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tv   Bloomberg Real Yield  Bloomberg  March 18, 2018 11:00am-11:30am EDT

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♪ jonathan: from new york city, i am jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, is goldilocks growth a fairytale? this week's data does not fit the optimism. the beginning of the end for the good times in credit. recent issues show fragility. and looking ahead to chairman powell's first news conference. penciling in another rate hike. we begin with the big issue. is goldilocks a fairytale? >> we are able to see big increases in the labor force without seeing a big push and -- a big push up in wages. at some point, that will end.
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when that starts to end, i think we will see a reaction in the bond market. >> inflation has an enormous amount of inertia built in on the downside and upside and it will move slowly on the upside. >> the fed will have to pick up the baton and say we are responsible for leaning against the economy so we don't get an inflation spiral going. i think that is going to create complications, especially as the market has to start repricing for more rate increases. >> a little inflation is not so bad but it is a slippery slope. you can go to two and change to three weekly. -- 23 pretty fast. jonathan: is the genie out of the bottle? >> not yet, but it is knocking. i'm thinking about coming out, and if i do, then what? jonathan: joining me around the table is bob michael, kathy
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jones and douglas peebles. great to catch up with you. kathy, the issue with goldilocks. this week's data doesn't quite paint the picture that everything is ok in the u.s. economy. kathy: first quarter is always a little soft and we had a pretty good fourth quarter in terms of consumer spending, so i think what we are seeing is a normal retrenchment you see, particularly a lot of credit card debt was run of over the past couple of months. there is a tendency to recoup. in general, the economy looks pretty good, job growth is good and that drives it. jonathan: bob, are things maybe not as brilliant as they seem? our things as good as people expected them to be disappeared? bob: things are awesome right now. jonathan: walk me through why. bob: i love the current environment. look at capacity, look at small business optimism. it posted the second highest reading in history.
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the highest was september, 1983, during the reagan reform years. you look at wage gains, they are starting to pick up. and you look at the central banks. they are being slow and gradual and normalizing at a glacial pace that we in the markets can easily absorb. jonathan: doug? douglas: i think people are looking in the wrong place at inflation, we don't have much consumer price inflation or core pce. wherever the fed is. inflation is in asset prices. everybody thinks that is a great thing. if you define goldilocks as a buoyant economy, and i think i agree with bob, we not only have a buoyant economy in the u.s. but globally. we have very little pressures on consumer prices, but we do have asset prices that are robust. jonathan: bob? bob: that is what is so great. the central banks see the asset price inflation also. why are we fighting this? why don't we embrace the ecb? they have moderate growth, moderate inflation, they have
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asset prices inflating, why not enjoy the asset price inflation until it spills over into the real economy and you see an inflation surge? douglas: how did that work for japan in the late 1980's and 1990's? bob: they are still figuring it out. douglas: it did not work out. bob: but they have the asset price inflation going on right now. they have optimal yield curve control and it is spilling through. jonathan: not a single jgb 10-year traded. it killed the market. bob: 0.0. douglas: boj owns 70% and 80% of jgb's. kathy: i think it's dangerous. i think in some markets we are close to the bubble popping. in some markets, we are pretty close. it is always the trouble, how do you time that? how high do the fed fund rates have to go? i would argue we are not there yet because it is still below the rate of inflation and so easy conditions right now. bob: i think the fed has a long way to go. i'm interested to see next week where the summary of economic
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projections come out. i think the dots will just drift higher. they are behind the curve. kathy is right. it is a negative real yield. they are not interested in normalizing a volcker-esque pace. for us in the markets, that is just great. jonathan: you agree to things are great, so what is it in the price? if i can bring in the short positions of treasuries, the consensus is get your treasuries, and if you put that against the yield, i'm wondering if the pain trade might be developing in the short-term. i bother this line from elon musk. is it stormy weather brewing? bob: where is it? we should have seen it by now. you'd the short position has been built up for a month and a half. why are we not to 50, 260? -- why are we not 250, 260? it is because we have the central banks continuing to run down their balance sheets, particularly the fed. there is an incremental amount of selling going on. you have a lack of flows coming in overseas because the cross currency basis has shifted.
