tv Bloomberg Real Yield Bloomberg May 27, 2018 5:00am-5:30am EDT
jonathan: from new york city, for our viewers worldwide, with 30 minutes dedicated to fixed income, this is "bloomberg real yield." ♪ jonathan: coming up, a shakeup brewing in the european bond market. political risks spreading from italy to spain. treasuries catching a big bid. 30 year yields trading where 10 year yields were a week ago. the central bank finally stepping in, desperately trying to regain some credibility. we begin with a big issue, political risk in europe making a comeback. >> italy is the toughest call tactically here. i think, in general, six to 24
months down the road is going to be -- >> if you are long, i think not just because of the level, but because of the speed with which these assets have re-priced. >> you don't have that vast pool of money coming in backstopping the bond market and keeping peripheral spreads from widening. >> the spreads widening with italy relative to bunds, and that is having a contagion effect with some of the other peripheral markets. >> we prefer u.s. treasuries or european sovereign bonds. >> italy has quite a lot of debt, but you have to look at the coupons of the bonds which are maturing and the coupons that they are going to replace. >> the europe story has run its course. as we just heard, there is a lot of money that has left. jonathan: joining me around the table is henry peabody, and bloomberg's lisa abramowicz, and coming to us from atlanta matt brill from invesco. it is great to catch up with you. henry, i want to begin with you.
why is so much of this happening in europe at the front end? we have seen volume explode, intraday moves of some 20 basis points on btp's on two years. why all of that? henry: there is a bit of a curve flattening going on. you see that risk coming out of the front end of the market with liquidity. let's take a step back. what has happened in europe? you have seen fairly solid improvement over the last handful of years -- debt sustainability, lower interest costs, but they have not grown to the degree the rest of the continent has. there is a reason for unrest there. the big question is, how do you actually decouple italy from europe, and you don't. that is the issue. will it get worse before it gets better? probably. you need to start thinking about, when is there an entry point? jonathan: to make that judgment call, you also have to think about, what are we pricing in? this is a government forming
that wants to spend more, and that just means we are pricing in more supply. where are we on those two things? which one is it, lisa? it feels like the latter and not the former, given the fact that we are still around 2.5%. lisa: it feels like a supply issue and the ecb is running out of room to suppress the yields on the periphery, and germany's flight to safety. it does seem like since we are getting to the end of that stimulus, the deficit starts to matter again. henry: exactly. these things do not matter until they do. jonathan: yup. henry: as soon as you have bedrock assumptions that institutions are going to keep these ratios in check, when you have those bedrock assumptions pulled out, all the sudden you are priced on fundamentals again. that is what we are in the process of doing. jonathan: matt, i do wonder if this is a classic eurozone mood swing, in the sense that things start to fall out of bed, but
the lesson of last year or so is that you profit from fading political risk in europe. we saw that in catalonia and france. what's to say we will not see that in italy, too? matt: you have been paid to buy the dip for the last several years. we have all gotten used to it, and some traders are getting too comfortable with that. this could be a bit worse. there really is not a lot of interesting things to look forward to in italy. they don't even get to go to the world cup this year. we've got to get a lot cheaper before we get in. not talk about the world cup. my father's italian. you are going to get us into trouble. i think we have to understa what the reaction function is of the ecb, to really make a call on the ecb's presence on this. is there a line in the sand? we brought up that chart. we can bring it back for our audience. this line in the sand has been around the 240 mark. yields have just come back down and down again, and we see that over the last couple of years. is 240 significant?
