tv Bloomberg Real Yield Bloomberg May 20, 2018 5:00am-5:31am EDT
jonathan: from new york city for our viewers worldwide, i'm jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, the week belongs to the treasury bears. yields breaking out to the highest level since 2011. the italian bond market adjusting to a populist government determined to spend more. and e.m. central-bank credibility very much in question. just who is turkey's central bank governor -- the governor himself, or president erdogan? we begin with a big issue, treasury yields breaking out to new highs. >> short-term, yields are going higher on a 10 year treasury. the reason is because inflation is making a comeback in the u.s.
i think we will see surprises, positive surprises on inflation during the summer. it seems inevitable to me with oil prices doing what they are doing recently. 3.25% is the first stop. >> 10 year yields have effectively doubled in a year-and-a-half. the question is, is that trade over and how much capacity is it to move higher if we look at 3.25% on a 30 year? >> that is going to be a big level. is there room for yields to move a little bit higher, for inflation expectations that creep into the markets more? absolutely. is it an out-of-control situation right now? i do not think so. >> if the fed goes up three times for the rest of this year, that is 75 basis points, and have to ask yourself if the 10-year is going to go up that much over that kind of timeframe? if if it doesn't, we will have an inverted yield curve this year or early in 2019. so, you know, i do think it is crunch time for this. jonathan: joining me around the table is luke hickmore, senior
investment manager at aberdeen. joe higgins is joining us as well, managing investor at tiaa-cref. and we are pleased to welcome back diana amoa, portfolio manager at jpmorgan asset management. luke, welcome to new york. let's begin on treasuries. a bit to close out the week, but kicking through some key levels through the week so far. luke: and this is a debate about how far above 3% can we sustain? we blew through all of the levels and we hit 3.05%, 3.10%. it is a bit irrelevant in a way what the level is. a bid for the end of the week, it may be a little more about italy and the u.s. being a safe haven, right? the spread versus germany is still out really high levels, really, really high levels, and it will get higher yet. jonathan: to luke's point, we took out the 2018 high. we took out the 2014 high, and i
wonder, when you look at the spread over germany when the bund treasury goes beyond 300 basis points, how much wider can it get and can the united states and the treasury market really decouple from the rest of the world? diana: it can certainly get wider. i think what is important to keep an eye on is what is going on with underlying european growth and inflation outlook. this quarter, we had disappointing growth out of europe relative to where we have been over the last few quarters. the ecb had to downgrade some of their language around growth. the transitory things, that might be explaining some of that as weather-related, but we are not seeing inflation coming through in a meaningful way. when you add that to quality or what is happening on the periphery with italy, it is possible to see the spread widening further.
jonathan: your thoughts? joe: i think that is a very good point that was just raised, a sentiment around italy, although that is fully priced in the market, will bring in those european yields considerably. and differential u.s. growth is pronounced at the moment. jonathan: joe, we have had these discussions multiple times, but the difference this week is the shape of the curve. a lot of people looking for a flattener of the curve. but it is a one-off week. what are your thoughts about the direction of that? the spread of the 2-10, narrow, narrow, narrow, and surely it gets flatter, and this week it changed. why? joe: in my view, it is u.s. underlying growth is strong and probably getting stronger as we see q2. that is what we are seeing with the long end, more confidence. jonathan: the 30 year yield was the last man standing on the treasury curve.
this week, something changed. the curve got steeper as well. what are your thoughts? luke: i agree with joe. i think the front-end steepens up again here. it is about the u.s. growth story. the long end of the curve, it will be looking past us a little bit and start worries about the 2020's and growth slowing down. jonathan: what is it about 2020's that we are thinking about more? luke: why are we not doing something about it now? it is about trump tax and when we could see the next problems coming up. i think it won't be a recession, i think it will just be some slow growth for a while. jonathan: diana, i hear this all the time with equity markets and the investors there. and also with fixed income more. this obsession between what happens now will be fine and then wait for 2019 or 2020, then you're going to start pricing in a slowdown. do you subscribe to that argument, diana? diana: i think eventually you will have to price in the slowdown. i think the reason why the market is -- right now, we are focused on too many moving parts to the story. so the impact of the fiscal stimulus in the u.s. is starting to come through. that could possibly push this into 2019.
what happens beyond that with a point in a cycle where monetary policy will be significantly tighter, i think that is a big question mark. jonathan: in the problem here is the market getting ahead of the federal reserve in terms of interest rates in a way that it has not in several years. the market is forecasting more rate hikes that the federal project is projecting. what is the signal you take from that? joe: i think markets are concerned about higher oil prices and the geopolitical risks raised, and that could have significant cyclical and lead into more sector inflation growth. jonathan: is it an oil story? joe: i am not convinced it is. the dollar is doing some of the military tightening for the fed. fiscal conditions are tightening, whether you look at the bloomberg index or the goldman sachs index, they are tightening up in the u.s. let's get to do this year, to next year, not three and two.