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if, in fact a short base were a big problem, i think we would see rates a lot lower. we have to accept we have not seen rates lower and more selling is to come. jonathan: doug? douglas: i agree but the ecb is still doing 30 billion euro per month. i think you see that impact on the bund market. every time the bund market wants to react to the data, the weight of 30 billion per month of the ecb weighs on it. the italian election is a perfect example. italian bond yields should be wider on the results of that election and they are not. the notion of price insensitive buyers impacting markets has not gone away. bob: but the magnitude has declined. january of last year it was 167 billion per month of new money being printed coming into the government bond market. last month, less than 40 billion. there is less of a backstop
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there. by october, it turns into net contraction. douglas: in october, we will have to see what that actually means. bob: it is a bond market that can support itself. douglas: exactly. jonathan: do you see that inflection point in october as something to worry about? kathy: i do. the fear of easy money is coming to an end slowly and gradually. as that happens, i am keeping an eye on the dollar. i think the currency market has been ahead of the other markets in this cycle and could signal, if we get a move up in the dollar, that could signal a further tightening of conditions. jonathan: do you see a catalyst for that? kathy: i think based on real yields right now, it should be higher, but clearly we have supply problems in terms of the u.s. market, both in terms of deficits and trade imbalance, we have a lot of political uncertainty going on.
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i would argue the dollar probably has room to move up from here. jonathan: another flashpoint has been a push higher in libor. if we can bring that up on the screen for our viewers. what is going on here? a lot of people scratching their heads and some have decent explanations. what is yours? bob: we look a lot at the libor. -- the libor overnight index swap basis. there are a couple of things going on, one there is a tremendous amount of issuance of treasury, 300 billion has put some weight on the market, you also have repatriation of foreign cash. a lot of the tech and pharma companies have cash overseas, they brought it back and liquidated short-term corporate and put more pressure on the market. on top of that, you have cross currency swap basis shifting. it's not as attractive for foreign investors to invest in the front end of the u.s. market. kathy: i would agree 100%. i don't think it is particularly dangerous right now, not signaling that banks are having trouble funding themselves or anything else, but keeping an eye on it and as libor goes up, it drives cost up for a lot of
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lending in the united states. that is a concern. douglas: i have total agreement. i would just caution one thing, often times we discount that the price move does not matter at this time, and because we have ways to explain it away, and then you look back and you say we should have listened to the libor spread. jonathan: it is not just libor. you can also look at paper and short dated bills in america, there's something on the front and that is high yield, and you wonder, we tried to have this conversation on this program, when does it compete for capital in a significant way? douglas: i think is probably indicating that the notion that capital is wanted by the real economy, which it has not wanted for a long time, and financial markets will have to compete with that in that shows up in price or yields. i think it is happening. bob: you look at three-month libor, 2.1%. suddenly, if you take a profit in an asset class, you have a place to put your money and generate a return.
