tv Bloomberg Real Yield Bloomberg February 18, 2018 11:00am-11:30am EST
jonathan: from new york for viewers worldwide, i am jonathan ferro with 30 minutes dedicated to fixed income. this is bloomberg "real yield". ♪ jonathan: coming up, treasuries close out the week on a firmer footing after 10 year yields hit four-year highs. more cracks appear in credits, investors head for the exits in high-yield and investment rate bond funds. but the easy money set to continue in japan as governor kuroda gets another term. we begin with a big issue, the return of inflation jitters. >> i wouldn't read too much into one print, but there is clear acceleration in inflation going on. >> it is stronger than we expected.
but we have felt for a while that the path of core inflation is going to move to a higher trajectory in the next couple of months. >> if people think there is a chance of some inflation in the economy, and you see strong growth numbers coming out, that is going to bring volatility back to a more normal environment. >> the 10 year near 3% makes sense here. that price is in four hikes, a lot better than six months ago when it was priced at one hike. >> when we get a big selloff in equities, it will be because of a selloff in bonds. bonds will lead equities down the next time. we have not yet seen it, but the idea that bonds will be a safe haven, i don't really get because the likely selloff in equities will come because bonds have to reprice because we have actually got inflation. jonathan: joining me around the table in new york is jeffrey rosenberg, chief income strategist at blackrock, kathleen, director of fixed income at eden park management,
and coming to us from london, i am pleased to say nick, from jpmorgan asset management. guys it's great to have you on , the program. i want to begin with you. the idea that bonds have no longer given risk mitigation if equities and turn lower, bonds still turn no one agrees go up. i'm wondering what you want to have the allocation to fixed income in that balanced portfolio. >> so in that last clip, and i did not catch his name, it is a really interesting perspective. but it is only one perspective, but an important perspective. jonathan: well, give me yours. >> how does the cycle end? that is really the big picture question. and there are two ways in which a business cycle and the credit cycle ends. either the economy overheats, and then the fed reacts to the overheating, and that is the scenario that that earlier clip is talking about. equities follow bonds lower. that's the scenario you get it -- if inflation is overheating. but there is another way, a more recent and familiar way as to how cycles end. and they end because of some kind of financial shock. if there is a shock, it delivers
a confidence shock that delivers a growth shock. then bonds don't necessarily lead equities down. it is equities and risky assets that lead. bonds can be a very effective hedge in that environment. jonathan: what is your base case -- to get my head around it -- what is your base case for why you would have the allocation? >> the base case is you don't know. you don't know which one it is going to be, and so you have to build a portfolio that is resilient to lots of different environments. the issue is basically, if you are building a portfolio that is resilient to a downward shock, to a recessionary outcome, and what you get first is some inflationary concerns before you get that, there is a price to pay. there is going to be a cost to owning that downside risk protection in bonds. jonathan: kathleen, your thoughts on that subject? kathleen: i think what we might see is a shock, but i think the inflation issue is a bigger problem for the fixed income markets to reckon with right now. jonathan: let's talk about that because a lot of people have talked about climate change moving away from the climate of , low inflation, after weather
reports of wage growth on the upside and u.s. cpi on the upside. are we witnessing a real shift? a real inflation pick up, kathleen? kathleen: we are differently having a shift here. in fact i would say the flack in the economy is quickly disappearing if there's any there, and the market has not priced that in yet. so what we are seeing right now is an adjustment, but if the data keeps coming through, there are going to be more and more adjustments for the market to reckon with. jonathan: new outsider in london, i want to bring you into the conversation. nick: when you think of inflation, absolutely biased to the upside, the bit you are missing of course though is the international dimension. and it is not just u.s. inflation going up. take a look at europe. in the most recent wage a deal there from german unions was 3.5% to 4% wage growth in german inflation. and for some of them have negotiated a 28-hour week.