we have breached that level now. why is that a key level for so many people? henry: i'm not sure that it is. one of the things the ecb has the opportunity to do is instill a little discipline. i think with the political shift in italy, they have the opportunity to fight back as they are pulling back. let's watch as this plays out. i think matt is right in that we do probably see this get weaker before it gets better. lisa: hold on a second. what you are saying is fascinating. you are saying the ecb would perhaps not step in on purpose, perhaps allow yields to blowout in order to send them a message. jonathan: it would not be the first time that the ecb would be accused of having political motives. would it? we saw that throughout the eurozone debt crisis. i think what you asked is really important because from a technical standpoint, to understand the ecb's reaction function, to justify stepping in aggressively, they would have to say the moves in italy are
harming the transition mechanism. do you see the moves in italy spreading to spain at the moment? do you see anything that can credit the ecb the justification to step in aggressively and say, our transmission mechanism is being harmed by what is happening? henry: no. not at this point. you are seeing a shift in tone from the central bankers to one away from pushing volatility down to one of fighting inflation. the ecb is being pulled in another direction in that they cannot keep rates so low for so long that they further invert or threaten to invert the u.s. curve. they do not want to be an accomplice to a bit of an unwind in leverage on u.s. rates. jonathan: they are looking to line down the whole qe program, so you just spotted the headline -- a june meeting to tweak qe. lisa: it goes to henry's point. they are not coming out as doves. we are seeing losses against the dollar in response to this. this indicates, guys, it is game on.
we want to exit quantitative easing, and if you have a political problem, that is your issue. not ours. jonathan: if you want to price this, let's talk about the spread where italy trades right now. italy trades closer to greece now on a 10-year yield basis than it does to germany. does that make sense? matt: it does. they have real substantial issues here. the ecb, they are going to have to be accommodative but not step in from a political standpoint. it gets worse before it gets better. jonathan: does it make sense to you, henry? henry: it does. what we have now is a lot of longs in italy, a lot of positioning that needs to get unwound. the technicals are going to be very important. that's why you need to respect them. jonathan: let's talk another level. through 100 basis points, the spread, spain over italy this week. does that make sense? does it make sense to have a multitiered bond market in the eurozone where people start applying the term semicall to
spain? henry: well, if we are getting to the point where we are going to have a multispeed europe, if this does force germany to the table to a greater degree to accept a franco-centered plan, you need to see some form of differentiation at the margin. when you have compressed spreads, greece trading on top of germany, bad things happen. some sort of differentiation is appropriate. lisa: i am looking at the spanish gdp and the acceleration we are expecting. it is a better economy than the italian economy. period. the end. does it make sense for there to be differentiation between the economies? yeah, that's what a bond market used to be. jonathan: that is what should be. lisa: yeah. jonathan: but it hasn't been. will it be? lisa: [laughter] makes sense. jonathan: will the ecb allow this to happen? doesn't make sense in the following sense -- does it make sense in the following sense, if italy went, and i am not saying that anybody's having real discussions about that happening, but if they went, the whole thing comes apart, doesn't it?
lisa: they are going to step in eventually. the issue is that this is not enough to scare them off. this is not enough for the ecb to try to take action yet. perhaps at a point when people start to talk about the 2011 european crisis more seriously, maybe then. jonathan: is this a buy at 250, 245? henry: not quite yet. but you always need to buy what others are selling to accumulate a position. you look at the banks as a barometer. you are looking at five to 10 points, depending on currency down for a name like unicredit. it does not seem like you are seeing enough selling pressure yet. you have to to start looking at when you start scaling into a position. jonathan: everybody is sticking with me, henry peabody, matt brill, and lisa abramowicz. coming up, the auction block. vodafone, holding the second largest corporate bond sale this year. that conversation is next. this is "bloomberg: real yield." ♪
the share for primary dealers was the highest since december. on the corporate side, vodafone selling $11.5 billion of bonds to help fund the acquisition in the second-largest u.s. corporate bond sale this year. this year, a 30-year security yield, 2.15 percentage points on the treasury. $300 million of triple c rated bonds sold, yielding 9% and they are trading above the issue price. outside of europe, the em crisis in turkey. take a listen. >> this is serious. i do not know that, all by itself, the central bank of turkey is going to be able to withstand this. >> when you have the administration saying they are going to take over the central bank, this is a country that is facing a lot of uncertainty.
