tv Bloomberg Real Yield Bloomberg June 10, 2018 10:30am-11:00am EDT
jonathan: from new york city for our viewers worldwide, i am jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, it is a breakdown on international diplomacy. enough to derail global growth? the central bank of e.m. is in a world of pain, asking the fed for help. and the ecb refusing to be held hostage and planning to discuss the end of qe. we begin with a big issue, emerging markets asking the fed for help. >> the fed is always clear they are making policy for america. but even if you do consider the rest of the world, you are not
making policy to bail out countries that are running their economies badly. >> the fed is guided mostly by u.s. factors and it would take a massive global crisis to change the fed's behavior. >> when people make the comparison to 2013 and say the e.m. is in a better place than 2013 and a significantly better place than the 1990's, we are missing the point that there are other vulnerabilities, not just external financing, but in places like brazil, public debt is a big issue. >> the emerging markets appears to be contained to argentina and perhaps turkey. you know, this is happening in a period of strong economic growth globally. if it is going to happen, it is a good time to happen. it's when institutions can best respond to it. >> this is an asset class where crossover money overwhelms the dedicated money. when crossover money decides to exit, which is what is happening these days, then most countries are impacted.
>> i hear there is talk about a crisis in emerging markets -- it is just nonsense. it pretty much depends on what the dollar is doing, but there are some stories that are weak. at this point, they should be avoided. jonathan: with that, we have a full house. around the table here in new york joining me is andrew chorlton, kathy jones, and jay berry, head of u.s. government bond strategy at jpmorgan. guys, it is great to have you with me around the table. kathy, this feels like a broader asset class story. not a single name, idiosyncratic theme we had a month ago. kathy: global liquidity is shrinking and we were not priced for it. you know, we went underway in e.m. quite some time ago, several months ago because the valuations were too high. as the fed tightens, this is what happens. risk premium starts to expand and that is where we are. jonathan: do you see signs of contagion now? mohammed talked about technical
factors. if it is technical, it is fundamental, it is real. are you starting to see the technical bleed through? andrew: yes. it was a really popular trade, particularly crowded at the turn of the year and you have the scenario and you could justify it. now technicals are turning and investor greed has really driven it, in my opinion. jonathan: jay, it is interesting that the r.b.i. governor wrote that they were asking for a basic call that the federal reserve balance sheet in the unlined of it and the treasury boosting issuance at the moment because of the fiscal stimulus is overwhelming dollar liquidity. it is taking away from emerging markets. there is the chart. they complained on the way up, they are complaining on the way down. how does the federal reserve respond? jay: this is coming front and center right now. at least for late last year and the beginning of this year, we were in a globally synchronized upswing of growth. it helped miss the point of the
fed tightening but now the growth has decelerated in the euro area and the japan, the yen, and the u.s. is going alone well above trend. it is coming out to the forefront. with labor markets running well above potential and inflation rising, it is hard for the fed to stop right now. jonathan: the fed faced severa calls this week from indonesia and india to slowdown the pace of the balance sheet. is that something you think the fed actually needs to consider? kathy: they need to consider it. i don't think they will do it anytime soon. so they seem to be on a fairly preset course to unwind this balance sheet. as long as domestic indicators are strong enough, i do not think that will change policy. they will have to see financial conditions really tighten or a really significant decline in global growth that would affect the u.s. before they would change the course. jonathan: andy, let's talk about the potential that these technical factors spill over into fundamental issues. we had an interest rate hike this week from india and turkey and movement from others as
well, including brazil with fx intervention. the hikes in turkey are real. they are real rates, potentially suffocating the economy. that is when the technical factor spills over into fundamental reasons. when you start to choke growth. do you see the potential that growth gets choked in emerging markets? andrew: you have to look at both ways. in some ways you are getting sensible central-bank responses to the challenges. in argentina, good news on the imf fund. but you are right, it does impact short-term domestic economy. it is going to help in terms of funding going forward. but the big story for us is on the blind side, short treasuries are decent value now. so that stretch for crossover investors we talked about in the earlier segment, you don't need to stretch as much to make 2.5% on the two-year treasury. jonathan: that is a good point. you have attacked on two fronts in e.m. right now. you have cash as an asset class in the united states competing elsewhere. you have treasuries more competing for capital elsewhere
and a more attractive yield. that attraction to u.s. assets and that competition for capital from elsewhere, is e.m. a loser or can e.m. still do well here? jay: we have gone neutral on e.m. and we think this downdraft in growth is set to slow in second half of the year. but it is the tension which will make returns more challenging. the u.s. is going to continue to look more attractive over the rest of the year. if we are right and get three more hikes, we will get two-year yields over 3%. jonathan: kathy, in the united states, yields are up by 3% in the united states on a front end of a two year yield. if i say 3% on a two-year, do you say inversion? kathy: i think we get close to it. i think two more hikes this year is probably more realistic than three. you know, we are already seeing the global growth picture, it is in a turnover, and i don't see the impetus for that last rate hike at the end of the year.
