tv Bloomberg Real Yield Bloomberg July 22, 2018 1:00am-1:30am EDT
jonathan: with 30 minutes dedicated to fixed income, live from jpmorgan asset management, this is "bloomberg real yield." ♪ jonathan: coming up, stepping on the fed's independence. president trump pushing back against higher rates. chairman powell testifying that gradual interest rate hikes will continue for now. and meeting presidential resistance. the dollar rally and the u.s. struggling to find stability. we begin with a big issue, stepping on fed independence. >> ultimately, i think it puts into question what the stature of the fed is, and fomc and their ability to maneuver. >> the federal reserve is not going to react to tweets from the president.
they don't need to. >> the fed is a strong institution, and they have staying power. i don't think it will have a big impact on them. >> it is time to move rates back to normal. and i think they will continue on that path. >> if people start to feel the fed is going to kowtow to the president and allow the economy to grow too fast, overheat, inflation to go up, interest rates will rise. the bond vigilantes will kick in and rates will rise, which is exactly what the president does not want. or maybe the fed will say, to show its independence, it will preemptively raise rates. either way, the president is shooting himself in the foot. jonathan: joining me now from jp morgan asset management are bob michele, the firm's global head of fixed income, and lisa coleman, the firm's head of global investment grade corporate credit. bob, i should say thank you for finally inviting me over again. bob: no, thanks for coming back. it is good to have you here. jonathan: the federal reserve pushes back against higher interest rates. does it change anything for chair powell?
bob: it doesn't. the fact that you have tweets today and yesterday tells you how independent the fed is. i think it is a complex question. certainly, the president gets to appoint who they want as the fed chair, so they pick someone who is reasonable and moderate like jay powell. they know kind of what they are going to get. i think it was a good appointment, but he is on his own now. and i think he has laid out a very credible path going forward. jonathan: it's safe to say that the president's tweets this friday have had more impact than what is happening with jay powell in congress. what is happening with the treasury curve? it has been flat and then all of a sudden we get steepness during the week. bob: there are a couple things going on. certainly there is a belief the fed is going to stick to its rate path, that we will see increases every other meeting for now. great set of words, but i think also there has been some news out of japan that the bank of japan may tinker with its
optimal yield curve control. so they may let the long end go a bit and be supported by market forces. jonathan: lisa, perception is absolutely everything. considering every single word, if it wasn't under a close watchful eye of the market, it is going to be much more so now for chairman powell. does chairman powell's job get more difficult because of the president, regardless of what you think he will or won't do? lisa: i agree with bob. i think the fed will continue on with its independence. chairman powell has a path that he is going to follow, and i don't think that changes as a result of the comments from the present. jonathan: we have gone back and forth on what happens with rates. you think yields are going higher. you think yields could have a full handle on the 10 year within 12 months. walk me through where we get from this really tight trading range where we experience on 10 year yields and treasuries, and how they get to 4% over the next 12 months. bob: 4% is only 100 basis points from here, and it is against the backdrop of the fed having raised rates already for two and a half years, indicating they are going to go for another
year. so that is a lot of upward pressure in the front end of the curve. does it look reasonable to buy treasuries with a sub 3% in 10-year? i don't think so. you've got huge tax reform just starting to work its way through the system. it is not fully into the system, and you have got a tremendous amount of treasury supply that will hit the market over the next 12 months. so i step back and i think a good stopping point for the fed is june of next year, 2.75% to 3%. it will look like a good place to stop, but the economy will be doing great. jonathan: you mentioned that the issuance story. the bulk has been at the front end. the overwhelming consensus of pretty much everyone that comes on this program is that the curve will flatten. it might even invert at the back end of this year. so you are not only looking to 4%, but looking for a steeper curve, aren't you? bob: looking for a steeper curve. you're right, there has been a lot of front end issuance, but i think the treasury has made it clear that they are going to
maintain a 70 month weighted average maturity on portfolios of outstanding debt. if they are issuing on the front end, the back half has to come over the second half of the year. and by the way, curves have flattened before and have inverted and it has not led to recession, and they quickly re-steepen. 1994 to 1998 comes to mind. which is a similar environment. that was the environment post the snl crisis and we had bonds outstanding. and the market continued to heat and the economy continued to heat up all the way into the dot-com bubble. jonathan: in bob's world, sooner or later, i'm going to get 4% on a treasury. why would i want to buy credit, lisa? lisa: well, you want to buy credit because you have a good underlying economy going on. but it depends, despite this good economy, where in the credit market you are going to buy. so let me give you a couple of examples. if you look at triple b rated credit, you might not want to spend a lot of your risk budget