if that is not inflation, i don't know what is. jonathan: i want to negotiate a 28-hour week with the wages as german workers are getting. jeff, it raises the question, whether you get a treasury that sounds off in a vacuum or this becomes a global bond market downturn. is it the latter or the former? jeffrey: it is absolutely global. i mean, having neck on and his perspective, and kathleen agreed none of us look at treasuries in , isolation. particularly the last couple of years, the whole narrative has been on global flows and their influence on interest rates. global qe. so it is absolutely a co-determined relationship where you have all of the factors. we take a lot of focus in the u.s. with the marginal data, what the fed says, and certainly the dollar is preeminent in its role in financial markets and therefore the role of the fed, but global factors absolutely matter. and it is a reflationary environment, not just from the u.s. perspective. the u.s. is in the lead, but it is also being influenced by global growth and inflation expectations. jonathan: on that side, let's
get our teeth into that particular debate. the global flow story, from one area of bond markets to another, we have been told again and again if you get up to 290 on the u.s. yield, that is capital. but when you bake in the fx hedging costs, the story changes quite radically. does 290 do it? does it get the capital to finance that deficit? nick: i think it does. and certainly 305, something like that on the three-year treasury has become very effective. they don't just focus on treasuries. when you look at the investment grade index in the u.s., you are 375 or something like that, so that is a big pickup both in terms of yield and credit spread if you are coming out of europe or japan. and remember, globally they are still printing money until the end of the earth. jonathan: kathleen, your thoughts on that? matt: i think --
watchen: i think you can that near-term movement, that you will get more inflation data coming out of other areas in the world and europe. but the bigger picture i think is a story that was drawing money into the dollar was it was just the u.s. alone. growth everywhere i think caps the potential for money to keep coming in. now the 10-year did hit 295 and came back. so there are going to be levels that are going to be tested. but i think the bigger picture is, rates are going to rise and the influence on currencies, your point about hedging is a good one. jonathan: jeff, you have done a lot of work on this. it is about how you balance a way from dollar-denominated assets. through the week i have heard arguments as to why loose fiscal actually ends up with a weaker currency. and one of the arguments is, forget the insurance debate about loose fiscal, strong monetary policy, tight monetary policy, tight currency. the argument now is the fx channel needs to adjust radically to attract the foreign capital back into the united states. you put it the other way around,
it is the foreign capital fleeing the united states that is leading to a weaker dollar. jeffrey: yeah this is a note we , put out about recalibration and repatriation. when we talk about repatriation, a lot of people talk about repatriation from the tax deal. that is a nonissue because those moneys are in dollars. the repatriation that is happening is you have to look at the data. and what most people, ourselves included, have been talking about for a long time is interest rate differentials drive inflows into the u.s. that is it is the rate differential driving the currency. since the second half of the year, if you look at the data causality, look at the information, it has flipped on its head and is the opposite. what is that telling you? you talked about hedging costs, a second ago. that argument is over with. if you take hedging costs, the u.s. is no longer attracting the rest of the world's flows. but it is the unhedged flows we are talking about that have currency impact. the u.s. has been the beneficiary of the carry trade. and you only are willing to bear
the risks of an unhedged dollar position in carry trades if you are comfortable with the currency. as soon as you lose the confidence in the currency, the carry goes away dramatically because the fx returns are in -- a much component of that. if you see the dollar lose the international attractiveness, because international returns start to look attractive, home alternatives start to look better the flows can turn. , i think that is what is happening, and it is now the dollar is declining and concerns driving up interest rate differentials. jonathan: hypothetical treasury, let's just pretend. anonymous country has a treasury secretary building up a budget deficit. how much of a mistake is it for the treasury secretary to go around talking down the currency? jeffrey: [laughter] it can be an issue, but the problem is the u.s. has great reservoirs of benefits that that short-term discussion may not be able to fully drain. how about that? jonathan: you handled that very
