tv Bloomberg Real Yield Bloomberg March 31, 2018 10:00am-10:31am EDT
jonathan: from new york city for our viewers worldwide, this is "bloomberg real yield." ♪ jonathan: coming up, there is some stormy weather in shortsville. treasury yields breaking out lower. tesla falling back down to earth. musk.g pressure on putting march behind us. looking forward to april, we look ahead to payroll friday. we begin now with the big issue of stormy weather in shortsville. kevin: i tend to subscribe to the wisdom of crowds.
when everybody got on that side of the trade, 2% yield on the 10-year coming. it is an automatic slamdunk guarantee that the fed is going to raise four times. this could turn. it just needs something to help it turn. eric: sentiment matters in markets. >> the most recent action in the 10 year treasury is more of a flight to safety, a flight to quality, in terms of this most recent move below the 2.8 level. michael: quite frankly, i think there is a pain trade down to 2.64%. maybe 2.6% in the next few weeks. i think people have to be aware of that. andrew: with risk assets looking full, we actually think that bonds look reasonable here. hey kind of a high quality bond a high quality bond fund now, you might get 4% to 5% yield. that was pretty reasonable. jonathan: joining me around the table is greg peters, jim keenan, plus kathleen gaffney.
kathleen, i want to begin with you. i asked many investors just a couple weeks ago when we break out of this trading range for treasury, where we break out to? would imagine would say to the upside. we break down to the downside in a significant way. what your thoughts? kathleen: i might have been one of those that was for the upside. but we are seeing a bit of a conundrum here. some of it is a flight to quality. but i also think you have some demand coming in that is caused by the equity volatility. so you have folks that are looking to de-risk and reduce their equity exposure. and they are actually coming back into the treasury market. the fixed income market. jonathan: do we have a pain trade developing, mr. peters? greg: i don't know. bonds are doing exactly as they are supposed to be doing. right? there is a flight to quality. risk off. bonds are adjusting. at the same time, there is a complete and utter overreaction
to the upside a month and a half ago. and so a combination of those two factors, with data being more mixed and expectations being too high, i think it was set up for bond yields to rally. jonathan: but jim, if this is risk aversion, it means the move is temporary until risk appetite picks up again. if it is based on the data, it could be something more fundamental and can have more longevity. what are your thoughts? jim: the level of the data matters as well. you are coming at a period of time that, post the commodity downturn in 2016, we had a pretty big global growth and a cyclical upside. jonathan: yeah. jim: you are starting to see some of that data weakening up. as kathleen points out, then there is some demand. of the last two years, you have seen a significant amount of clients really pile into that equity upside trade and avoid fixed income or rates. and i think you are seeing that demand come back. yields are at a much different level right now. jonathan: kathleen, we have spent weeks talking about the
risk-mitigation quality of treasuries and the absence of treasuries over the last month. what has changed in the last week when the volatility came bid came backe into treasuries. kathleen: the bid did come back. but when you look at the magnitude of the volatility, i would have expected a bigger rally. so i do think it speaks to the demand that is coming in temporarily. and i think we have to remain focused on the fundamentals. the data for the underlying economy is still positive. we are expecting a good jobs number. jonathan: yeah. kathleen we have not seen wage : group. things are really percolating underneath. jonathan: greg, i think this is a really good point that kathleen makes, and i thought the same thing a couple of weeks ago. i was quite surprised that treasuries only dropped lower by about 3-4 basis points on a
10-year yield. it was not so dramatic. why do you think that is? greg: positioning was such that everyone believes that rates are going to move higher. i think what has kind of reset the levels here is the l.rsistence of equity vo you see this big spike in volatility. it persisted at a much higher level relative to last year. i think that persistence in higher volatility in equities has had a slow bleed into the rate market. jonathan: so the money is coming into the rate market, into 10 year treasuries, where it has not come and is the two-year space. i think that is what is interesting about this. twos-tens is now 50 basis points, which is a cycle low for this spread, we are flat, flat, flat. not completely flat, but flattening. it is interesting that despite the decline, the rolling over of risk appetite, no one is taking out rate hikes for this year. end is two-year