there because this is an area where we have seen a lot of m&a issuance and companies have levered themselves up. maybe what you want to look at is, let's say, double b rated credit. double b credit this year has really underperformed other parts of the high-yield market, yet with the good economy, the balance sheets look good, fundamentals look good and valuations are attractive. jonathan: some of the cfos have an incentive to run a triple b balance sheet, don't they? because the yield pickup, going further up in quality, is not that great, is it? lisa: this has been the problem. if you look at the amount of m&a activity we have had this year, we are on pace for a record amount of acquisitions. you are right. companies have no incentive to run the balance sheet at single-a. that is actually why i like the double b part of the market. these are companies not making acquisitions. the fundamentals look good and you are getting paid a spread per unit of leverage more to take those companies than the triple b rated companies where
ceos are just putting on more and more debt to make acquisitions. bob: that is some of the disconnect in the market. you're talking about should the 10-year should flatten and invert with the 2-handle, so sub 3%. it is a mindset that people are used to 10 years of secular stagnation, investors are and bond buyers are. yet you hear corporate america has made the shift, preparing for a growing america again. not one in secular stagnation. they are going to leverage the balance sheet and take advantage of the growth and the stimulus. jonathan: the difference this time around and what everybody is thinking about the moment, the two americas levering up at the same time. the america you are talking about, lisa, is corporate america, and the other is the sovereign levering up at the same time. when you have the corporate america and sovereign america lever up at the same time, it could be a toxic mix, couldn't it? bob: ultimately, it could end bad. i think that some of the angst coming out of the tweets, at a
time borrowing is going to go up, why would you want borrowing rate to go up as well? the other way to look at it is the opportunity is now. you still are at relatively low levels of interest rates. there is plentiful liquidity. you are having structural reform through taxes. you will get a fiscal spend, you may get some deregulation. let's borrow and really jumpstart the economy. jonathan: what does it say that we are having these kinds of conversations when the federal reserve is still considering their monetary policy setting to be accommodative? they are nowhere near neutral in the minds of a lot of people, and the real rate is barely positive, and yet we are still having these conversation about risks in markets. what will we be talking about in 12 months? bob: 12 months from now i think we are going to say this is a good place for the fed to pause. there is some digestion going on. we are going to see what corporate america does with the leverage it supplies, what it does with the repetitive benefit
of tax reform. we are going to have to look at what the bank of japan is doing. has the ecb begun to raise rates? is the economy plowing through that as it did in 1998? if it is, the market will make the bet that the fed has to go higher, not lower. jonathan: do you agree? lisa: i totally agree with bob. thinking back to your comments about the president talking about maybe the fed should not be hiking rates at this point in time, for corporate america, they are not feeling the pinch of higher rates. almost, in a way, it is a little bit disconnected. but to them, the levels they are able to come and access the investment grade market remain incredibly attractive. jonathan: let's go full circle and wrap up where we started it, bob. do you think the president has a point, that the federal reserve should slow down? bob: well, he -- this is the most pro-growth administration anyone can remember since the reagan administration. so he wants ample liquidity and low-cost funding.
so he is going to argue for that. but it does tell you that he is focused on growth, growth, growth. jonathan: i'm going to put you on the spot. do you agree with him? bob: no, i don't. i think the fed is leaning into it for real for now. the last two and a half years, they have been trying to get to normal. we are going to see gdp print in the next couple of weeks with a four handle on it. and we've got inflation, core p.c.e. is 2%. wage gains are 2.7%. headline cpi, 2.9%. that is above their 2% target. jonathan: bob michele at jpmorgan asset management sticking with me. our special thanks to lisa coleman, who heads up global investment grade corporate credit. great to catch up with you, lisa. coming up on the program, we will stick right here at jpmorgan asset management hq in new york city. joining us around the table, i am really pleased to say, will be diana amoa to talk emerging markets. that conversation up next. this is "bloomberg real yield." ♪
♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield," live from jpmorgan asset management. over to china we go, where chinese markets ended the week on a stronger footing, with the yuan reversing an earlier slump spurred by the central bank's move to weaken the daily currency fixing by the most since 2016. joining me to discuss china and emerging markets is diana amoa, senior portfolio manager involved with emerging markets debt here at jpmorgan, and still with me is bob michele, head of global investment grade corporate credit. always good to catch up with you. your thoughts on china, and whether you have a handle on what is happening with the pboc and the currency policy, which seems to have changed in the last few months? diana: i think what the chinese are doing is absolutely the right response right now.