well. you handled that really well. nick, let's bring it into the conversation, the conversation here in new york about balancing dollar-denominated assets. take me into the book a little bit at jpmorgan asset management. how are you guys thinking about it? what are you doing? nick: the very clear risk price is what is mispriced is the ecb. when you look at policy setting in europe, let's be frank, a fairly absurd levels. it is at emergency levels, and europe is clearly not in an emergency. so the risk is that we see that -- that we see the ecb raise rates and that will have a dramatic impact on the currency and would lead further to a weakening of the dollar. by year-end, 135 is not unreasonable for that euro-dollar exchange rate. jonathan: nick, are you advising moving away from dollar rated assets? is that what you are doing? nick: we like the dollar
denominated assets in places like high yields, but critically we want that currency hedged. jonathan: net of jpmorgan, kathleen, and jeff from blackrock sticking with me. , coming up on the program on bloomberg "real yield," the auction block. csx holding a auction to break up the u.s. market. that is coming up next. this is bloomberg "real yield." ♪
csx did hold a $2 billion later offering in the week, which features three chances at 10, 30 and 15 years. in the u.s. market $7 billion of , 30 year temps were sold. it covers 2.31, which is less demand than at a previous sale, and a sign that investor appetite for risky sovereign paper. egypt of all places raising from international investors, receiving about $12 billion in orders. still with me, jeff rothenberg from blackrock, kathleen, and nick from j.p. morgan. kathleen, i want to get your thoughts on credit. a lot of people look at the fund flows and money draining out over the last week or so. kathleen: we had some big headlines. jonathan: are you seeing some cracks in the fundamentals? never mind the flows. kathleen: what is interesting is that the fundamentals are solid, it is the technicals we have to be concerned about. the technicals drove us to the yields and the spreads we are seeing.
so yes, you have seen some flows. i think you are seeing a big move of investors taking some duration off the table. i'm not sure that is the best idea at this moment. the front end of the curve looks like the more exciting place to keep an eye on. and that is not something we have done for 30 years or so. i think that is where all the action is taking place. jonathan: jeff rosenberg? jeffrey: so look we had a , wake-up call on volatility and liquidity. you first saw it hit the cdx market in the liquid parts, where i think they are liquid, and then it spread over to the cash markets late in the week. so spreads spreads certainly , widened. it has nothing to do with fundamentals. it is not like anything changed overnight with regards to corporate fundamentals. something has changed in the broader market narrative and the outlook for interest rates in the short end of the curve that changes valuations. and so this movement, this movement of rates and spreads is
really interesting because that is about relative of value, and can you continue to press down spreads in an environment where very safe alternatives on the front end -- i mean 2% two-year is a big deal. you now have restored safe alternative yields so reach for yield trade has to be repriced. kathleen: the fed is behind the curve. jonathan: that is a good point as well, and it raises the interesting shift we have seen over the last 12 months. nick, weigh in. is the opportunity of cash products versus investment-grade and versus treasuries, and that has shifted in the last few months, never mind the last year. how has that shifted for you, nick? how are you thinking about that? cast light products versus treasuries versus investment-grade? nick: you are right. when you look at it, cash is real competitor now, let's be frank about that. but the reality is when you look at the repricing we have seen in credit, you can look at it in a total yield perspective. so you have got the u.s.
3.75tment-grade index at as a total yield. that is not bad. but before we get to high-yield when you see 6.5 as a total yield. so on a relative basis, that looks attractive, particularly given the fundamentals. and again let us be frank about the fundamentals. corporate america has probably never ever been in better shape. jonathan: it raises the question why em high-yield is raising almost as much. if corporate america is doing so well, why have we got a spread between u.s. high-yield and em? it has basically collapsed over the past year. why? jeffrey: em is doing well, too. look at the improvement of the fundamentals. look at the credit fundamentals. em has a history of risks, but they deal with their risks, and they wash out the debt. argentina is a great example. the gdp of argentina is a lot -- the debt to gdp of argentina is a lot lower than the u.s. so yes, it has had some over
time persistent problems. where it stands today is a much better position. that goes for much of emerging markets. jonathan: kathleen, your thoughts? kathleen: i think it is an important time for investors to pay attention because you see the spreads on top of each other, but then go back to the fundamentals. because where are there better fundamentals? when i hear fiscal looseness, that is bad for the u.s. so if they are on top, i want to go with the asset class where there are better fundamentals. i think that is em. i would buy the dip here. jonathan: so let's talk about credit over in europe, i am not talking about corporate credit. i am talking about sovereign credit. many people are looking at italy and spain as if they are credits. we had a viewer send in a question on the bloomberg terminal, try to understand why the spread is not widening here. why isn't it? jeffrey: well, you have a lot of distortion in the european fixed income markets because of the role of the ecb, and