and the markets are starting to take pricing out. it will remain 2.5 and 2. the fed is at real risk of going too far, too soon. jonathan: you really think so? luke: jay powell looks an uberhawk. jonathan: what gives you that indication? luke: just the rhetoric we have had since he got appointed a few months ago. he wants to get up the hill. he is the grand old duke of york. he wants to go marching up the hill with rates. so he has some room to get down the other side. i just think he is going to continue down that path, and the risk is just too much. and that could be where we get 2020 as our problem area. jonathan: that is really interesting. diana, real rates are still negative at the federal reserve. this is still an accommodative federal reserve, isn't it? diana: it is, but that is the point. that raises the likelihood that
you do get more hikes. the federal reserve is concerned that we have had unprecedented stimulus at a time when the labor market is tight. we do not want to be caught behind the curve, but we want to see other language that way. i think the next two meetings, it will be important to see what happens with the dots. we expect the median dot to signal one more hike this year. we agree that you get three hikes this year and possibly another three next year. jonathan: joe, do you like really yield at 90 basis points? 90 basisields at points? joe: yes, i think so. at shorter ends of the curve, that is attractive. not so much the longer end. jonathan: you are all staying with me. coming up on the program, the auction block. turkey holding twin bond auctions despite a 10-year government bond having the worst week since 2013. this is "bloomberg real yield." ♪
♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield." i want to head to the auction block now, where investors are being lord away from junk bonds as they seek better returns. so fierce is the demand, valeant is getting the loan and with weaker lender protections than before. on the sovereign side of things, there was an $11 billion sale of 10 year tips that had a yield of 0.934%, the highest since january 2011. and less than planned from bond hawks as the lira tumbled on tumbledons as the lira
on speculation that the central bank will not be giving a free hand to surging inflation. we heard from the turkish president earlier this week about monetary policy. >> you will play a role in monetary policy going forward, is that the big change? >> this may make some uncomfortable, but we have to do it. because it is those that rule the state that are accountable to the citizens. jonathan: still with me, joe higgins, and luke hickmore, and diana amoa. luke, we both know guy really, really well. a fantastic interviewer, but he barely had to push him. the president volunteered this. he wants to control the central bank. luke: and he was trying to tell us that it was a normal thing and that everybody does that. remarkable.
i was biting my lip all the way through, rather than shouting at the telly. turkey, if you are thinking about em countries and risk, we have seen argentina with 40% interest rates all of a sudden. you know, turkey is not far off in terms of the same problem, the external debt problems they've got. they need to be keeping external investors happy. i'm not sure erdogan controlling the bank does that. jonathan: does erdogan control the central bank now? is that what we are seeing in turkey? diana: this rhetoric from turkey -- this is nothing new. we have had this rhetoric from the turkish president for a number of years. so there's nothing particularly new there. the issue is, central bank independence has always been questioned in turkey. that is the narrative. you have lack of credible monetary policy, you have deteriorating fiscal external balances. you have inflation that, frankly speaking, they cannot get a grip on. the macro picture remains quite weak. whether the central bank will
come around and hike, we will just wait and see what the next meeting brings. jonathan: more broadly, the chief economic advisor has a trifecta of poison for emerging markets. crude up, dollar stronger, rates climbing. how much of a challenge is that? joe: you have to differentiate between crude importers and crude exporters. jonathan: absolutely. joe: within em, we know that it is always country specific. there are a lot of winners and losers. it is a trifecta, of course. we are not convinced the dollar rally continues. we think it could be near the top. there were some technical corrections in dollar shorts that have been reversed. one thing you have to look at when you are talking about problems in a em, individual stories, argentina. a great policy response, completely different from turkey. it is country specific. jonathan: you said a great
policy response to adjust to a bad policy decision. joe: fair point. jonathan: diana, do you still have the confidence around those two issues? and maybe crucially for the investors at the moment, that exposure to the local currency bonds is whether the fx volatility can stabilize. do you have the confidence it can stabilize here? diana: i think now technicals are cleaner. there was a huge amount of positioning in local. we have seen outflows in the last few weeks. so there is less of a crowded position. that is something that had become a little bit concerning for us. additionally, we have seen a repricing and some of the weaker stories. valuations look more attractive. i agree that you need to pick your winners if you want to reengage. so there are some markets that will continue to perform well. look for places that export commodities. commodity prices at this point in the cycle should remain supportive, have credible institutions and policymakers, and the adjustment has happened so the external balances are not as vulnerable. one last point is also within
the market debt space. i think em corporate should do well in this sort of environment. if you look at where we are in terms of leverage, leverage has been falling in corporate. weaker currencies should help with exporters. this is a little more nuanced and then wholesale emerging market selling. jonathan: as you know, whenever there is a fire, there is someone to pour gasoline over it. this week, that someone was a harvard economist, saying that emerging markets are in worse shape than where they were in the financial crisis of 2008. take a listen to this. she said if u.s. policy becomes tighter, you have a double whammy. even more debt is doubled and nominated, even more has been borrowed from china. this is not from gloom and doom, but there are external and internal vulnerabilities. get to the essence of that. comparing now to 2008 with the macro backdrop as firm as it is globally at the moment. what are your thoughts? diana: my thoughts are