what we have seen in the last few days is they stepped back from intervening in the currency. they are willing to let the market determine where the currency levels trade. initially they were fixing them stronger, but they are willing to see where the market is pricing it. that is the right response to something that could likely be a growth shock. so for the pboc it is the right thing. today we saw some announcements they will allow some of the banks to invest in loans again, and an easing of some regulations they had. again, trying to redirect liquidity and to loosen a bit the domestic liquidity conditions. so as far as china goes, the right response. we think they are doing the right thing. jonathan: as you know, there are many ways to look at the chinese currency. you can look at the chinese currency against the u.s. dollar, alone, in a vacuum, or in the basket. as you look at those two things right now, what kind of story do you see? diana: i think versus the dollar, the currency is trading roughly where we think fair value is.
when you look at it versus the basket, it has been depreciating. underperforming some of the peers in the trade basket, particularly when you look at the euro and some asian currencies. that makes absolute sense when you think about it, the trade impact right now is going more toward asia. so we do expect a bit more weakness coming in versus the basket. i think the u.s. is a tough call. we just had bob and lisa discussing what the u.s. policy response is and the president pushing back against the strong dollar. i think that is more of a harder call. jonathan: bob, are you worried about a slowdown in china and what that ultimately means for global growth? bob: certainly if the tariffs escalated to a full-blown trade war, i would be more concerned. i think we through a typical q1 slowdown and we will see a real acceleration. when you look at what is going on in china and what the
policymakers are doing, i think this is the frustration you see in the administration in the u.s. they look at the tariffs they are going to levy and talk about levying, and they see the chinese policymakers making accommodation for that, relaxing policy. and if you are the administration, you're looking at your own central bank actually continuing to tighten rather than try to accommodate the reverse tariffs coming from china. jonathan: for many it is a global story. what we are finding out right now is that global growth is really dispersed. as someone managing e.m. debt, are you looking at more on the regional basis ex-asia because of the trade story? diana: yes, exactly. we think the impact for tariffs is disproportionately heavy on asia, so for now we are steering clear of the region until we get more clarity on where the trade tensions are going. we like latin america. a lot of value has been created. plus, we are getting past the election cycle. so we had columbia, and mexico had the elections. that have traded reasonably well
since. brazil, we are getting closer to the point, but markets have enough premium. jonathan: local or dollar denominated? diana: local, but very select, so pick your spots. jonathan: latin am has had a lot of problems this year. argentina taking a series of policy mistakes and central banks struggling to regain credibility. brazil also having a bit of a stumble as well. why lat am for you guys at the moment? bob: i think there are a number of things. first, when i think about being a crossover investor in the emerging markets, diana is right. it is difficult. i need a big bottle of antacid to get in and invest. but there are things that are attractive about latin america. i think the currencies look oversold to us. the dollar is not going to go up forever, and some of our models are telling us that is going to flatten out. when you look at real yields, the u.s. is struggling to restore real yields to its government bond market.