we are getting pretty close to the neutral rate. we have two people at the fed now -- i am assuming will be the vice chair, and williams, also in the new neutral camp. so why rush? but yes, if we get a 3% on the short end, we would be pretty close to inverting. jonathan: there are two competing forces in play, the intuitive idea that when the federal reserve goes into a hiking cycle, the curve inverts, that is what you would expect and what history suggests. at the same time, and this is why this time it might be different, we've got unwind of the balance sheet in the federal reserve, the removal of quantitative easing, which could lead to a steepening of the curve. and the risk premium, the term premium picking up again. how do you put those two competing forces together and develop what the curve is going to look like and how it materializes over the next several months? andrew: it is not easy. the first question is what to do if it hits 2% or 3%, you buy them. in terms of the curve, short
term up until september. there could be a technical from pension plans that could certainly impact the shape of the curve. i think the challenge with domestic policy in the u.s., is you have inflation coming up. the previous segment before we came on talked about the price of monster energy cans going up. but if you go to the macroeconomists at schroders, all the credit analysts, everyone is feeling cost pressure and inflation could be a problem. it doesn't give much room for maneuver to react to market concerns and it certainly impacts the curve outlook if inflation comes through or not. jonathan: in a moment, we're going to talk about europe and btp's and italy. i spoke to steve major and asked him an important question, when he asked me where financial conditions are, i would respond by saying things are still easy. his line of argument is as follows -- if you look outside the united states right now in an issue with btp's, credit stress abroad, an issue in turkey and brazil.
you are seeing credit stress and you are seeing a significant tightening in global financial conditions. is that what you are seeing? kathy: we are seeing the early stages in the u.s. we are starting to see credit spreads widen a little bit, the dollar has moved back up again. so we are starting to see the early stages. domestically it is still pretty easy, which is why i think the fed will continue on a fairly preset course to shrink the balance sheet. but globally, yeah, we are starting to see the financial conditions tightening. jonathan: my guests are staying with me. coming up on the program, the auction block. this might be the year of the u.s. convertible bond, twitter out with $1 billion. we will run you through some of the numbers in just a moment. this is "bloomberg real yield." ♪
jonathan: i'm jonathan ferro. this is "bloomberg real yield." let's head to the auction block, where twitter entered into the s&p 500 by selling $1 billion of bonds. in its second ever offering, there is interest at a quarter percent rate a year, maturing in 2024. who knows where we will be in 2024. twitter is a broader trend for u.s. convertible bonds, issuance is on pace to top the greatest volume since 2007. changes made to the corporate tax code helping. and finally, u.s. investment grade bouncing back from a slow week from last week, with more than $30 billion in issuance. union pacific was one of the highlights as the company priced $6 billion in a seven part transaction. with me around the table is kathy jones, jay berry, and andrew chorlton. guys, i want to talk europe. andy, i have to give out a shout out to your colleague. lisa hornby came on the program for months and i continued to
give her a hard time about short btp's. then the trade suddenly paid off. let's talk about the trade and what you did that tuesday when things blew up. andrew: lisa did a great job and withstood a lot of pressure from you and internally. i think it shows the reaction last tuesday, coming off of a holiday weekend both in the u.k. and the u.s., shows you how fickle and over positioned markets are. we cut position on tuesday. we are looking to reinstate it on the basis that you had the headlines about the economic minister and the technical outlook and all of that stuff, but fundamentally, it is a deteriorating story. the only way to justify in my opinion any yields in europe is qe. as you said in the lead before, we think qe is going away in europe pretty soon. so on that basis, with liquidity being withdrawn in the u.s. and europe, sell it. jonathan: have you got an idea of where you would like to reenter that short, where on the curve you are looking to do it,
where you would like to find the liquidity, all of those things. where are you looking to do it? andrew: if we had a time machine, we would have covered it on tuesday and sold on wednesday. we are looking for some kind of relief rally. we feel high-yield credit and investment grade credit and european markets, it is looking for some sort of respite and you sell that relief. so it is a tricky one. we are discussing it. jonathan: i imagine you are. and you as well, kathy. looking at the situation in italy right now and across europe. the ecb, they are incredibly reluctant to be held hostage by politics in italy. what do you make of that and how does that set us up for the ecb meeting next week? kathy: they have a tough line to walk. they do have all of this pressure coming from this populist push that has been underappreciated for about two years right now. so they have to deal with that and they have to show they are not taking that into account and setting policy. i think we are not going to get much out of the ecb next week.
