tv Bloomberg Real Yield Bloomberg July 1, 2017 10:00am-10:31am EDT
jonathan: from new york city, i'm jonathan ferro. this is "real yield". ♪ jonathan: coming up, yellen says evaluations look somewhat rich. president draghi's words start a bond tantrum, but did investors misjudge his speech? halfway through 2017, sales are on track to pass the 2016 record. we begin with the big issue. did investors misjudge draghi's speech? >> i think it was actually very eloquently put. >> i think the words are pretty confusing to be honest.
, >> a titanic shift we have been waiting for. >> the speech itself, i'm not sure the market misinterpreted it. there was a very clear shift in the tone relative to the last policy meeting. it was quite a dramatic tone. >> a backslide to explaining how the tightening is not really a tightening, and i think the hope was if you explained it that way, financial markets will not get into a tizzy. >> i didn't read draghi's statement on tuesday to be anywhere near as bearish as the market is taking it. actually i took it the other way. i think it was a signal from draghi that even if there was going to be further support and tailwind in the economy that, -- economy, that the central bank is still there. >> they need to get going early here. they are already late getting going. jonathan: eloquent or confusing? joining me now is jim karen, from morgan stanley investment
management, and from boston, the senior portfolio manager with the wells fargo asset management. let's get to the quote itself. these are the words that seem to move markets. the e.c.b. forum in central portugal. >> as the economy continues to recover, a constant policy stance will become more accommodative. and the central bank can accompany the recovery by adjusting the parameters of its policy instruments. not in order to tighten the policy stance but to keep it , broadly unchanged. jonathan: they were the words of president draghi earlier this week. big moves on the bond market off the back of it. treasuries and yields and bonds absolutely plunging. did the markets misjudge the speech? according to people familiar with the thinking of the e.c.b., it kind of did. >> yeah, it is kind of
interesting. i think what draghi said was 100% correct. they are not looking to tighten. they are just looking to remove excess accommodation and stay at levels that are consistent with where financial conditions need to be. i didn't view his talk as overly hawkish. i think it was a reinforcement of what he has been saying. it came at a time when the markets were a little bit surprised, when people were expecting a dovish comment. we looked at inflation in the u.s. which has been low. the data has been decent globally, but nobody was really expecting it to come out so strongly put by draghi. it caught people by surprise a little bit. >> i have to argue this is not about the short-term of policy , but rather about steepening the e.c.b.'s policy response function, which for the last five, six years since the whatever it takes speech has been basically no matter what the data come out, ease, ease, ease. right? so we're returning to a period in which to some degree economic data may define the policy
outlook and that policy response function goes from flat to maybe a little bit deeper. not naturally where it was 10-15 years ago but a little bit steeper. jonathan: we have had aggressive pricing from central bank to central bank throughout the week. we can bring up the chart. whether that is the european central bank, bank of england, bank of canada in there as well. across the board, really expectations have increased off the back of a loaded central-bank speech this week. do we now have a market more in line with the direction of the central banks? or maybe the market maybe misjudged some of the central spanks -- banks speech this week go -- week? >> no, i think the central banks are going to maintain what i call a dovish posture. i think we have seen this pattern before where they have strong talk and weak action. so i think it was a momentary reaction to the market but i don't think there will be a material change in rates. i don't think this is the beginning of an upswing.