anchored. money is going into the 10 year. you end up with 46 basis points. at what point, greg, do we start looking at the front end of the curve and say, risk appetite has been damaged to such an extent that the fundamentals have rolled over and i want to start taking out rate hikes for this year? greg: yeah, that is where the dots and the rhetoric come into play. the argument a month ago was, how come four is not being priced in? there was a 100% probability of everything going right. i do think if the data continues to come in mixed, you will see the front end get a better bid as well, but the front end at this current point in time is completely and utterly broken. jonathan: kathleen, are you any closer to looking at the front end and saying, that is a buy? i imagine you are not. kathleen: not at all. not by a longshot. i actually think think there is the potential -- it might be a couldobability -- but you see an inverted curve simply because of the technicals. a lot of what has driven the market to where we are today has
been the technicals, that incentive to take risk. and i find it really interesting that at this current point in time, when the fed is starting to talk about raising rates and we're not sure if they're going to get behind the curve, all of a sudden you have got the fiscal spending picking up and we have seen this tremendous issuance at the short end. so the treasury bill supply has been overwhelming the market, to some extent. and on top of that, you have got incentives from the tax reform that are encouraging money at the short end to be liquidated. so there is a lot of selling pressure that is going on at the short end that could continue to weigh on the market and put push short rates higher. jonathan: greg, is that the reason you think the front end is broken? this dynamic at the front end? greg: that is a big piece of it. you are seeing all sorts of huge issues with libor, bill issuance, other factors around
tax policy, and there is really no bid. jonathan: jim? jim: i think there are opportunities to get high quality carry or get some income on the front end of the curve. we do like the bank loan market. the more floating-rate instruments that you can buy at this time, there are opportunities that you can buy credit instruments globally and hedge back the dollar. you can get a pretty nice carry associated with that. at a period of time when you are seeing a lot of volatility, you and certainly are seeing a regime shift in regards where the markets are going and where policy is going. right now, on the front end of the market, with the back-off, you can get a decent income play on the front-end. jonathan: you said the same thing when you, greg? g wouldn't you, greg?
greg: totally agree. there is an opportunity there. i am not sure you will get a lot of love out of it over the near-term, but there is real opportunity. they do have this pull to maturity. jim: if you look at the rally this year, and certainly in january, if you look at the aggregate levels of risk, when you think about the return scenarios, they're going to be far more compressed or lower than what we have seen over the last couple of years. so as a way to protect yourself and get some return profile, the front end is a good way to play it. jonathan: greg peters, jim keenan, and kathleen gaffney, thank you very much. coming up on the program, elon musk creditors are having a serious bout of buyer's remorse. that conversation coming up next. ♪
♪ jonathan: i am jonathan ferro. this is "bloomberg real yield." i want to head to the auction block now where the united states treasury auctions almost $300 billion of debt notes and bill through the week. it is the largest supply ever. the $30 billion 2-year note sale was one of the biggest. it is the largest sale since january 2014 with a five-year offering. looking closer at the two-year option, that sale had a yield of 2.13 percent, the highest since august 2008. over in europe, high-grade corporate cells fell about 30% compared to a year ago. way down by a plunge in february issuance. elsewhere, we get to a flashing warning sign from tesla. back in august, investors lined up for a chance to finance the company's ambitious rollout of the model three sedan.
