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tv   Bloomberg Real Yield  Bloomberg  February 23, 2020 1:00am-1:30am EST

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jonathan: from new york city for our audience worldwide, i'm jonathan ferro. bloomberg "real yield" starts right now. ♪ jonathan: coming up, more signs the coronavirus is spreading beyond china, hitting supply chains, taking a bite out of u.s. economic data, sending u.s. 30-year bond yields to an all-time low. we begin with the big issue, the data providing a little more fuel for the treasury market. >> what a mixed bag for u.s. data. >> demand delay versus demand destruction case. >> ism going up, pmi going down. >> i still think there are challenges ahead. >> the worst is yet to come. >> what we are seeing in china move to the global supply chain.
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>> we will see mixed pmi globally. >> the pmi will continue falling. >> it will be a big hit to china, hong kong, maybe all of asia. >> the bond market is saying something is wrong. >> you look at where we are in 10 year yields. >> fixed income yields keep falling. >> yields are incredibly low. >> very low yields. >> they are pricing in structural stagnation, recession, or deflation. >> weakness overseas, negative yields overseas and the relative attractiveness of the treasury. >> investors trying to find safe havens to ride some of this out. jonathan: joining me around the table in new york, priya misra, vishwanath tirupattur, and from minneapolis, tony rodriguez. we will talk about the data and then move into the treasury market. let's begin with the data. it is really quite messy and difficult to get your hands around. priya: it is, but today's data is the only data point where we can say the u.s. might be
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impacted by the coronavirus. i would say you look at price action across asset classes, it looks like the treasury market is running with this weakness in growth theme. whether you look at credit or equities, they all seem much more complacent. what is the story? is the treasury market too pessimistic? i will argue that we have seen an allocation trade away from global rates, global equities into the u.s. that explains why the fx markets are moving the way they have, why long-end treasuries have seen the bid. if this was the market saying u.s. growth was slower, we should have seen steepening. essentially the market should have been pricing more fed rate cuts than they are pricing in now. you have also seen some convexity below. insurance companies have to hedge. the rate move is getting ahead of itself. i am still extremely worried, to quote the who, how big is this iceberg? now that infections are outside china, this will keep growth weak for a while. this rebound we are looking for,
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i'm arguing we have not yet seen the weakness, let alone the rebound. jonathan: this is more technical than fundamental? priya: the movement in treasuries over the last couple of weeks is largely technical, it is largely flow. it is a function of positioning and hedging. if the growth data weaens, which i will argue, it is only a matter of time, it will show up in global growth data first, then the u.s. i think treasuries have a lot more room to decline. jonathan: what do you make of that argument, that this is a more of a technical move in treasuries, not a fundamental move yet? tony: i think there's a combination of factors. the fundamental view is there could be significant weakness from coronavirus. people are starting to price that in. convexity hedging is showing part of this. there is a significant technical component. one thing to keep in mind is not only is the treasury market the most liquid in the world, yields are still the highest in the world, but when you look at safe haven flows, japan is typically a beneficiary of that.
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right now, they happen to be in the crosshairs of weakness in china, and it is spreading to broader asian markets. there's a little bit of uncertainty around looking at both the yen and japanese markets as a safe haven. so all of those flows are pushing to the u.s. i think technicals is the biggest portion of the move right now. you also have to respect the fact that fundamentals could be impaired as we move through the month of february in a significant way. jonathan: your take? vishwanath: i think what is happening with fundamentals, the evolution has expanded. we have a much greater uncertainty. it is hard to precisely say what is the growth impact, when is this going to peak? all of those are estimates. the uncertainty band around those estimates has widened. we have our base case. we talk to our analysts in
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china, those covering u.s. companies looking at china, impacted by china, and say, how soon do we expect production to come back to normal levels? there is an expectation that if they come back by march, we will see by the end of march, if we see production come back to 80%, 100 percent levels, then this would be a one-quarter gdp impact. but if this spills over into the second quarter, coming back into production, you are looking at a larger impact. we simply don't know and don't have a clear way of estimating when all of this will come out. jonathan: you are touching on the happy talk around the v-shaped recovery, that has the -- at as the year gets older, the outlook looks better. priya, you are pushing back against that. why? priya: we don't know how big this problem is. perhaps there is a rebound but there could be some permanence to the loss of consumptions. to the extent services are impacted, if i'm not going to have a coffee every day, maybe don't have two cups of coffee. even if production comes back online, some of the loss could be permanent.