jonathan: my colleagues here at bloomberg are pointing out we have this amazing paradox at the moment. inflation expectations are either diminishing or completely rolling over, but central banks are read finding and re-caliber -- redefining and recalibrating their reaction function at the same time. >> i have on my screen here a chart which is a look at five-year inflation compared to where the bond has been trading. if you take at look at the reaction that a look at the reaction of the last two weeks or so the right side of the , chart here, you can see the increase of inflation expectations has been an inch worth of moves and reaction for bonds is five inches worth of move. metaphorically, on the chart, of course. i think that is a little bit of an extreme reaction particularly , considering we have had a swing much, much larger than has occurred over the last few weeks. jonathan: who holds the keys to
global rates and who holds the keys to a steeping yield curve did you get that answer this , week? >> i don't know if i got that answer this week, but it reinforced what i have been thinking. when i come in in the morning, i look at where are bond yields and gilt yields. i think the u.s. is being dictated by what other central banks are doing. today is a great example. we have low inflation. yields are higher. jonathan: as expected. >> absolutely. inflation has been on a downtick for the last several months. we're in a position what matters more what the e.c.b. is doing and the bank of england is doing. more so than even what the u.s. data tells us. jonathan: what is on your bloomberg now? what does that tell you? >> i'm looking at the shape of the 2/10 curve. i think perspective really matters a lot here. people have been talking about the yield curve flattening in the u.s., and there have been historic periods. in 1994 and 2004, where the fed was actually tightening policy
to slow down the economy and kill inflation. today, actually the yield curve has been flattening since 2011. aside from a small blip that we had in 2013, we have been in a flattening trend since 2011. i don't think that the fed, which has been flat lining, the fed really isn't trying to tighten policy now. they are trying to actually remove excess accommodation. what they are doing today is not tightening. once they move above 3%, if we ever get there, that is tightening. jonathan: what we have is the change in the way the curve is flattening. last year it was a bold flattening, an aggressive long at the long end. long duration. now we have a bear flattening. how does that shape your thinking? >> the front end is pretty much pinned to the point that it is going to follow what the fed is telling it and make that assessment. the back end is free to move around more based on expectation. depending on where those inflation expectations go, we have a lull for the last three
months, that is going to produce a flatter curve. plus we have the excesses of q.e., of all the bonds that many central banks have bought, that is also keeping the demand or the supply duration very, very low in the markets and that is keeping yields particularly on the back and very, very low. jonathan: how important is that for the federal reserve? we have a anchor at the back end of the yield curve? does that give them more accommodation to move? is that an automatic stabilizer before they even get out of the corner? >> well, it does give them a little more flexibility. they can begin to unwind their long portfolio or try to raise short rates. that is a little flexibility they didn't have. but i think it doesn't really change the fundamentals which is their actions will have very little effect on the real economy.
it is really more trading reaction. as long as inflation is low, i think they will be pinned to very low rates. jonathan: do you agree with that? >> the federal reserve starts managing the long end of the curve and buying and selling on a regular basis, we need to go into our bunkers and hide out for a long time. they have the strongest hand in the entire markets by a longshot, and so far the exit , path or the wind down path that was discussed in june, really doesn't include any management on the back end over the yield curve. one thing lost in the equation is that each year that progresses, each three months that progresses, the fed stock portfolio comes shorter of duration whereas the markets for , the most part are extending right now. there is still plenty of duration and supply of duration in the markets. i'm not concerned about the stock effective central bank purposes -- purchases -- effect in central bank purchases, at least not in in u.s. dollar terms compressing long rates
anymore. >> i also think we can't look past high levels of cash. one of the ways to pick up yield is to extend duration. as long as we see the nine-week positive growth environment where inflation really isn't ticking up, you're going to see more demand for long duration assets. >> we started this conversation about the 2/10 spread. that chart you showed. on a historical basis, we're in the 40th, 45th percentile of what that is. all of this drama about a flattening yield curve, only a little bit below average. jonathan: we have the opposite story what we had last year. -- last week. we are talking about a yield curve starting to go steeper after a decade low. are we trapped in this range of 215 to 216 and we kind of bounce 60, -- 260, and we kind of bounce around? we published updated rate forecasts for the balance of 2017 and 2018 just this morning and took down our forecast range down to a 2%, 260.