threefold. one, em economies are overheating. this time around, emerging markets as a whole still have a negative point gap, around 2.5%. startingrent point. second point, although rates are slightly lower, when you look at inflation for em back then, they had overheating economies at an average inflation close to 8%. right now, the average inflation for em is around 3%. so a stronger starting point. and external debt growing is a natural progression as economies mature. suddenly, you have companies that did not have access to external markets that can access those. i think looking at the number, it is slightly alarmist. i think emerging markets can weather this. you have policymakers were are doing the right thing. the responses are credible. you have brazil not cutting when the markets expected it. indonesia is quick to respond. i take a slightly different take on that. i think this time is different
continue. president moon of south korea meeting with president trump, fomc minutes and the bank of england and the fed's jay powell and other central bankers will be at a conference. also, we will be watching closely to see if an italian prime minister is named now that the government program has been agreed-upon. still with me is luke hickmore, joe higgins, and diana amoa. luke, btp, totally battered through the week. we wondered when the risk would bite. here it is. are they a buy yet? luke: no. i do not think they are. you could easily say it will be difficult to get a lot of stuff through for italy, and that is right. but we have to get this government off the ground. there will be so much rhetoric from them in the beginning when they get things done, how they will be successful and they will get brussels to support them. it is at 164 over in italy. i want to see 170 or 180. you know, the european sovereign crisis was not that long ago and we could get back to something a bit like that.
jonathan: really? luke: a bit like that, but it feels to me it should be 200 to compensate, not 160. jonathan: do think it might be conditioned by an old trading regime to some extent? is risk domination a factor or is it about an increase of btp supplies? luke: it depends on how far brussels comes toward italy. if they don't come anywhere towards italy to help the bank with their fiscal spending plans, which are massive, no problem at all. if they come too far and give a little bit to italy, spain will look over and say ok, why are we going to everything we are going through when italy is getting it from brussels? then, you will have more risk in europe. jonathan: that is your answer, why would the europeans do it? why would they let that happen? why give one inch to italy to
allow spain to follow this and get out of control? joe: the europe response will be measured. ultimately, we are not convinced that much will happen as opposed to what is being talked about. jonathan: would you buy btp's where they are now? joe: we think they are fairly priced. there could be better points of entry, though. jonathan: interesting. diana, your thoughts? diana: i think with the political stories, especially when the outcome is uncertain, i don't buy when things are fairly priced, only when there is some cheapness in the price. so i think it is still too early. we do not know exactly what it is that you will get in the end, who the prime minister is, and who the finance minister will be. we will wait and see how it plays out. jonathan: luke, we have an interesting situation in europe now. we used to talk about core and periphery. we now have super core, semi-core, core, and periphery, super-periphery.
spain, italy, germany, italy and greece somewhere out there. luke: and who leads in europe? the leadership has changed. emmanuel macron will be the voice of europe because angela merkel has lost so much power. how he responds to italy will be be the key story to watch in the next several weeks. if they want to push forward on this fiscal and that suits him, we may see brussels. the splitting of the market is a classic approach to look at your portfolio. clients.n it to your it is all europe and the same risk. you know, italy at the moment, i agree with diana, buy when it is cheap. jonathan: you don't like btp's now, do you like bunds even less? luke: yes. jonathan: that bad for bunds? luke: yes. yeah. it is two years past full capacity in germany. in germany, you are seeing wage rises coming through and you are seeing the need to get fiscal expansion out there to the rest of europe so then it will be disastrous. jonathan: the front end is just there, like a cold spring, push -- coiled spring, pushing down by -40 basis points.
when do we start adjusting for a change there? luke: will make it to the 10-year at plus 40. that is year-and-a-half again. that is what i feel would be fair value. that would be pricing in where germany should be going. in october, when draghi is no longer buying germany, maybe that is when you start seeing 90 or 100. jonathan: we will wrap things up and i will ask you a few quick final questions as a rapidfire round. i put you in the boxes and run through questions for you. first, will the market come down to the fed, or will the fed to move up to the market? there is that much in it. what will happen? luke? luke: i think the market will come down to the fed because it will only do two. jonathan: joe? joe: i think the fed comes to the market. we are calling for three this year. jonathan: diana? diana: i think the fed comes to the market. jonathan: btp bund spread, wider or narrower by year-end? luke: wider. joe: flat.
diana: flat. jonathan: and the final one, who runs the central bank of turkey, who is the governor? the governor or the president? luke: erdogan. joe: erdogan. diana: a joint effort. jonathan: there we go, very diplomatic. great to catch up with you diana amoa, joe higgins, and luke hickmore. that does it for me, from us from new york. we will see you next friday. 1:00 p.m. new york time and 6:00 p.m. in london. this was "bloomberg real yield." you are watching bloomberg tv. ♪ retail.
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