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i also don't know how weak it is. the bigger the drop, the longer it could take to actually rebound. i would completely agree with the idea, the uncertainty bands are high. when volatility is high, you need to pay me more to take risk. the equity market, credit market is not pricing that in. jonathan: you know why. this is tug-of-war between the central bank and the market right now. you have a market with loose financial conditions with the exception of the back end of this week. it's looking at a powerful reaction function from the fed, expecting the fed to do more. the fed is looking at loose financial market conditions and saying we are ok, we can wait. at some point that has to give, doesn't it, tony? the fed has to deliver. tony: that is clearly what squares the circle between record high equity markets, even though they are off the bid, very tight spreads and risk
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premiums, with treasury rates that are clearly pricing in what you would think are recessionary conditions. what connects the dots are global central bank liquidity, financial conditions that are very attractive for borrowers. you saw a record borrowing over the course of january, first couple of weeks in february, emerging market borrowers, investment grade and high yield. that liquidity that is helping the global risk market connects the dots between the very high-end certainty around fundamentals in growth, depending on where the coronavirus develops here, versus a treasury market that is clearly, i would say, the single safe haven in the global markets today. jonathan: today, the whole curve is sinking lower. forgive me, i feel like i say this every week. this shift in the reaction function of the fed this year is
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so powerful. you have a federal reserve that is telling us as things get better, we will not step in. if things get worse, we will be there for you. the market is listening, the fed is low for longer, but we don't believe it will make a difference. we think rates will stay where they are, we don't think inflation will pick up. is there any surprise that we see a 30-year sub 2%? vishwanath: the moral outcome for the fed this year is no cuts or hikes occur this year. but there is a risk premium, you are right. the function from the fed, and broadly the global central bank function has been to convince the markets that if growth falters, if financial conditions globally wobble, you would expect to see central banks easing more. we have been trained like this. multiple occurrences in the last five years and this has been the pattern. jonathan: right now, the 10-year, 1.47.
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the all-time low in the summer of 2016, 1.32. let's think about what that environment was like. we had a real risk in terms of perception of a global recession. we were wrong, but that was the view at the time. how much downside is there on the 10-year absent a u.s. recession? how are you thinking about that dynamic at the moment? priya: it might be useful to decompose it into fed expectations and term premium. if you look at term premium, we are pretty far from the lows. as much as i love treasuries -- we have talked about it in the past, i think bunds are extremely attractive. if global growth will be impacted, bunds can decline more. that can bring u.s. treasury's lower. even if the fed is not cutting, we could see the 10-year get to 1.25 or lower.
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this technical flow of hedging, it's the only safe haven asset. if risk assets are still high, what am i supposed to buy? businesses are not going to give me any hedge protection. i have to buy the 10-year. there is a decent amount of room for rates to fall even without recession. jonathan: what do you think of that argument? tony: it is legitimate for sure. we will look at 1.25 as a place where you can get safe haven flows. if you have that occur, it is probably because the news on the coronavirus continues to leak out negatively, increasing incidents of the virus. then you start to have greater probability of fundamental impairments, so not only china growth, but more broadly, in europe and the u.s. in that environment, where you see growth risk to the u.s. market, then i think you open up the playbook to sub 1% 10-year levels in a recessionary
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environment where global central banks are starting to run out of ammunition and tools to respond. jonathan: we will continue the conversation. you are all sticking with us. coming up on the program, the auction block. new deals for the primary market this week. that conversation is up 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 and kick things off in europe. jaguar shelving plans to issue its dollars bond after investors demanded too high interest-rates to compensate for coronavirus risk. in the u.s., high yield issuers on the sidelines after a $2.6 billion deal attracted more than $10 billion of orders.
