tv Bloomberg Real Yield Bloomberg March 5, 2017 12:00pm-12:31pm EST
jonathan: from new york city to our viewers worldwide. i am jonathan ferro. with 30 minutes dedicated to fixed income, this is "bloomberg real yield." ♪ jonathan: coming up, the final word belongs to chairman yellen ahead of the central banks march meeting after a week of fed speech shakes up the treasury market. le spread dominates eruope. french presidential candidate emmanuel macron gains ground in the polls. and the window for issuance opens up. deutsche bank is said to be reviewing options to raise capital. tcw's tad rivelle tells us why he is getting out of that
sector. we start with a big issue. why for the treasury, it is all about the fed and the potential move in march. >> she kept the march meeting. >> there will be a rate hike in march. >> wage growth is the most important number that will determine what the fed does. what the fomc meets in the middle of march. >> i think the fed has been itching, wanting to raise rates for some time. >> i don't think there is going to be a hike on march 15, but i can understand why the odds climbed from where they were. >> the fed is taking a big risk by moving early. they are dictated by the calendar in europe to some extent, so that is why they might want to move early. jonathan: fed speak has been front and center. officials seemed to be leaning towards a hike this month. even the fed's chief staff, lael brainard, said it will likely be appropriate soon to remove additional accommodations, continuing on a gradual path. we want to bring in the guests. joining us from l.a., tad
rivelle is tcw's chief investment chief of fixed income. with me in new york, jeff cucunato of blackrock's head of u.s. investment grade credit and, of course, oksana aronov, the alternative fixed income strategist at jpmorgan asset management. it seems the journey for the federal reserve will begin a little bit earlier in 2017. has the destination, the terminal rate, the ultimate endgame, has that changed at all? tad: well, the fed is obviously in a period of transition. the janet yellen dovish fed we have lived with a number of years has vacancies. there is going to be a presumptive change with respect to who the chairman's going to be in a years time. i don't know if we can make any long-term productions on where the fed wants to take the rate environment. certainly, as the chatter you have put together in the clip indicates, the believe has -- the belief has changed in the
marketplace as it relates to the near-term probability of a fed tightening. but i think the reality is the fed talks an awful lot. for years and years, we keep hearing the same thing out of them. that they would love to raise rates when they reach their targets, and when they reach the targets, they redefine what those targets should be. as it relates to what we are looking at currently, there is a higher probability of the fed going at its next meeting in the middle of march. on the other hand, the quote you put forward a few moments ago also indicated what she said was "soon." "soon" doesn't mean march. it could mean may or june or could mean never. as i said, the fed has a very poor record of actually doing what they said they were going to do. oksana: i would say that not only does the fed have a very poor record, they do not really do what they say they will do. in general, if we look at any investor who has tried to predict the directionality of
rates, doing that is a failed prophecy. i find it frankly comical that we are calling this move early. the fed has essentially been looking at the same stream differently depending on where market sentiment has been, and because it very hard is starting to experience -- jonathan: comparatively earlier, yes, but is the fed behind the curve to some extent already? tad: i think the way the fed defines it, even the way they defines it, they are probably somewhat behind the curve. the way it should properly be i think defined, which is not just to focus on inflation and growth, but rather a focus on the amount of leverage in the system, the amount of financial excess that has gone on during these years. i think you can make the case that they are years behind the curve as it relates to having
normalized rates. probably or perhaps going back to the taper tantrum of 2013. i think the longer term context here is we should remind results ourselves that 0% rates, when implemented, was an extraordinary measure. it was taken as an emergency response to a dire financial situation. we have lived, essentially, for eight or nine years within spitting distance of 0%. jonathan: i want to bring up what you said, and that is the word "leverage." i want to talk about leverage, specifically in credit. cross single-a's, double b's whatever grade you look at, , leverage has been building up over the last year or so. bloomberg intelligence put this together. whatever it is, leverage has been climbing. what is the message for you? tad: well, that business cycles, asset price cycles, are killed,
ultimately, by excesses of leverage. there are a number of places in the global financial system where we do see excesses leverage. the corporate area or the investment grade corporate area is indeed one of them. while i cannot comment likely on the chart you have in front of you, i put this statistic in front of you. according to data as of one quarter ago, the median level of leverage on a gross basis in the investment grade sector is about three terms. meaning three units of debt for every unit of earning. traditionally, two to two and a half terms of leverage marks the outer boundaries of what rating agencies have considered to be investment-grade. four terms is basically where you start the high yield universe. so the medium to half of the investment-grade universe is already beyond the traditional metrics, which implies there is a high degree of ratings risk. and should there be a profit slowdown or, indeed, an economic