i think they will say they discussed the idea of ending qe, and that will be all we get. jonathan: kathy, to your point, these are risks on the table for years, months, especially in italy, and we are still vulnerable to sudden reversals in risk appetite. why, when we are aware of the risks at the time are we pricing in doom and risk suddenly? kathy: because we did not price it in ahead of time. you know, markets just weren't priced for anything to go wrong. we had this scenario where spreads, it doesn't matter if you go from the u.s. high-yield market to em, everything else, spreads have been very compressed, partly because of qe and the idea that there would always be a central bank to step in. the whole market has to reprice. jonathan: it is concerning when you consider the rest of europe as a fixed income universe. typically, we think about central bank stepping back and fundamentals taking over. i go back to a conversation i had with mohammed and he talked
about the typical handoff you would look for. in europe, i struggle to see how any kind of economic example in history would justify the price of credit, or where rates are, when negative outpaces six-year on bunds, we have issued corporate debt with negative yields. it doesn't make sense. there is no economic scenario that justifies that. how does the ecb get away from doing this without creating many, many examples of that big btp blowup we saw last week? will we see more of that? andrew: the volatility will pick up as the ecb withdraws liquidity, but as kathy said, you hadn't priced it in before and we are coming after free money around the world. that is our problem. arguably if you look at the financial assets that have done a good job, real assets that affect real economy, less so. people now need to take a hard look at the risk reward across many asset classes in fixed income.
it is not a pretty picture until we get a correction. price is so important is often forgotten. jonathan: jay, they are two different things, credit risk and liquidity. there is some liquidity risk at ecb as well, and saw an example of that several weeks ago. is that a broader issue that we need to pay more attention to? jay: it is something we have been paying attention to for the past couple of years. it is not just what happened to btp's a couple of weeks ago, it happened yesterday and one could argue four years ago, what we notice with liquidity is when the volatility picks up, much more sensitive to the pickup in volatility and liquidity can disappear. that is the point that andy made before, if you look at our colleagues in london, they were arguing that many clients had overrated peripherals heading into it, which only exaggerated the move. treasury showed a high degree of sensitivity and conditions were short in the u.s. as well and that amplifies the moves that occur. jonathan: if this can happen in treasuries, it can happen
anywhere. kathy, what are you worried about when you look across the world and the fixed income universe? kathy: now that em is starting to react, we are less worried about it because it is starting to price in a more rational way. i am worried about the domestic investment grade and high-yield. and the reason is the deterioration in credit quality, especially in investment grade, we have half the universe is triple b and even the single a category is looking less robust these days. so i am worried about that. and again, markets just not priced very well for it. jonathan: how do you convince people there is a concern there where the macro bank drops seem so solid in the united states when the g7 is going to take place over the weekend and everyone is talking about the g6 and plus one. the plus one is the outperformer. they are alone because they are better than the other six. how do you convince people there is a problem in investment grade credit when it is not an obvious problem in the economy in the
united states? kathy: that's the reason we are neutral and not yet underweight, because we are waiting for the domestic economic indicators to give a signal there really is going to be a problem and that may not be the case. if we get some excess cash to buy back debt, which we are hearing here and there, that would be alleviated. we would not be that concerned about it, but right now leverage on balance sheets is what we really worry about, and global indicators are rolling over and the u.s. may have a hard time continuing to outperform. jonathan: jay, do you share these concerns? jay: on credit, our hike grade team has a target for year end. credit spreads look moderately better than where we are now. the supply picture for the balance of the year looks better and we think part of the reason we are here is because of the demand in the rest of the world has disappeared in the backdrop of currency adjusted yield pickups, which are worse than they were. so against the backdrop of fundamentals should be pretty stable.