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the investment grade primary market hitting some choppy waters with issuers paying elevated concessions to close out the week. turning to the hopes of a v-shaped recovery. mohamed el-erian pushing back. >> we have been conditioned to think of v's. everything has been containable, temporary, and reversible. this one i think will be different. those three conditions are not met by the coronavirus. jonathan: priya misra, vishwanath tirupattur, and tony rodriguez are still with me. what do you make of that? priya: the world economy was not firing on all cylinders when we went into this. we were already weak, supply chains were already constrained. european growth, we were flirting with recession. now we get this shock. is that enough to weaken things even further?
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i'm not calling for recession, but i struggle to see where certainty will come back. uncertainty remains high. we also have an election coming up in the u.s. the business, corporate sector that is dealing with declining profit margins, elevated level of uncertainty. i'm not sure lower interest rates help the corporate sector. you could certainly get some rebound. this v-shaped -- maybe it is u-shaped, maybe l. i hope i am wrong on the l. jonathan: many people hope that is the case as well. let's talk about credit. credit spreads have not widened a whole lot until today. before that, doing ok at 3.50 on high-yield. why? vishwanath: one, the investment grade market, as my colleague puts it, it is progressively becoming a rate product. it is becoming more of a proxy for the rate market. that is driven by the global
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easing, the hunt for yield that continues to drive rate of flows into u.s. investment grade. the market's conviction remains. i see the point that mohammed el-erian made, but the market conviction remains that the effect of the stimulus that the chinese will be putting in, the potential stimulus that could be coming from the rest of central banks, it would be a second half recovery. may not be a robust recovery. i agree there is greater asymmetry here, greater downside, not that there will be a huge upside. but i think the market has a strong conviction we will see a recovery and things will not fall off. jonathan: an interesting time. u.s. investment grade borrowing costs are at record lows. high-yield in europe, record
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lows. what is behind the dynamic other than central banks keeping them there? tony: central banks are key drivers. as a result, an insatiable demand for yield. you are seeing flows into the u.s. from foreign investors and also seeing u.s. investors looking to find yield. that is why we can get multibillion-dollar, weekly flows into the investment grade credit markets. it keeps valuations at a level that, as you know, we have been talking at for a while -- valuations are stretched. fundamentals, we think are reasonably steady, not improving dramatically, but not seeing big deterioration either. when you combine that with a strong liquidity, it's a place for investors to get some yield. we think the best case is that you have risk premiums remain steady at these levels, maybe a touch wider. there is very little room in our view for any kind of tightening from here. absent a movement toward pandemic conditions, and therefore, global recession emanating from this coronavirus, we think the fundamentals still point toward a 2% u.s. growth environment. that will help support credit
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when combined with global central banks who we don't think are anywhere near starting to reduce liquidity. jonathan: priya? priya: when investment grade corporate is considered a rates product, my blood pressure goes up. it was in the fourth quarter 2018 when the quiddity difference between government bonds and even ig credit was very stark. there is this reach for yield that is keeping spreads tightened. if default risk gets tight, if liquidity risk gets repriced, these breads have room to widen. then the only hedge will be u.s. treasuries. if there is a slowdown in u.s. growth or global growth, that becomes clear that a 2% growth economy is not lasting. jonathan: now some fallen angels in the mix in the u.s. i will not name the company, but there was a name out there in the last couple of weeks, an example of how some of these companies will not defend their investment grade credit rating.