but now after a spate of setbacks, including a credit rating downgrade, tesla's notes have plunged. still with me, greg peters, jim keenan, and kathleen gaffney. jim keenan, in august of last year, for this maturity, for this credit rating, that tesla issue was a record low yield of 5.3%. and it has fallen out of bed. is it a tesla issue specifically, or does this speak to something broader in credit markets? jim: in general, you have seen volatility increased dramatically since you had that issue. it is a combination of aggregate volatility built in the equities, and what that has meant in spread volatility. so the credit markets, and certainly the high yield markets, have been weaker since that issuance. on top of that, you have seen the yield curve move. so there has been a duration component to that aspect. obviously, you have seen some issues with tesla with the unfortunate events of the crash
and regulation picking up between that and uber. there are a combination of events that have weighed on that credit. when you look at the issuing itself, it is obviously a very significant, probably market cap company that is growing. so it has to issue a lot of paper or raise a lot of capital. that is certainly going to weigh on sentiment as well because they know they have to come back to the market. jonathan: greg, it has been burning through cash. and for some reason last august, investors were willing to fund the dreamlike returns. except you are a debt holder. you are not going to see the fruits of that dream, are you? so what on earth is going on? greg: that is exactly right. and so this is a free cash flow, negative company that is highly levered. but i think it speaks to the penalty for missteps. so maybe this time last year there was not the same kind of penalty. the benefit of the doubt, maybe, perhaps. jonathan: yeah. what we're seeing
broadly in credit is dispersion. we are seeing a separation of winners and losers. i actually think that is a good thing. it is not just a single beta trade where you will get rewarded for selecting the right corporates and companies and you'll be punished for making mistakes. that is how it is supposed be done. jonathan: let's be clear, $.87 on the dollar with an implied yield of $7.50. we have come from 5.3% coupon to $7.50. if they have to come back, it is going to be pretty expensive. kathleen, when you compare this , this isher triple-c's trading rich to some of their peers in the market. that issue, kathleen, spoke to have tight things got in the credit. do you see the dispersion or the discrimination in this market? kathleen: i don't see that dispersion just yet. we are seeing some cracks in the high-yield market. the new issues that have been coming to market have been struggling if they do not have strong covenants and if the companies are highly leveraged. so there is some discernment
coming into the primary market. but high-yield spreads more broadly have not really widened out. so tesla is very much facing the pressures, as greg and jim have already mentioned, that the company faces, but high-yield still has a way to go. if the short end though keeps going up, it does mean that the corporate costs of borrowing are rising. and what i think is interesting about so many folks who were jumping into the short end to pick up that additional yield, is that with high-yield credit s or levered loans, you want a longer runway if they have to grow into their capital structure. and tesla is a good example of not potentially not having enough runway to grow into their capital structure. jonathan: jim, talk to me about that, the opportunities that you might see in high-yield at the moment. because triple c's, that is where the outperformance was.
can that continue? jim: it can continue, but i would not necessarily say it is sustainable. obviously some of that is because of the yield curve move, and the duration component connected to double d's when spreads are supertight. if you just take a step back, growth, there is certainly an uncertainty of volatility on a go-forward basis. but growth is still pretty healthy. corporate earnings are pretty strong. there is a regime shift in regard to the structural volatility. where we are in policy, where we are with regards to the gap in the cycle. that is going to have more volatility. but when you look at the underlying, credit fundamentals are still strong, which is why even though you have seen some backups, spreads are still pretty tight. because the underlying fundamentals of, can you pay back the debt, are still pretty good. we are debating the level of growth but not at recession. jonathan: we had a conversation with someone from jpmorgan last week on this show.
they said this year what you want is the most equity-like products, equity-like securities and fixed income. the performance will come. the capital returns will come. this was a week where the high securities really got smashed around. some people might be screaming at the tv and saying, that is a deutsche bank story. but you did see that start to move the other way this week. so tell me why that is still going to be the story. securities,ity-like incomes, convertibles, etc. why? jim: when you are buying, you are buying a solid growth story that is leading to good corporate earnings. there is not going to be volatility. i do think you are going to be at a period of time where you will see more vol and dispersion in assets. the winners and losers will start to play out. so there's going to be vol spikes. i think credit in general does not have the upside. but in this environment, you do have the ability to get some income that is now mid-single digits and you are protecting
against that drawdown risk that you saw in equities in february. jonathan: greg, you're going to have to give us a clue of what you have been doing. what are you looking at? which pieces are you picking up? o are interested in the short end of the investment market. what is notable is that you are seeing real stress and strain in investment grade corporate's , particularly at the front end, and not in high-yield. it has underperformed its data. on the high-yield side, we actually have been more involved in triple c's than double b's. the part of the market that confuses me the most in high-yield is the short-dated double b paper. i think it is well over owned. no upside it all. nothing but downsides. i think the rotation there is something to look at. jonathan: greg peters, jim keenan, and kathleen gaffney are sticking with me.