jonathan: kathy jones, jay berry, and andrew chorlton are staying with us. we want to get a check of the markets for you. across the bond curve in treasury, yields up just a basis point on a 2-year note, up by three points on the 10 year and on a 30 year. a mild week if you take the last five days together. that is the story in the bond market. still ahead, the final spread. the week ahead, featuring decisions from the fed, ecb and boj, the three big ones. we will discuss them. this is "bloomberg real yield." ♪
jonathan: i'm jonathan ferro. this is "bloomberg real yield." it is time for the final spread. coming up over the next week, a trio of central bank decisions. the three big ones -- the fed, ecb, and bank of japan out with announcements, a ton of economic data as well, including u.s. cpi and retail sales. plus you have the trump-kim summit in singapore. and the president set to publish
a final list of targets on chinese imports. i mean, unbelievable week ahead that we have coming up. with me around the table, andy chorlton, kathy jones, and jay berry. is international diplomacy a risk for the global bond market? kathy jones, is that something you even have to think about over the next week? kathy: we have had a few surprises recently when it comes to the international diplomacy. and obviously, the big thing we worry about is the trade outlook. because that has the potential to impact global growth and fed policy and central-bank policy and inflation, etc. but at this stage of the game, we tend to shrug these off quickly. jonathan: because they take so long to burn through, jay. and i guess the markets looking at the situation thinking, is a breakdown of diplomacy a risk to the global growth story? does it derail global growth? does it? jay: from our perspective, we do
not think it does at this point. and with what has been announced on trade so far, it takes a little off of u.s. growth this year but nothing that changes our view on inflation or the fed or those developments. that is the first order of events for us. jonathan: andrew, is that your view? andrew: it will matter next week because people like to focus on -- jonathan: the front page of the newspaper. andrew: they like a reason to justify a market move. longer-term, it won't matter and even trade, it should matter but you never know what the final result is going to be from the initial blows. jonathan: if you had to pick a central-bank decision out of the three -- and if i could give you a video of it now and the news conference, which one would you pick? kathy: i would pick the fed. i do not expect much out of the other two for noteworthy information. it will be interesting to see how the fed projects forward in terms of the dots and the summary of economic projections and how powell handles the press conference. jonathan: are you expecting some changes for the federal reserve outside of the rate hike? kathy: i think we might see a
little more consolidation of the dots. we've had dispersion that has been wide and i think they may consolidate. i want to see the longer run target. has it changed at all? right now it is hovering under 3%, and if it stays there, that means not much change in the 10 year treasury, but if it moves, that is significant. jonathan: we'll leave it there and wrap things up. we will give you some quick questions to end the program with the rapidfire round. let me run through the first one for you. andy, apparently you are either a long e.m. or long u.s. dollar. which is it? andy: dollar. kathy: dollar. jay: dollar. jonathan: there we go. that was a struggle. [laughter] jonathan: traditional complainers of emerging markets, one is india and one is brazil. do you buy india or do you buy brazil? the two complainers of emerging markets. andy? andrew: brazil. kathy: brazil. jay: i think we are indifferent
between the two. [laughter] jonathan: final question. treasury has acted as a shock absorber. is treasury still the ultimate fixed income haven? s or no answer. andrew: 100% percent. kathy: yes. jay: absolutely. jonathan: guys, it has been great to catch up with you. thank you very much. really interesting stuff. from new york city, that does it for us, i will see you next friday at 1:00 p.m. new york time, 6:00 p.m. in london ahead of a massive week ahead and i'm looking forward to it. this was "bloomberg real yield." this is bloomberg tv. ♪
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