some yield around it. you will find investors forced into that space, too. that may be wrong from an economic long perspective, but in an investable timescale, i would still be in credit. lisa: in the past couple of weeks, there has been a paradigm shift from low rates pushing people into riskier assets, into yield, to low rates indicate a slow down, pushing people away from the riskier assets, and you have seen a diversion between the lowest and highest rated debt, and how people are trying to hide out in stuff that is more credit worthy. how are you viewing that? are you seeing opportunities in the lower rated credit, or are you also going into higher rated debt to gird for what could be a downturn? matt: the opportunity has been to be crowded into the higher-quality spread alternatives to government bonds. that is a nice way to diversify and get some extra income.
that is absolutely the trade, we think that continues, and it expands into other sectors in the bond market that benefit from low rates like housing bonds, commercial real estate. that is a trade that we think continues. lisa: do you agree, jim? jim: you have to be selective because we are getting to the point where there is elevated recession risk. at the end of the day, risk premiums are tight, whether you look at them on a nominal basis and then you leverage adjust them. what is interesting about this cycle is the fact that typically at the end of a business cycle when corporate profits and cash flow are peaking, leverage is at a trough, not a peak. this cycle, leverage is that a peak. we know why. the largest buyer of equities has been corporations buying back their own shares, $5
trillion worth, and a lot of that has been debt financed. if you look at spreads on a leverage adjusted basis, they are pretty close to the record tight, the fourth quarter of 2017. lisa: luke, final thought on you. jim expects that we are getting closer to recession. would you agree? luke: absolutely. all the signs are there. you would now be really hard-pressed to ignore them and look for growth forever. the thing is, it could be six months or a year away, but it is coming, and it will come in germany first. it will then come to the u.s., and it may be mild in the u.s., but saying any longer, we are just going to avoid that -- is hard to say. lisa: you are all sticking with us. let's get a check on where bonds have been this week. we are seeing yields lower in the longer dated bonds. two-year yields rising four basis points, leading to that flattening, a brief inversion between twos and 10's. the 10-year poised to end the week at the lowest level since
♪ lisa: i'm lisa abramowicz. this is bloomberg "real yield." time for the final spread. coming up over the next few days, president donald trump and u.k. prime minister boris johnson among the leaders set to meet in france for the g7 summit on saturday. tuesday, u.s. consumer confidence data, followed by fed speeches from thomas barkan and mary daly. friday, look up for u.s. personal spending and consumer sentiment data. plus, a policy decision from the
bank of korea. matt toms, luke hickmore, and jim keegan still with us. so much uncertainty. are you expecting anything definitive from the g7 meeting that could potentially give a floor to bond yields? matt: unfortunately not. the g7 gives us a chance to fear what if the trade war expands from china toward europe. it was forestalled earlier this year to clear the decks with china. there is more downside risk, should there be negative tweets or headlines out of g7. we fear there is more of a downside case as opposed to stability. lisa: luke, do you agree? luke: that has to be the central case. g7 has struggled to come up with a communique which reflects a more settled joint opinion from the last couple of meetings, and this one does not feel any different. actually, prime minister johnson in the mix there as well will not make anything anything any easier. lisa: jim, do you think the pressure is for yields to go
lower here? jim: absolutely. lisa: for government bond yields? jim: absolutely. especially long-term rates, it is a relative gain. as we talked about where the ecb will be the deposit rate even further, that will put downward pressure on yield. the u.s. is the best house in a low yielding neighborhood. lisa: it is time for rapid fire. we have a lot going on. my first question to you all is when do we get a recession in the united states? matt: 2021. luke: december 2020. jim: when the fed goes from a midcycle adjustment to a full easing cycle, that is we know we are in recession. lisa: second question, will we see negative yields in the u.s.? jim: short-term, policy rates? lisa: yes. jim: no.
luke: 10-year yield, yes. matt: no. lisa: the next question, em debt, buy or sell? matt: i'm a buyer here. luke: i cannot buy it. it is too expensive, it is dollars. jim: the dollar is getting stronger and i will put pressure on e.m. lisa: my thanks to jim keegan, luke hickmore, matt toms. focus very much on bonds. from new york, this is bloomberg "real yield." ♪