tv Bloomberg Real Yield Bloomberg June 4, 2017 5:30am-6:01am EDT
jonathan: from new york city for our viewers worldwide, i am jonathan ferro with 30 minutes dedicated to fixed income, this is "bloomberg real yield." ♪ jonathan: coming up, a downside surprise on payrolls. may job numbers in the united states disappoint. wage growth goes nowhere fast. fuel for treasury bulls, the 10 year yield plunges to a new low. spreads just keep grinding tighter. we start with the big issue, the payrolls report injecting uncertainty into the fed's next move.
>> it is a weaker number than the market expected. >> it is a weak to mixed report. >> it is disappointing. >> the overall trend is good. since inauguration day, the u6 rate is down 12%. we have brought back 12,000 people that were disappointed or underemployed. that, to us, is an amazing trend. >> we have already begun to question the fed's rate have on inflation data. this is only fueling the fire, so to speak. inflation is one side of it. now you have the labor market data disappointing little bit. it is not surprising that folks are starting to question whether the fed will go twice this year and three times next year. >> the chair believes in job growth more than anything else. it is lower than the market expected perhaps, but she is going in june. >> june is on the table, 60% to 70%. september, probably off the table at this stage. jonathan: let's bring in our guests around the table.
what a lineup we have for you. bob michael with jpmorgan. kathleen gafney at eaton vance. and mike collins, senior investment officer at pgim. the message in treasuries, i want to start there. it is yields and spreads and a curve that is flat, flat, flat. whatever you look at, one day it is something, the other is 50. that is the -- just as flat. it says i don't buy the reflation story anymore. what is it saying to you? michael: markets are coming around to the view we have had. the fed is going to keep pushing the front end up, and the long end is pricing in the slower growth. i think that is coming through on the treasury curve. i would argue there is more room to run. typically in past cycles, i have
a chart of 230 spreads going back decades. typically that goes to zero. when the fed is done hiking, let's say they get to 2.5%, you will see yields around that level across the whole curve. jonathan: that 2.30, you think we can get flat? michael: if they keep tightening. if they insist on hitting that 3% long-term dot they have. i think that is too much. kathleen: i think they are definitely pricing in weakness. i think there is good demand in the economy. i think it is a misread. i think the weakness is just short-term. jonathan: bob michele. bob: i think it is more about flows than expectations on the economy or the fed. i think there is so much money out there. central banks outside the u.s. are still printing money. there is $2 trillion a year that is being printed and coming into the bond market. that is what is keeping yields down. jonathan: let's talk about how difficult it has been through 2017 to be a treasury bear.
bob: it has been tough. it definitely has been tough. if you look at a couple things, central banks have been a bit more hawkish than anyone anticipated. you have got the fed talking about taking down its balance sheet before the end of the year and pretty committed to more increases in the fed funds rate than everyone anticipated. you have the ecb talking about tapering their balance sheet. corporate earnings look great. the revenue recession of last year is gone. they look very, very strong, so i think there is a lot of good going on in the market. i think the term premium in the bond market is wrong. i agree with kathleen. but i accept that there is a mountain of cash out there. it is being printed every month. it is hunting for anything that looks high in yield. jonathan: is there a message for the fed? mike collins. michael: at the beginning of the year after the trump trade, the markets were pricing in a funds rate of about 2.75. that is something we look at.
we are long-term investors. today, this rally we have had, the markets are pricing in about 1.75, that is probably much closer to what is likely to be realized and closer to fair value. so even as a bond bull, you are supposed to fade this rally a little bit because a lot of those lower rate hike expectations are being priced into the market. jonathan: kathleen, you want to weigh in? kathleen: i think the challenge for the markets is if you look at the short-term data, it says we should take a pause. when you look at what rates are pricing in over the next two years, it is only two and a half hikes. that is not enough for the economy. it is tough to be a bond bear. the risk with rates so low is there's a lot of downside left on the table. bob: don't listen to me. listen to brainard. she laid out a clear and precise path for fed tightening.
when i look at bloomberg financial conditions, it shows that the fed has raised rates three times, financial conditions have actually eased quite a bit. this suggests they are falling behind. remember, they stopped raising rates, stopped qe because financial conditions had tightened. now that they are going the other way, it is more than offset. kathleen: it is not tightening. it is just less accommodative. bob: true. they have miles to go. if i were the fed, go every other meeting until you get to 2%. that is the zero real rate. wait there. jonathan: you said the signal is they are not going quick enough, but you look at twos and 30's, but you are saying maybe they are going to fast. michael: we are still short the front end.