recession, we are probably going to see a massive amount of downgrade to below investment grade. jonathan: i want to bring in blackrock's jeff cucunato. china to get the other side of the trade. -- trying to get other side of the trade. spread is high, leverage is up. explain that for me. jeff: i think the points that are made are very valid. in that leverage is high. there has been a tremendous amount of debt issued. i think there are offsetting factors working to, in essence, extend this credit cycle. i think that when you look at net leverage, it is not as high. what you're seeing is some of the companies issuing debt are those that can afford to issue debt. so some of the large technology companies have issued massive debt that they have kept offshore therefore they can't access that cash, but the net leverage is quite low. the other thing is i think the debt that has been issued, which may be a problem at some point,
has been at low rates. so the interest coverage aspect of things is still quite healthy and high. the last thing is when i think about investment-grade companies, what gets investment-grade companies into trouble a lot of times is the ability to roll over debt. i would say that companies have done a good job of turning out the debt, so you don't have huge debt maturities in the coming years. jonathan: i have to know where you sit on the current argument. oksana: i think the broader question that we are discussing is are we seeing a bond bubble? right? jonathan: we've been talking for now.for how long oksana: and i don't think it is applicable specifically to credit. yes, we are seeing a bond bubble broadly. because broadly, yields are at multi-year lows. no matter what part of the market you look at. what is important for portfolios and investors is how much
incremental compensation are you getting for the incremental risk you are taking on. when you look at the market through that prism, it becomes clear that you are not getting enough compensation in anything bb and above. all of that is moving purely off of interest rate risks. which is a huge wildcard, to say the least. bb's are trading at high 200 spreads now, which is roughly 30 basis points off their all-time low. triple c's are trading at 279 basis points roughly, which is roughly 200 to 250 basis points off they are low. even if you see egregious losses, you're compensated to take the risk. but that is not necessarily how investors define safety. jonathan: at this point, we talked about if we are in a bubble, talked about credit, let's talk about treasuries. oksana said we have been dead wrong on rates time and time and agai again.
we come into a new year again where the market is dead wrong on fixed income and again, we are waiting for inflation. i'm looking at a 10 year breakeven. we haven't aggressively pricing -- have an aggressive repricing after the election. now we have done this. nothing for months. where is the reflation? tad: well, reflation -- i think first of all, we should recognize that their rate rise, as you pointed out, occurred postelection. and post the election, i believe the proper interpretation is twofold. it is, one, to recognize monetary policy, while not irrelevant, is not the be-all, end-all that it had been for the eight years of the cycle. the change in political regime i think indicated to the marketplace that fiscal policy was going to become a much more component of the valuation proposition in the treasury market. i think that is just a fancy way of saying tax cuts are certainly in the cards in the near-term.
that is going to expand the federal borrowing requirement that, should all other things being equal, which of course, they never are, should put up ward pressure on rates. i think you are quite right, as it relates to the market, is becoming more concerned about the prospects of inflation as conventionally defined. but i think the conventional definitions and metrics are pretty narrow. when you think about it, about 30% to 35% of the consumer price index, while not the preferred measure of the fed, the 30% to 35% of the cpi is a made-up number. the owner's equivalent rent. it is a manufactured number. it may not be presenting you a very relevant picture of nascent price pressures. jeff: i was going to say, we discuss in our morning meetings this exact point, which is people talk about the trump reflation trade. i think there is a compelling argument to be made there are
two separate trades going on. there is a cyclical reflation trade that started well before the election. then the election itself sort of turbocharged that reflation trade. so the cyclical trade may be getting longer in the tooth. but the trump trade, in the way that if you get the policies spoken about, may actually still be coming. jonathan: you're sticking with us. tcw's tad rivelle. jeff cucunato, thank you. the markets this week, big repricing for treasury. specifically on the front end of the curve. two-year yields up. 19 basis points on the week so far. up to 251. coming up next on this program, we take to the auction block. we head to a european market held hostage by politics. you are watching bloomberg. ♪
♪ jonathan: from new york city, i am jonathan ferro. you are watching "bloomberg real yield." i want to take you to the auction block where emmanuel macron is helping stoke demand in europe. the treasury in paris saw more than $7 billion in debt and investors ate it up with 10 year bonds jumping to the highest since october. that risk created some optimism in the spread to the french 10 year bond and the german bund. that spread shrunk to the tightest in about a month. and proving corporate issues are held hostage somewhat by politics, we have coca-cola and pfizer driving issuance about 14 billion euros. to talk europe and all things credit, i want to bring back in our roundtable.