the reason for that is that inflation at least here in the united states is a random variable in the short-term and it has down shifted a little bit and that has pulled the end of the curve down along with it. we're stuck in that range. jonathan: outside of the drama, the theater a big move this week we have a wimpy bond market but , a range bound one. this maybe an inflection point. >> yes. that's right. because for the last how many years from the end of 2008, we have been in this trading range for the 10-year. we haven't broken out on the upside which people have been hoping. i think that is because inflation is anchored at a very low rate. where can rates go? nowhere. that's why we're -- -- cycling around. jonathan: coming up next on this program, "real yield," the auction block. on course for a record year of investment grade supply. from new york city, you're
♪ jonathan: i'm jonathan ferro. this is bloomberg "real yield". let's head to the auction block now. last week we told you about a few debt yields in the high yield market. one came back to the market rather quickly. charter communications. they sold $1.5 billion of bonds. they sold secure debt which carried higher ratings than the unsecure plans just last week. over on investment grade, we have hit the midpoint of the year. 27 seal -- 2017 sales are on track to surpass 2016's record. total volume 4% ahead of last year's tally at this time.
sovereigns, treasuries, $28 billion worth of seven-year notes drew a yield of over 2%. of 2.46, the lowest since january and below the 2.53 average over the past 10 auctions. our guests still with us. earlier this week, we heard from the fed chair. globally we have a series of central bankers worried about financial stability. risk -- rich asset prices and risk. did you take any notice what they have to say about asset prices? >> i think what they really are saying is they are extremely sensitive to upsetting the financial marks. -- markets. most of the zero rate policy they followed has caused money to flow into financial assets rather than raising the economic growth rates. of course they were very
concerned about the reverse financial asset prices cascading into the real economy. but the real economy looks pretty good at this point. jonathan: the real economy looks pretty good but what interested me in terms of risk this week is that equities fell out of bed a couple of days. bonds were plunging a couple of days. investment grade credit hung tough. high yield was ok. spreads were still tight. why was credit performing so well when the rest of the market was experiencing a sense of jitters? >> it is like what we were talking about in our last segment. yields are in a range volatility , is very, very low. the likelihood you're going to capture that carry is very good. that is what the markets are thinking about it today. where else are we going to go for a yield and investment grade, high yield, securitized assets -- there are a lot of things you can do. the bottom line is you're right. there has been an insatiable demand for fixed income products, for yield and product. we'll see in 12 months if rates rise. that has to be the catalyst. you need to see a rate rise and
a shock or on the other side, you could see financial type of an event take place. jonathan: tight investment spreads this week with a sign of resiliency or complacency? >> hopefully you can zoom in on my screen here. one ig, too, high yield. on the i.g. side one of the big keys has been sources of issuance. increasingly we're seeing tech companies become the dominant net issuer of new debt. guess what was buying that debt? in many cases, tech companies. these are entities like apple. i am picking on them for no particular reason, they are cash trapped overseas. they put that with investment managers and buy bonds and issue bonds in the u.s. that provides various functions to avoid a tax overcharge. so they are both the source of supply and demand. i wonder if you strip out that number whether there is an increase for net supply for 2017. i doubt it. jonathan: the headline numbers scream a lot of supply coming into the market and all being sucked up.
is that a story here? actually maybe something else is going on. >> i think it shows there is a voracious demand for higher income securities. as far as looking as the high yield market, so far this year for the last couple of years, over half of the growth issuance has been simply to take out other debt and pay off loans. pay off existing lower coupon yields and high yield bonds. companies are going crazy in the high yield market. they have improved their balance sheets. that's what makes the spread so resilient. they absolutely cannot go wrong when the fundamental's are so bad. >> at the same time, spreads are not tight on a historical basis. spreadd about the 2-10 -- two/10 spread, and investment grade spreads are somewhere in the 40th percentile. spreads were high during the global financial crisis but that doesn't scream rich to me like it does in the high yield mark. -- market. >> how do you think about that? do you think of it as a spread or an absolute nominal yield? nominally they are incredibly , low.