they are readily abundant across latin america. so if we get a bit of stabilization, we do expect money to recycle back into lat am, both the external and local markets. jonathan: diana, i guess the big question for jpmorgan asset management as well, just from speaking to you guys on such a regular basis, the very nature of this conversation -- we are talking regionally. we are not talking very specific, security to security. how important is it to be active in that space right now? diana: extremely important. so there is the security selection or the regional selection, which you get with an active manager. but also ultimately as we progress with quantitative tightening, liquidity will have to become a factor. and what we have seen in the past cycle, the passive managers have struggled managing some of the flows that are coming in and out of the sector, where active positioning allows you to manage your liquidity much better. so we think at this point in the cycle, go with an active manager. jonathan: diana amoa -- i guess that is the sale from bob michele as well. is that a pitch from jp morgan today? diana amoa, senior portfolio manager, and bob michele, you'll
be sticking with me. in the markets now to check on treasuries through the week, 2's, 10's, and 30's. closing out last week with a yield curve that was flat, flat, flat at about 25 basis points. today, we steepen. into the close of the week, a steeper curve, very slightly through to the end of the week. next up on the program, the final spread. the week ahead, featuring a decision from the ecb and mario draghi. this is "bloomberg real yield." ♪
♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield." we are live from jpmorgan asset management this week. it is time now for the final spread. coming up over the next week, a rate decision from the european central bank, plus you have a g20 weekend meeting of finance ministers. another round of earnings that includes big tech and european banks, and the latest reading on u.s. gdp. for some quick final thoughts, i
am joined again by bob michele, global head of fixed income. bob, we want to go over your four conviction trades. the first one being you really believe the federal reserve will raise four more times and then pause. why? bob: absolutely, because that brings the fed funds rate to a range of 2.75% to 3% depending where inflation is. that is an all-star real yield of about 0.5% to 1%. that is still generous by historic fed terms, but not overly accommodative. they will have raised rates for 3.5 years, why not step back and see what the other central banks are doing and also see how the economy is doing a year on? jonathan: and to wait it out. that takes me to your second conviction call, which is short duration. bob: as you know, we are bearish on yields. we think as the fed raises rates, supply hits the market, and quantitative easing switches to quantitative tightening, yields will drift higher across the curve. so we want to hide in the front end of the curve.
so short securitized credit for example. jonathan: where do you see that more pronounced in the rate space in sovereigns? do you see that more pronounced in europe, how that's going to play out, or in the united states? bob: i think more in the u.s., frankly. i think people will have to adjust to what the curve looks like in a growing america. i think you're going to see the fed -- it is a new fed -- get its feet under itself. and the market will have to interpret that a year from now. jonathan: which takes us to the spread between europe and the united states, but not bonds-treasuries. u.s. high-yield and european high-yield -- do you think they are going to narrow in spread in the coming year, and from which direction and why? bob: i think both look great. if we look at u.s. high-yield, it has traded in a range of 330 to 380 over since the start of february, and we are kind of in the middle of that range. as lisa pointed out, there is a tremendous tailwind coming to corporate earnings. that's going to be reflected in better credit quality. end of cycle, u.s. high-yield
tends to go through 300 over, so i think there is at least 50 to 60 basis points of tightening. you have european high-yield at a 4% handle, but europe actually looks pretty good. you have a very accommodative central bank, you have them buying investment-grade corporates. money will spill over to the european high-yield market again. so we would expect yields to go to 3%. jonathan: should we get to the elephant in the building just quickly? bob: absolutely. jonathan: your boss at jpmorgan asset management, somewhere on a higher floor talked about zombie companies this week in european high-yield. what is the thinking? bob: it is a reflection of looking at the european central banks and trying to understand why they continue to print money and invest in corporate debt. they don't need to do that, and you want to be careful that it doesn't entrench bad practices in corporate behavior across europe. so i think it is a valid warning, and i think the ecb
will be sensitive to that. so our expectation is at next week's meeting, you are going to hear more clarity on what the plan for normalization looks like. and by the way, they cannot be happy with their last meeting, when they talked about not raising rates until the end of next summer, and then seeing a rally. jonathan: i am going to what i consider a big call. is that a soft call? bob: the call actually is 3.5% to 4%, but i take your point. i like the 4% call. corporate america is growing again, we are not in a time of secular stagnation. but that is scrambling, despite the administration, to get to something that looks normal. credit is readily available, and you are seeing companies in the early stages of accessing it. wait until they deploy it, wait until we see what growth looks like a year from now. jonathan: typically, i get a list of thoughts from my guests
when i arrive to work on a friday morning. i got a list of thoughts from my guests and the fifth call was nothing to do with markets. it just said, support liverpool and nothing else. bob: we are ready. next week's champions week for us. we have the brazilian keeper. jonathan: you have more conviction about that than the treasury market? bob: equal conviction. jonathan: there you go. bob michele with jpmorgan, thank you so much for hosting us. bob: thank you. jonathan: bob michele from jpmorgan, thanks to him. from new york, that does it for us and we will see you next week. from new york, this was "bloomberg real yield." this is bloomberg tv. ♪ retail.
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