tcw's ted rivelle, blackrock's jeff cucunato, and jpmorgan's oksana aronov. what do you make of a credit market, sovereign debt market held hostage by a single election in france? oksana: the european market is held hostage by a number of things, including the political picture. the ecb owns 10% of the european corporate bond market. that is roughly 800 securities, and roughly 100 of them are negative yielding securities. so as the bond market nears the end of the corporate support, every one of those issues will be evaluated on risk, the sovereign risk. the fundamentals are probably being overlooked by now. in that perspective, they are in proposition because you are dealing with the end of the purchase program. you are dealing with political risks that are frankly hard to know. marine le pen, as much as much as her numbers have calmed down,
i think the probability of her winning should not be completely dismissed, so that wildcard is still out there. the regulatory picture is still somewhat unclear. jonathan: let's look at the situation in europe. for yields over in france, i wonder what takes us higher. in the short term, you could get a macron win, which gets yield lower. but fundamentally, you need growth and reforms to take it higher. will that happen anytime soon? what will fundamentally drive core yields higher? jeff: i think it is not a fundamental issue in the near-term as much as what oksana referenced, which is if you get through these elections, focus starts to turn towards the ecb exit and what that means. you had the same cyclical turn in growth i referenced before occurring in europe, but it seems more cyclical than short euro. i do not think a lot has been done to address the growth potential issue, so i think, to
your point, the fundamentals argue for lower rates. i think the risk is the ecb. jonathan: let's talk about a chart. this shows high-yield in europe. high yield in europe is tight because of what we have seen is yield in europe blow out the beginning of last year. then never really recovered. here is the spread for the cocos versus the high-yield. what does that tell you that the banks in europe have not cleaned up anything in a big way? oksana: very true. the broader conversation here is about banks in europe, frankly. the rising, steepening yield curves are a positive for banks. but when you talk about the european banks, corporate purchase programs have not received support from that program.
and there has not been an enormous amount of pressure on them to clean up the way u.s. banks have had. i think this brings it back to implications for portfolios and investment opportunities. there will be better entry points into those markets, certainly into the european bank markets, then there are now. jonathan: do you agree? is there an entry point down the road for european bank or do you want to outsource? tad: yes, there will be better entry points down the road. you have to look no further than the problem loan ratios to recognize europe is not even close to having dealt with the issues from the last cycle. and we should remind ourselves for every problem loan, there is a problem company on the other side of the loan. until you do something about those problem companies, your growth problem is going to be with you. the political challenge of dealing with that is massive. and we have not even begun to deal with that in any meaningful way. jonathan: deutsche bank in the news, potentially a capital raise. are they top-down issues? or are they bottom-up issues?
tad: well, deutsche bank a few months ago came to the u.s. markets, or the capital markets, and borrowed in dollars. my recollection is they borrowed five-year money about three or four months ago. they paid about 4% or 5% for it. here you have is what many used to think of as a money center bank borrowing in dollar term at dd spread levels. which is to say it does not matter what my opinion is. capital markets have spoken, which is to say these institutions are not deemed as being especially credit worthy. jonathan: guys, you're sticking with us. tad rivelle, jeff cucunato, and oksana aronov. the markets capturing these stories of optimism in the united states and pessimism and in europe. it's the spread between the two year in germany and united states blowing out to euro area wide. coming up, we talk the final spread.
♪ jonathan: from new york city, to our viewers worldwide, i am jonathan ferro. you are watching "bloomberg real yield." it is time for the final spread, where we look at what us coming up over the week. we have a speech from the fed chair later. and we conclude a busy week with the u.s. payrolls report. head of that, futures trade scrambling to react to hawkish talk. volume surged across fed funds futures. still with us to round out the program, our roundtable. tcw's tad rivelle, blackrock's jeff cucunato, and jpmorgan's oksana aronov. as you look ahead to a series of risk events, the fed chair
speaking of 30 minutes time. do you look at the technicals and treasury? oksana: we talk a lot about the fundamentals, the economic fundamentals that are going to drive yields, hopefully. but there is something else going on in the technicals of that market space. we do know there is $600 billion of maturities coming off of the fed balance sheet the next couple years. the fed has indicated they are looking to reduce the size of their balance sheet. once the rate goes above 1%, which is not so unbelievable. that is something to keep in mind. when you look at the largest holders of treasuries, the fed being the largest, the next to being china and japan, both of them have reduced their holdings due to the economic picture in their countries. but they are reducing the holdings of treasuries. finally, when you look at what the banks have done because of regulatory requirements, they have doubled their high quality assets. because they are required to. if the current administration starts to reduce some of the regulatory pressure and change some of the regulatory guidelines, what does that mean for technical support of the treasury market?
so i think even from a technical standpoint, it is really hard to argue that there are any bargains there. jonathan: you mentioned the fundamentals the fed is facing. we can look at the balance sheet of the federal reserve and the treasuries they hold. 2017, 164 billion this year. 2018, if they start rolling the stuff off the balance sheet, that is 425 next year. 350 after that. tad rivelle, when the fed speaks a little bit later, we all will be looking for comments from her on rates. when do they get serious about the balance sheet? tad: well, as you indicated, what they have said is when they get north of 1%. i think more realistically, as rates rise, potentially, the fed is faced with a dilemma. which is as you are pulling around trillions of dollars, the fed is going to be accountable. that's potentially on a market to market basis. i believe they will be much more sensitive to that as they go forward. but it is probably coming, or the point in time where they have to start thinking seriously about dealing with the
accumulation. jonathan: final question to you. next week, payrolls. do we get an upside surprise? do we price and a more aggressive fed and do we get a flatter curve because of it? oksana: yes. was that quick enough? jonathan: yes. thank you to our roundtable on "bloomberg real yield." thank you very much to tcw's tad rivelle, blackrock's jeff cucunato, and jpmorgan's oksana aronov. from new york to our viewers worldwide. that does it for us. we will be here same time, same place next week. thank you for watching "bloomberg real yield." ♪
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