>> even in the healthy countries, politics have a way of destroying good economic policies. in turkey, politics has a way of making bad economic policies even worse. >> there needs to be more, and i think that is what the market is telling the turkish central bank here. the question is whether they remain some semblance of independence. >> it is important that you again does not get carried away with historical parallels because things are very different now. >> anybody that is an importer of energy, running an account deficit of bigger than 4% gdp, they should be running scared, to be honest. jonathan: still with me, henry peabody, lisa abramowicz, and matt brill. matt, this has been one of these stories of the week. has the turkish central bank done enough without an emergency intervention in an interest rate hike? is that enough? matt: not yet. just a week ago, the question was whether the president or the central bank was in charge. who was in charge was the
market, and the market forced them to do it. the market forced them to hike 300 basis points to 16.5%. we saw a little reprieve in the lira. bonds rallied back. they have a $900 billion economy. at the end of the day, they are going to be fine, but they are probably going to have to be pushed to the brink one more time before they realize the market is going to demand this. they've been running way too hot for way too long. you cannot have a president talking about central-bank policy he does not believe works. jonathan: henry, to rethink your point and make it bigger narrative that has been the story of the week. you take turkey and you make an em crisis and compare it to the 1990's. by definition, it is not the 1990's, because they had a fixed exchange rate regime compared to what we have now. you might say we might get a crisis, but to compare it to the 1990's, as so many people have through the last week? henry: a lot of development since the 1990's. exchange rates are not fixed. developments of local bond
markets have pulled us away from dollar liabilities. the turkey question is really an interesting one. they are in a vortex between being late to the hike, between presidential interference, between the president calling for an ease. you don't know, aside from it being potentially cheap on a real effective exchange rate basis, but inflation is going to rise, you don't know why you are jumping into this. compare that to brazil, that also went through the ringer. compare that argentina, that is going through structural reform. there are currencies that have weakened substantially the have offered a more sound reason for voting for the long-term. for us, turkey is not somewhere that is remotely inexpensive enough to get involved with. jonathan: lisa. lisa: to your point of what narrative you want to paint, here is one that a lot of people are coming to. emerging markets as a whole look better than they did in the late 1990's. there are idiosyncratic stories, turkey among them, african nations that have become so indebted in this period of easy money that any little hiccup is
going to cause a serious issue. i think that is what is coming to the fore. jonathan: matt, there was a big overweight and a big consensus position. overweight in emerging markets through much of last year and part of 2018. matt, what is your view? what is the house you? you maintain it despite the events of the last couple of weeks? matt: if you told me that oil is roughly $70 a barrel and that em would be down 4% or 5% of the year, i would have told you you are crazy. but that is what has happened. you have to look at individual credits and countries. right now, anybody that has a large external deficit and is relying on their exchange rate to be solid is under a lot of pressure. from that standpoint, argentina, turkey, you want to stay away from them for now. there is a better entry point for each of those. if you can stick with things like mexico, pam x looks very attractive right now. we would buy pam x 10-year bonds at 60%. we are going to go that route rather than try to pick some of these other credits. jonathan: on oil, that has been
a really difficult part of all of this. if you run a big current account deficit, if you're importing a ton of crude the way turkey is, higher oil is bad news for turkey, good news for russia. it is not a blanket, em, ok story. henry: no. it is higher oil and a higher dollar. the cost of capital is increasing on two fronts. they are getting squeezed on both ends. it is very, very rough. the oil situation is an interesting question. what you have now is, essentially, the u.s. and saudi going after iran and russia. today's opec announcement as an acknowledgment of that. jonathan: and crude getting hammered to close out the week