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it's creating competition. kathy: i think you are seeing in -- seeing it in the equity market, dividend payers are losing ground because people can stick with shorter duration and much less risky asset and get a similar yield to a dividend yield. jonathan: you are sticking with us. coming up, the auction block. campbell soup offering this week, is it offering indigestion? coming up. this is "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 russia's bond sale is defining its most recent diplomatic spat. -- defying its most recent
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diplomatic spat. bids for europe on sale for russia were almost double the $4 billion, the 11-year note narrowing from initial guidance. in the u.s., another round of treasury offerings. $223 billion to be exact. we will highlight the average demand for 10-year note, fell to the lowest level since 2009. in the u.s. investment grade market, campbell soup sold $5.3 billion of bonds to fund its acquisition. they did not narrow to execution and weakened after they were sold. still with me, bob michele, kathy jones and doug peebles. in the good old days, 12 months ago, you could narrow through execution. that didn't happen with campbell soup. a lot of people use it as an
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example to say maybe it is the beginning of the end of the good times for investment grade credit. what is your view? douglas: i think it goes back to this discussion around the central bank. it is not an on-off switch, but they are slowing significantly. the liquidity that has been available 12 months ago, it is a different level now. it is a dimmer. we don't expect to see lights out at any point in time, but markets are behaving today i think more normal than 12 months ago. namely, there is a name that comes up, a concession in the marketplace, it prices, it does not trade immediately stronger but we are digesting it and from the day after issuance until now, it is doing reasonably well. kathy: there has been a lot of supply to absorb, a huge amount of supply to absorb, and you have the expectation of higher rates down the road. a year ago, i'm not sure everyone believed rates would move up and be higher six months or 12 months from now. now if you are a buyer, you have to give some concession to discount the potential gain. jonathan: it's not dramatic but something you should take some time to look at and pay attention to. do you see some soft spots in investment grade? bob: no, i don't.
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i think the market got addicted to massive flows into the market. one was asian cash coming in, when hedge fact yen in particular was attractive to the local market. that has dried up as the yield curve has flattened. and a lot of the offshore cash trapped on corporate balance sheets. with tax reform, this gets repatriated. the market is trying to adjust to the absent of those two flows, which i think covered up a lot of deals. jonathan: we caught up with scott. this is what he thinks you should do with credit. scott: in fixed income, people should be dramatically upgrading the quality of their portfolios. it is time to get out of high-yield. bank loans typically performed fairly well at this phase, but at some point you should be out of it. investment-grade corporate debt,
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i would get out of. jonathan: kathy jones, your thoughts? kathy: we are not underweight high-yield or investment grade, but we have been moving up in credit quality, and have been for some time because spreads were so narrow and the premium you got for credit risk was low. i would agree to some extent. the other problem is timing. you don't really know when the cycle turns until it turns abruptly. we think it is time to dial back the risk. bob: i think when you look at bank loans, and this market today, things that we worry about are liquidity and crowding, and i can't think of a better example of double the risk than bank loans. you have a tremendous amount of people who own that class who don't understand it well. the second thing, the liquidity is not good in that market. it is terrible. you get crowding into liquidity,
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that is what we would sell. bob: i have been doing this 37 years. i don't remember a time when corporate america has had more financial flexibility. i certainly would not be a seller of credit in here. i think the horizon looks pretty good. when you look at credit spreads, high-yield in particular, you can build a model, there is only one thing to get right. the expectation of default rising. that is highly correlated to an approaching recession. if you don't see an approaching recession, you will not see default rising, and you are not going to see a lot of pressure on the high-yield market. i would like to buy cheaper but i will take it. jonathan: isn't that the point, if it is so good and corporate flexibility so great, the rough end of the deal is an investor hands? bob: in some transactions, maybe. by and large, no. they have this enormous tax windfall coming to them. it is not a one-time windfall, we get hung up on that. it is year after year. they do have a lot of