coming up on the program, we are going to run you through some of the markets. a big move in the long end of the treasury curve. twos, tens, and 30's. a very small bit of the front end leaves us with a much flatter curve. 2.97%, sub-3%. still ahead, the final spread, the week ahead featuring a new month and a new u.s. jobs report. this is "bloomberg real yield." ♪
♪ jonathan: i am jonathan ferro. this is "bloomberg real yield." it is time now for the final spread. coming up over the next week, it will be a shortened trading week in some areas of the world, mainly due to easter monday. we will look at balanced numbers and the march jobs report in the u.s. plus the debut of the secured
overnight financing rate, which is being called america's libor replacement. still with me, greg peters, jim keenan, and kathleen gaffney. i want to wrap things up with a conversation about what has been happening with libor. kathleen, the conversation continues because the grind high continues for -- i've lost count of how many days. for three months libor. why does that signal a flashing for you? kathleen: i think we want to watch and see how long this is going to persist for. i think there is a market consensus that once we reach april 15 and we start getting revenues in the u.s., you are going to see that come down. i do think we should pay attention to that. because if it continues to persist, we are likely to start to see the market and credit risk react to tighter financial conditions. jonathan: how close are we to that actually happening, greg? theays to be precise, three-month libor has just done this and drifting higher. greg: i agree. i think it is about persistence.
the issue with this is that it is not a single factor. it is not just simply t-bill issuance. there are other factors at play. it is hard to disentangle what the true diver is. and there is a big debate around it. to widen andtinues it continues to remain at these high levels, it is a de facto tightening. i submit that is already happening. it is causing credit spreads to widen. and if it persists at these levels, i think that is something to really worry about. jonathan: jim, i don't think we should waste too much time talking about if it is a flashing sign regarding credit stresses. when i speak to all of you, you always say no, it is not. but it could have real consequences. are you seeing it start to bite at all? jim: not at all. it is the persistence of it and it is an expense. it is not an expense directly related to the household, but when you think about how many people fund their positions,
there is an expense on it. you are seeing people shrink their books because the cost of leverage and the cost of borrowing is more expensive now. you are seeing some of that play in. i think that is some of the reason you see the front end of the investment-grade market start to weaken out. it has an impact when you think about some of the foreign buyers of u.s. credit or assets on the front end. and so you have seen some selling on that side. so it is definitely having an impact. the longer it stays, the arbitrage of leverage does not work in our favor. jonathan: something we will continue to watch. before i let you go, you know how this works. i put you all in the boxes and we do a quick round of quick questions. i want to begin with the low end of the treasury yield, 2.40% for 2018, have we seen the low for 2018? greg? greg: no. jim: no. kathleen: yes. jonathan: buy the two-year note, the treasury, or get out of the way, the fed is still coming? greg? greg: get out of the way. jim: no. kathleen: get out of the way.
jonathan: tesla 2025, or netflix with a similar maturity through year in? both companies have burned through cash. both companies have had to raise a lot of capital. would you hold the tesla 2025 or netflix of a similar maturity to year end? greg? greg: netflix. jim: tesla. kathleen: don't make me choose. on.than: go you have got to. kathleen: netflix. jonathan: there we go. thank you very much for your time. that does it for us. that does it for "bloomberg real yield." we will see you next friday at 1:00 p.m. new york time. 6:00 p.m. in london. this is bloomberg. ♪
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