as the saudis signaled they can open up supply on the back end of this year. three key variables in what is happening with em. you have higher short-term rates in the states, crude has been rallying, and the dollar has been strengthening. on the latter, crude gets really uncertain, and be dollar call is what -- the dollar call is what fascinates me. i have spoke with investors this week who have a conviction call on the em and a really flaky call on the dollar. i don't know how you can reconcile the two things. the flaky call on the dollar, if you are going to have conviction on em, can you have a flaky call on the dollar? lisa: this is a great question. so far, em and the dollar have moved in sync. this is to be expected since a lot of their debt is dollar denominated. there is another question embedded in this. everyone is saying good there are idiosyncratic stories with emerging markets but so much of the money has gone into index funds. at what point do people pull out of index funds and the idiosyncrasies do not matter anymore? jonathan: it becomes a story for everybody. bloomberg's lisa abramowicz sticking with me alongside henry peabody and matt brill from invesco. in the markets this week, we shake out as follows. the bonds, twos, tens, and 30's over the last five trading days. remarkable stability coming through the curve. two-year yields down seven, 10-year yields down 13 basis
look ahead to the payroll, we see the payroll market. and stability has come about. -- plus, the fed's base book and the g7 meeting for central bankers. for final thoughts, still with me is henry peabody, lisa abramowicz, and matt brill. matt, as we look ahead to payrolls, i want to highlight a story in the treasury market. it is this remarkable stability that has come about at the front end of the curve. two-year yields close out the week for the fourth straight week. what did you make of the stability at the front-end? what is the signal that comes from that? matt: we had such a big run-up earlier in the year where everyone was concerned about inflation. we have gotten to a much more stable place. we felt the fed minutes this past week were telling you that the fed is for three for all of 2018, and that is why the two-year has held where it is. jonathan: how important is that? henry: the fed is pretty important. the policy will be something to pay close attention to over the next 12 to 18 months. matt's point is a good one. that delta between zero fed hikes priced into the front-end and three or four is gargantuan. that front end, the delta that
ties in with dollar strength, is not necessarily going to be so big. i personally thought the fed minutes were interesting in that the feds seem to build in a lot of flexibility. they said we will take inflation higher, a steeper curve, there are conversations around the dot plot going away, so the fed is introducing ambiguity into the market, which is healthy. lisa: people are finding cash attractive. we are hearing a growing number of investors saying they are increasing the allocation to cash. how are they getting the allocation? in two-year treasuries. there is a balance going on. jonathan: has 250 become an entry point for a lot of people to buy into the front end of the curve? matt: judging by your program and other media publications, yeah. you are hearing a lot of big investors. us, that is not something we are enamored by. we think there is a lot more pain to be felt in the front end. jonathan: matt, what are your
thoughts on that? matt: we're looking at corporate credit. if you go back six to eight months, only about 40% of the whole ig market had yields, and now we are at 85%. we think it is a very attractive trade. you can sleep at night, and you don't have to weather the volatility. jonathan: we all want to sleep at night, matt brill, thank you. we're going to end the program with the rapidfire round, some short, quick questions. we begin with the italian 10-year or the spanish 10-year. which one did would you buy and hold through to year end? henry: spain. lisa: the consensus is spain. matt: spain. jonathan: ok, i will swap it up a bit. 10-year bunds or 10-year treasuries through year-end. henry? henry: treasuries, but not an emphatic endorsement. lisa: i would think the markets position is towards bunds. matt: i'll take treasuries in the carry. jonathan: here is one for you:
have we seen the high on the 10-year yield for 2018? i like to recycle that question. we are right off the high's now, given the rallies we have seen this week. have we seen the high on the 10-year yield? henry: no. lisa: the consensus is no. matt: no, but we close below it. jonathan: lisa, i think you are right on the consensus. henry peabody, lisa abramowicz, and matt brill. great way to close out a week. thank you very much for your time. from new york city, that does it for us. we will see you next friday at 1 p.m. new york time, 6:00 p.m. in london. enjoy the three-day weekend if you get one. this is bloomberg real yield. ♪ retail.
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alix: let's talk. russia says opec plus could cut back supply cuts as oil nears 80. spread out. midland houston differential blows out as stockpiles build in the u.s. we hunt investment oportunities in the oil patch. revving into china. electric vehicle growth will help drive the adoption rate over the next two decades. a new report breaks down what company wins and when we hit peak oil demand. alix: i am alix steel, and welcome to "bloomberg commodities edge." it is 30 minutes focused on the companies, physical assets, and