they still have this 2% dot. it looks like they are adamant to rate hikes. some of these more dovish members are getting cold feet. you look at the surprise index, that is rolling over heart. bob: at what point do they get cold feet? not a three quarters of a percent. maybe a year from now. michael: we should all hope they get to about 1.5% to 2%. kathleen: my question is what are they tightening for? they seem to be tightening as a result of the labor market. it has reached their goal. what nobody is talking about is inflation. they just don't think it exists. and yet, every day that goes by, we get more and more risk of inflation heating up. bob: they are tightening to normalize. surely a -1% to -1.5% real rate is nowhere near normal. get to something that looks normal or at least neutral. then see what happens. she talked about the term
premium, and she said it is the foreign money coming into the u.s. market. so there you go. jonathan: let's talk about the global reflation story. the last time you were on the program, bob, and you have the face-off between the bulls and bears, you brought up chinese ppi. it is not just inflation in the united states that has started to bleed, in china we started to roll over of it. does that make it difficult to remain a treasury bear when the data for 2017 seems to have peaked? bob: it doesn't make it more difficult to be a treasury bear. i still think it is pretty stupid to buy treasury bonds at these levels when everything coming out of the central banks tells you that over the next year they are going to withdraw accommodation. we are debating the speed of it. that is a secular change. i think china has done a great job. i will take the other side of that. they have a very complex array of problems to deal with. i think they have done it well. they tackled the banking system. they tackled what they needed to
do with infrastructure. they are targeting a reasonable level of growth. not something above 10%, 8%. 6.5%, i think that is a good level. jonathan: you say it is stupid to buy a 10 year, but 30's at 1.52, is that too steep? are you confident and that curve? bob: absolutely. everything the fed is telling us is that by the end of the year they are going to begin balance sheet reduction. that supports the market having to deal with. so the traditional metrics we have looked at, when the fed raises rates, the curve flats. it is built into everyone's interest rate model. we have never had to build in, what happens when they control the long end of the curve? we will have to adjust for that. michael: i totally agree with that. that this will not be a normal cycle. in the past cycles, they had one tool. it is the funds rate. now they have two.
i don't think you will see the curve get flat as a pancake. jonathan: kathleen? kathleen: my only concern is that the supply at the long end is shrinking. so, actually, i don't think there's going to be as much havoc in the market because there is less supply. bob: it depends on what balance sheet runoff they have. kathleen: true. bob: in 2018 and 2019, they have $800 billion in treasuries that mature. having something that is transparent and steps up. if it gets to say, i don't know, $10 billion or $20 billion in treasuries and mortgages per month, we can absorb that. i still think it leads to a steeper curve. jonathan: final question for you michael collins, are the numbers today an opportunity to sell down holdings? michael: yes. we're going to cut down a little bit at these lower levels. maybe they don't hit 1.75, but that is much closer to fair
the spread between high yields bonds and treasuries is expected to tighten. currently that spread is about 360 basis points. as investors search for yield, selling $1.25 billion in bonds, managed to increase its offering from one billion, offering five-year notes with a coupon. i want to bring back in the bob michele, kathleen gaffney, and michael collins. kathleen, let's use that hertz offering as a catalyst. how difficult is it to get adequately compensated for the risk you assume no matter where you look? kathleen: you are not adequately compensated no matter where you look. it is tough, tough, tough in high-yield. jonathan: let's use the car rental companies as an example. they have a capacity issue.
they have an issue around the price of their vehicles. a lot of people are looking at the companies and saying there are problems in the subprime auto debt, and problems with these companies. michael: there are two problems with the credit markets and high-yield markets, one is these cracks we are seeing on the credit side. you mentioned subprime auto lending. the auto companies themselves have finance arms. we are seeing auto sales and auto production rollover. you're seeing problems in the auto rental companies, big problems in retail, and some signs the lodging sector is being hit by technological change of potential excess supply, so you have valuation problems. one third of the bonds in the high-yield market have spread under 200 basis points. i don't think we've ever seen that. jonathan: bob? bob: i think everyone is being a little too greedy on the high-yield market. i think a spread of 360 basis points with default rate coming down, we had the accident in
energy, and default rates only got to 4%. we are headed to 1% by the end of the year. 360 basis points compensate you for that. i would like to buy high-yield at 8% to 10%, but i cannot. if i don't buy it, someone else is going to come in. as long as defaults don't go up, i am ok. jonathan: what about the auto related concerns, the specific cracks in high-yield? bob: there are some. you have to understand what has happened in the auto industry. there were no purchases of autos in 2007, 2008, 2009, and that pent-up demand got sated in 2012 through 2014. you had that buildup of credit, and yes, you are seeing some delinquencies and losses going up as a normal curve would. but again, in that market, like in a lot of credit markets, you cannot buy it at the spread you might like to buy it at, but you are getting 35% credit enhancement.