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flexibility. douglas: i think when you look at the average credit quality of the investment-grade market today, it is pretty low. i am with bob, you want to clip your coupon as long as you can, but also with kathy that it is hard to figure out when to worry about clipping the coupon. when the time comes, i think the amount of ig issuance that falls, the fallen angels so to speak, it will dwarf anything we have seen. jonathan: we can look at the leverage of investment grade, it has been picking up, in the data and numbers. nevermind the sentiment. it is there to be seen, isn't it? kathy: that is one of the biggest concerns. you have had a huge increase in leverage on corporate balance sheets. when the moment comes, the inflection point comes, when it is harder to service that debt or you know are got it paid a lot to take the risk. jonathan: the leverage is picking up? bob: it is true. i would argue companies did the right thing when they built up that leverage. they had ultra, generational funding and return that the shareholders. this is a new year, earnings estimates are up in the have financial flexibility, tax reform windfall and they will
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generate earnings to cover the leverage. jonathan: in terms of a big story this week, it goes to show investors can be terrible at timing. toys "r" us. you bring them up and it is easy to say you can take your point and look back on things and explain them away perfectly, but no one saw this coming in early september when this debt was trading close to par and then out of nowhere bang. bob: i'm sorry. toys "r" us, people have not been looking at brick-and-mortar stores. and talking about the threats. jonathan: we have doing it for years. why was it trading near par in september? bob: i don't know. maybe it's the passive etf story. [laughter] douglas: i am with bob. jonathan: i think there might still be some skin in the game. i want to get a market check on where bonds have been through the week, twos, tens and 30's. 2-year note higher by two basis points, down eight on a 30 year. some curve flattening once again in the treasury market. still ahead, the final spread, the week ahead featuring rate decisions from the fed and bank
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of england. this is "bloomberg real yield." ♪
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♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield," and it is time for the final spread. coming up over the next week, it is a big week to come with jay powell's first rate decision and news conference since being elected. plus, a decision from the bank of england, a new governor of the bank of china, and another potential u.s. government shutdown that not many of you will be paying attention to. still with me, bob michele, kathy jones and doug peebles. do we assume that the federal reserve next week grants three?
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kathy: you need four dots to move. to get the median to move up. i think it is doable. assuming that powell is one of them, i think we could see the dots grind up a little. jonathan: doug? douglas: i think we will certainly see some sort of inching higher in and out, the dots and they should be moving higher, but i think the real story is the market is coming up to meet the dots. it has been a long time since we have had that. jonathan: without much encouragement, it has just happened. bob, incredibly enthusiastic in the last 25 minutes, but isn't it most prudent to have optionality as a central banker and leave the upside risk of a four rate hike move further into the year and leave it at three? bob: i think they will leave it at three rate hikes this year. we are interested in the longer-term dots, where is the two and three quarters moving to? is it getting back to three or higher? jonathan: is there a catalyst for it to shift up? bob: i think there is pretty good growth and the labor market looks pretty tight.
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why not start to get back up to a level that looks more rational on the historical perspective? jonathan: if the fed is starting to guide higher for longer-term rates, how would the market react? kathy: i don't think the general public talks a lot about this, but if you start to see the terminal rate move up, i think it would catch a lot of people's attention. 10 year yields tend to peak with the fed funds rate, so we see the terminal rate move up, we can expect bond deals to move up that should -- we can expect bond yields to move up as well. jonathan: is there a reason for terminal race to shift higher instead of just dropping? douglas: not necessarily. if you look at what potential growth is in the u.s. economy, it has not changed much and productivity is what productivity is. jonathan: isn't that the point, the long-term production potential of the economy isn't improving that much? you might get a short-term boost
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from fiscal stimulus, but longer-term, what is the story? bob: i think longer-term you can expect some shift. you are at a generational transition, the baby boomers are moving out, we are passing that on to millennials. you have to plan for that. we are coming into more of a technology-based economy. at some time you will reach capacity there. when i look at the dots, i don't know how forecastable they have been. it strikes me that they have been coincidental to the rates. jonathan: let's wrap up a program with those thoughts. all of you, let's begin with a quick question with short yes or no answers if possible. him and does the fed stick with four or three? bob: three. kathy: four. douglas: four. jonathan: have 10-year treasury yields peaked for 2018? >> no. >> no. >> no. jonathan: have we seen the bottom for credit spreads this year?
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have we seen the bottom for credit spreads this year in ig? yes or no? bob: spreads are going tighter. jonathan: they're always going tighter for you. kathy: yes. we have seen below. douglas: pretty close to the low. jonathan: great to have you with this, fantastic program with us. thank you for joining us, bob michele, kathy jones and doug peebles. from new york, that does it for us. we will see you next friday at 11:30 a.m. new york time. this is "bloomberg real yield." ♪ retail.
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