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maybe they don't need to either. walk me through that dynamic. vishwanath: you are talking about kraft heinz. big name, outstanding debt for the name. it was downgraded by two agencies to below investment grade. what did we see? we have not seen a major reaction from the market. in some ways, the high-yield bond market -- you may hear this from tony -- has been relatively steady. not a lot of growth withstanding in the market there. the high-yield market sees this as a large cap structure, high quality high-yield name. therefore, there is a path back
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to investment grade. jonathan: with some duration. vishwanath: you have seen some support from the high-yield investor space. another important point, in this context, there are two things. one, when high leverage meets earnings misses, do the companies have the levers to pull to remain investment grade? do the companies want to exercise that option or not? they would not pull the levers and basically afford to take a 30, 40 basis points higher cost of capital. can they afford it? i think the calculation in this context, potentially they could have signaled they would move toward cycling those levers, but didn't do it. jonathan: still ahead, the final spread and the week ahead, featuring a slew of economic data, including china pmi's. that is coming up next. this is bloomberg "real yield." ♪
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♪ jonathan: i'm jonathan ferro. this is bloomberg "real yield." time for the final spread. coming up over the next week, g20 finance chiefs meet in saudi arabia over the weekend. saturday, it is the nevada caucuses. monday, we get germany's business survey, followed by the democratic debate in south carolina on tuesday. u.s. gdp and durable goods come out on thursday. closing out the week with personal income and spending numbers, and a big one, china pmi's. back with me, priya misra, vishwanath tirupattur, and tony rodriguez. can we talk about these china pmi's? i will run you through them. the estimates as they stand in our bloomberg survey, 47.4 is the estimate for manufacturing. 50.0 is the estimate for nonmanufacturing. bear in mind, this economy has been almost shut down for weeks.
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it is an estimate and can move around, but what are you looking for out of china in those pmi's a week out? tony: my expectation is i would take the under. [laughter] of course, hard to say how much do you really believe the data? it could certainly be a massage. it is hard to believe those numbers can stay even in the high 40's to 50's level given you mentioned you just had a complete shutdown for almost a month. i would expect to see weaker numbers than the current set of expectations. jonathan: the u.s. pmi was soft, the german pmi, we should touch in it a little bit, a really weird quirk. delivery times, as they linking, the number drops 50 on the subject index. then they invert it as a positive. on this occasion, delivery times have lengthened, not because demand or things have backed up, but supply chain disruption. priya: this pmi in europe did not pick up this coronavirus supply chain disruption. it is sort of an odd quirk in the data.
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absolutely if you look at the details, it was not a good report, which is why i am surprised with this narrative that the economy is ok and we are seeing the rebound. we have not really seen the weakness. for the chinese pmi, uncertainty around how the number is estimated, if the factories are shut, who are you serving? even if the numbers are good, i would think the real numbers are much worse. jonathan: and thinking about the prospect of rate cuts from the federal reserve sometime in 2020. let's get to the rapidfire round. three quick questions and quick answers. fed funds pricing in easing in 2020. i know it is premature, i just want to ask to see how this moves in the coming weeks. march 18, is the fed in play as you see things? priya: no. vishwanath: no. tony: no. jonathan: interesting to see how that changes in the few fridays
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coming up ahead of that. u.s. three year yield, around 1.90 at the moment. do we see 1.60 or 2.20? what do we see first? 1.60 or 2.20? tony: 2.20. vishwanath: 2.20. priya: 1.60. jonathan: final question. u.s. 2 vs. 10. in and around 10 basis points. do we go to zero or 20 first? vishwanath: zero. tony: zero. priya: zero first. jonathan: great to catch up with all of you. thank you so much. from new york that is it for us. we will see you next friday, same time, same place. this was bloomberg "real yield." this is bloomberg tv. ♪ [ fast-paced drumming ]
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♪ david: as a child, he grew up doing mathematics and was perplexed by anomalies that did not make sense to him, even the rules for scrabble and monopoly. so he changed the rules. he could not make mathematics work for him in the way he would have liked and in a way that would let him follow in the footsteps of his actuary father, so he turned to economics. richard thaler got his phd at the university of rochester where he entered faculty until he discovered work of daniel kahneman and amos tversky and made his way to stanford to study with them.


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