>> they are incredibly low. in the i.g. space, we think of everything in spreads. the high-yield space because , there seems to be a little bit of a floor for many real and absolute return investors, i would have to argue that is probably nonlinear to some degree. but nonetheless, spreads and high yield are relatively tight and yields are obviously quite low -- not as low as 2014. that is when we hit the absolute bottom. >> there is a duration component to this risk. that is the right question. when you construct a portfolio and are thinking about putting together a portfolio of bonds, there is a big duration to it. lower yields go in the tighter spreads get, the more duration exposure you have. you are more exposed to a shocked higher move in rates. that's something we do at morgan stanley investment management is we try to balance that risk. we try to strip out that interest rate component and try to isolate the credit component. in some cases when we look at spreads and yields, they can be somewhat attractive for a period of time but as long as we're
cognizant for the risk of higher rates. jonathan: do you see that as well? the increased duration risk and the risk around it full stop? >> when i look at high yields, you're not taking duration risks. you're taking fundamental credit risks. that's how you lose money. i think it is better to have a longer than average duration risk in high yield. it is not a risk of rates. you still have 350, 360 basis points to absorb and move in treasuries, which i do not think is coming. really when you look at the default rate of 2%, that is really a pretty low risk market. you're being paid to extend duration in the high yield market and get that extra yield. jonathan: the anchor for risk over the last 10 years, it has been central bank policy. are central banks still your friend? >> they are certainly going the wrong way to be good friends. obviously here with the federal reserve tightening, pretty unclear what the next step is for the b.o.e.
nonetheless, the biases in that direction. the only friend we have in central bank land is over in asia. the bank of japan for the most part now. that said, whether a central bank is supporting or detracting from risk demand in a given market is whether they are tightening faster or slower than what is priced in. what is priced in right now for most central-bank action it is a -- is a relatively gradual pace of tightening. if we get tightening that is not priced in, that poses a modest problem for risk assets. i doubt it is a huge one. the issues are high yield are about evaluations and tied to the equity markets more than direct policy. jonathan: everyone seems to be confused by bank of england policy. our guests are sticking with us. let's get you up to speed on the markets this week. two 10/30's in treasuries. what a week it has been. the big moves further down the
curve. 13 basis points on the 10-year. 11 on 30. this as we get back up to 2.82. still ahead on this program, the final spread for the week ahead featuring the first meeting between presidents trump and putin. and a u.s. jobs report as well. from new york, you're watching bloomberg's "real yield." ♪
♪ jonathan: from new york, i'm jonathan ferro. this is bloomberg "real yield". time now for the final spread. coming up over the next week, we have a shortened trading week here in the united states with an early close monday and markets closed entirely on july 4. the fed will release minutes a little bit later in the week and the jobs report will come out of the u.s. too. plus presidents trump and putin , will apparently be meeting at the g-20 summit in germany.
a wrap up and look ahead to next week. jim, the heavy lifting for the bond bears is coming from the central banks this week. are they going to get it next week? >> i think we should see some recovery. we are probably still 4.2% unemployment -- 4.3% unemployment, but 175,000 payrolls is the survey estimate now. i think that is a good number in -- and anything above 120,000 in my book is a good number now. >> the markets are not going to treat 120,000 as a good number. the balance here is for economic -- bias here is for economic upside surprises. that should drive is further until jonathan: we're going to july 14. do a rapid fire round quickly. short questions. very short answers. one word if possible. did the market misjudge the words of draghi? yes or no? starting with jim. >> no. >> negative. >> yes. jonathan: who hikes first?
the bank of england or e.c.b.? this has changed radically in the couple of weeks. >> e.c.b. >> e.c.b. >> boe. jonathan: u.s. high yield or german bonds, high risk? >> high yield. >> high yield. but you are paying for it better. >> bonds. jonathan: thank you very much for joining us. thank you very much to our guests. from new york city that's it for , us. we'll see you next friday at 12:00 new york time, 5:00 p.m. in london. the payroll is friday. from new york, this is bloomberg "real yield".
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