jonathan: the fundamentals are rough. you take the autos, for instance, take this chart we can pull up. you look at inventories for every car sold, outside of recessionary periods we are at highs or off of highs we haven't seen since the 1980's. there is a lot of inventory out there. kathleen: why buy a new car? i am at 110,000 miles on mine, and i'm going to go another 110,000 miles. there is no need. there is less demand because of technology for cars. it doesn't mean there is weak demand in the economy. jonathan: let's talk about demand in the debt market. are you concerned about subprime auto loans or hertz or car companies? kathleen: i am concerned about the health of the auto companies. i think they represent poor value right now. i would stay away. that doesn't mean you cannot find good opportunities in credit or high-yield if you
broaden your horizon. corporate are a good example. jonathan: mike? michael: that 360 spread on the high-yield market is a little misleading. a lot of the cable companies, health care companies, consumer companies, gaming companies have those really, really tight spreads, those sleep at night ones. if you want to get that average yield, you have to do a barbell and take a chance, and hopefully you are ally smart oally lucky and add value. jonathan: going through the notes of individual portfolios, what stood out for me is your cash allocation. it is about 15%. it is really, really high. kathleen: it has been higher. jonathan: justify it for me. kathleen: there is little to buy if you are a value investor thinking about the long-term. i don't want to take risk, so i don't own treasuries. credit spreads are two tight. i worry about the bond math. yes, the fundamentals are good, and it has paid to be an credit for a very long time, but i
don't want to be the last one at the party. bob: all year, everyone in any asset class has suffered from valuation fatigue. everyone would like to buy cheaper. valuations have been stretched by a lot of metrics. i will agree with that, yet the money keeps pouring in. and maybe we are supposed to blame the fed and central banks in aggregate. maybe they are supposed to step up the reduction in their size of their aggregate balance sheet. maybe the fed starting is just not enough, but until that ends, you will feel the pain. because the money is being printed. it is going to be exported to us in the u.s. and we are painfully going to have to invest it in asset classes where we do have valuation. kathleen: you can reach out more broadly. 15% is not a high cash position, i have been as high as 20%, 25%. bob: where are you reaching out? kathleen: currency and emerging-market corporates.
it is a lot about technology, globalization, the challenge to get growth going. there is a lot of upside and growth potential about emerging markets. markets are nervous about emerging markets of protectionism. bob: that is a quantum increase in risk. you are predicated on the developed markets being somewhat robust. we talked about china slowing down and the central banks not pulling the liquidity. kathleen: you are talking about the perception of risk. i would argue that em corporates and reform potential in em countries is a much better risk to take than to take the rate risk with 10 year treasuries. bob: i will confess, i like local emerging markets. jonathan: that is not a confession. bob: i will confess to that. you are right. they are still statistically cheap from where they were back when the taper tantrum started. i like the government bonds. i like more liquidity there.
i like the fact that they have a higher real yield. it is at the highest relative to the developed market. jonathan: looking at the bloomberg barclays, talk about the sleep at night buffer you might have or maybe not at all. kathleen: no. not at all when you look at breakevens. i have a chart here that looks at the u.s. agg equal weighted for duration. if you look back at 2008, we were at 1.60, so a nice cushion. today in the lower right you see we are at 42 basis points. if we get an increase in interest rates, you are wiping out that total return potential. that is where i get very nervous about staying too late in credit. jonathan: guys, you are all stay with us. bob michele, kathleen gaffney, mike collins. let's get a market check on where bonds have been this week. yields grinding lower by two basis points on a two-year. 2.81%.
jonathan: i am jonathan ferro. this is "bloomberg real yield." it is time for the final spread. coming up over the next week, rate decisions from the ecb, australia, and india. the big event in the u.k., the election. june 8, busy, busy, busy. the u.k. election, the ecb, and director comey is testifying as well. back with me to wrap up a few final thoughts and a look to next week, bob michael, kathleen gaffney, and michael collins. what are you looking for?
michael: we are going to start talking about tapering purchases of bonds. the fed is years ahead of them. the fed is talking about reducing the size of the balance sheet, and the ecb is talking about reducing purchases. look at the data out of europe, spain, italy, greece moving ahead. italy has posted better numbers. europe is outgrowing the u.s. right now. kathleen: i completely agree. europe is going to become the focus. there is a lot of youthfulness coming out of europe, and we have inflation there too. jonathan: i want to wrap this up with the rapid fire round. one word answers from each of you. do we hit 2% on the 10 year before we hit 2.5%? bob: 2.5%. kathleen: 2%. michael: i wish it was 2%. jonathan: high yield or cash? bob: high-yield. kathleen: cash.
michael: high-yield. jonathan: are you long euro or long sterling going into next week? bob: sterling. kathleen: euro. jonathan: mike? michael: i will take the other side and go with the sterling. jonathan: it has been great to have you with us on the program. kathleen gaffney, michael collins, and bob michele. that does it from new york. we will see you next friday with special coverage of the u.k. election and that ecb decision, the reaction taking place next friday. this is "bloomberg real yield." ♪ ♪
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