quantitative easing, and the persistence of quantitative easing, going back to doing whatever it takes. we haven't had a real credit market in europe ever since that time period. jonathan: yep. jeffrey: this is financial repression. financial repression is an explicit policy to hold everything together so you buy time to let the fiscal and political side try to work itself out. so the bond market signals are not real price signals. jonathan: nick gartside, you are in london. you are closer to the heart of all of this then we are. the spread between bunds and bdp. i think it was 12 months ago today we talked about where the spread would be going into an italian election. we have a very different view of things. why are we so much more comfortable? nick: i think when you look at levels of support for the euro in a country like italy, it is is actually very high and increasing. one reason is italy itself has now healed very much in terms of the economic profile. and we all know the result of the italian election. when you look at italy's political dislocation, frankly
it is nothing new. away from that, italy is a very well-run country with a very modest budget deficit. so when you think of that spread versus bund, it goes a lot tighter, and our target for that is 80 basis points. from where we are now. all that does, it sounds aggressive, all that does, it puts that spread back to 2015 levels. jonathan: radically better shape. nick: it's better shape. jonathan: are you much more comfortable looking at the situation in europe, instead of corporate credit risks, do you much prefer to take the risk with the periphery, with the likes of italy? nick: absolutely, you take the periphery risk, and you take high-yield risk in europe. gatside, thank you. he is sticking with us along with kathleen and jeffrey. you are all sticking with us. i want to get you a market check in with treasuries have been this week. twos, tens and 30's. on the front end, we retrace some of movement of the previous week.
yields are back up 12 basis points relatively unmoved on a 10 year basis point. on 30 years we grind a little bit dour -- down down by four to , 3.12%. still ahead, it is the final spread on this program and the week ahead featuring minutes from the fed, the powell era begins at the central bank. this is bloomberg "real yield". ♪
♪ i am jonathan ferro. this is bloomberg "real yield." it is time now for final spread. coming up over the next week monday is president's day in the , united states. stock and bond markets are closed. european prime ministers will vote for the ecb's next vice president. we will also get minutes from the fed and bank of england. governor mark carney will be addressing the parliaments treasury committee. still with me, jeff from blackrock, kathleen, and nick gartside from j.p. morgan. about the amount of issuance coming from the treasury,
specifically t-bills into next week. kathleen, is there going to be the insatiable demand for treasury needs as they ramp up issuance in the coming months? kathleen: i doubt that very much. and i think that is why looking at the short end is going to be important. you have got supply from the treasury. also got companies that are now scented to-- in start investing and using their cash. they are already in dollar investments, but they are in short duration investments. so when those holdings start getting sold, those yields will be a lot higher. so i think it means the short end is going to be where the attention should be. jonathan: just quickly, jeff rosenberg, your thoughts? jeffrey: i agree with kathleen, the short corporate trade and theme is a big one. that is the impact in terms of repatriation. in terms of the issuance and your broader question, we are going to have this theme for a while. there is lot of issuance to come. it is not so much the demand, but the demand at what price? where will the price be, where will the issuance end up?
we are going to talk about the curve impacts. right now everybody is focused on the front end of the curve. they are going to have to move out the front end of the curve if they want to get maturity. jonathan: i want to run through the rapidfire round. we begin with the first question, will treasuries offer the safety you need if you get a downdraft in equities? jeffrey: big downdraft absolutely. , kathleen: no safe haven in treasuries, look at em. nick: absolutely, safe haven. jonathan: if i give you a decision u.s.-yield or emerging , market high-yield? which em or u.s.? one, kathleen: e.m. jeffrey: em. nick: u.s. jonathan: and to wrap things up, yellen, she is gone. we have got powell in the hot seat. which means yellen 2.0. kuroda gets another term. i wonder what happens to the ecb. will we get draghi 2.0? kathleen: no. nick: no. jens videman. jonathan: there you go.
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