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tv   Bloomberg Real Yield  Bloomberg  August 4, 2019 11:00am-11:30am EDT

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>> bloomberg -- real yield starts now. coming up, no drama in the payroll report, the attention elsewhere as there are more tariffs announced on chinese vonrts, providing fuel for markets, with yield curves below zero. let's begin with the big issue. is the fed prepared to underwrite the trade war? >> it is highly likely the trade issue will dominate the thinking at the fed. you have to extrapolate this and think about the fed delivering a series of cuts.
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>> this creates enough uncertainty to where even the strong payrolls report that we got today is likely going to secure that cut. >> we are going to get a 50 basis points one way or the other. >> mr. trump now knows the buttons he has to press to get the outcomes that he wants. >> good policy, bad policy, the white house is listening. that is why you are seeing the president be so aggressive right now. >> to the extent trump continues to push on the trade war and that hurts economic growth and creates these downside risk, presumably means that central banks will push more in terms of easier monetary policy. >> jay powell has made clear that he is willing to step into the breach and backstop the president in this trade war. >> this is an adverse feedback loop that could get very dangerous. jonathan: joining us to discuss is oksana aronov, priya misra, and robert tipp. oksana, that interplay between the federal reserve and trade policy from the white house, just talk to us about it. oksana: the fed went from the frying pan into the fire with their announcement.
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powell never really had a particularly good reason for the cut, right, he kind of cited increasing uncertainty overseas, slowing conditions overseas, perhaps the lower inflation we are seeing, which by the way, did not induce the cut in 2017 when we saw lower inflation. but they decided to use it as reason this time. and trade tensions, of course. he tried to walk a fine line by staying middle ground, saying this is a midcycle adjustment. and then in a sentence-first, verdict-later fashion, the president then delivered precisely what powell cited as the reason for the cut, and turns it into an easing cycle probably, if the threat materializes, this threat of additional tariffs from a midcycle cut. so in this fashion, trump has got powell's back against the wall, and the fed has essentially chosen to fashion itself after the worst student in the class, the ecb and the bank of japan. jonathan: we can talk about that later in the program. i have had so many people tell me through the week, if you tell
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me what happens september 1, i will tell you what happens with my outlook. that has been the last 24 hours for me. i wonder about is it the same for you, if this tweet had come out on tuesday and the chair had to hold this conference on wednesday, how different might have things been? priya: i think he would have said trade tensions, which would have boiled over instead of simmering, i think they would have said it is still boiling over. that is the only difference. i think the fed is actually grappling with a lot of uncertainty. they don't know how the global growth slowdown is feeding into the u.s. they are getting mixed signals. they don't know how the manufacturing -- and i'm going to go out and say that the manufacturing recession globally is actually feeding into the u.s. how does that affect the service sector? they have no idea how to get inflation higher, which is why they are really selling this hard as an insurance cut. i think the market reaction tells you that the market has no belief that these insurance cuts will work. we have been calling for an extended easing cycle, calling for two more cuts this year, three more potentially next year. this idea that insurance cuts work, i am very skeptical that it will work.
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it is not really changing our call, but there is this waffling attitude on wednesday. i think that would have changed, had the tweet come out tuesday. jonathan: it was a terrible performance wednesday, most people would agree. the morgan stanley argument, i think, is easy to get your hands around. if you believe that monetary easing was going to work, inflation expectations would be higher, long rates would be higher. that is not happening. robert: it is not happening. there are different styles we have seen at the fed. i think what we are used to from a mario draghi, alan greenspan or janet yellen, is they get the committee on a message, or come in at least with -- we are easing conditions, that is the thrust of the committee's move today. no if's, and's or but's. in that way, you have the best chance of easing financial conditions. if you come in and talk about, maybe we will raise rates before we cut rates and you go back and forth, it confuses things. there are different ways of doing it. the reason i say that, his approach is, i'll just be
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completely transparent. in a way, he reflected what the committee told us in june which is half of them do not want to cut at all. and they mean it, and they are getting dragged, kicking and screaming. what we saw in the fourth quarter of last year is the fed will be hiking rates, and he said absolutely not. this is an unsustainable gap between u.s. yields and other yields. the u.s. is going to be to be destabilizing. you are going to have to get on board with the global program. oksana: the issue here is that the market absolutely refuses to be weaned off of the central bank banking. look at just the past couple of days, the fed comes out and says, we don't need anything other than an insurance cut, and the market hates it. the following day we have a bad ism number and the stock market rallies. bad news is good news because you'll have more central bank intervention, which, by the way, you mentioned the potential manufacturing recession, what is wrong with a manufacturing recession if it comes about organically, as opposed to a
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financial asset, or a financially-driven recession, which is what central banks are engineering here? jonathan: you touched on something that is critical, how this market is responding to different pieces of information. the ism was softer, stock markets rallied. risk assets performed. but how the markets responded to the tweet was different. that wasn't a bad news is good news situation. what that told me was, at least from a lot of people's perspectives, we are this close to the tipping point in the global economy. and any further pressure and it rolls over. you are seeing that remarkable move in the bond market the last couple of days of this week, really struck me as this could be the moment where people start to price in the policy mistakes of december last year all over again, because they aren't going quick enough. priya: i think people understand monetary policy in general is pushing on a string. forget getting help from the fiscal side. if we actually get hurt in a sense from tariffs, i think the market is sort of treating this
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like a nonlinear response. i think the fact that the next $300 billion is retail products, consumer products, it will hit the u.s. economy much more. we estimate the entire gdp shock of the tariffs implemented so far, plus the 10%, is as much as half a percentage point of gdp. we don't have that cushion. we are going to go to 1%, 1.5%. what can the fed do to get that higher? jonathan: so, we have to think about how the curve responds to the potential rate cuts in the future. you think they go a couple more? priya: i do, but until the fed comes out to say that this is more than insurance cuts, the market will continue to price 75 basis points. jonathan: let's talk about the yield curve then. most assume the fed would come into play, front end would have to rally yields, and we would have curve steepness. what we are seeing play out in the united states is that we are seeing play out in switzerland, germany. as rates go lower, it just see the whole curve come in. all the way out to 30 on the bund curve. negative yield at one point on
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friday. robert, is that what you feel like is happening in the u.s.? not these kind of levels, but just that the federal reserve will struggle to engineer the yield curve and what will happen is the whole curve will drop down all the way up to 30? robert: the market drives the equilibrium rate. right? and the economy adjusts to that. going back to 2003, we marked down our forecast in the long run, that the 10-year would average 3%. and then as we came down, averaging 3% and looking at the feedback from the economy, we marked it down to 2.5%, then 2%, then we said, you know, the central tendency is probably 1.5, but it will take a year or two to get there. that may sound crazy, when you look at other places where the central bank is actually running the mandate as stated, so -- australia, new zealand, they
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want the good growth, they see the room on inflation, they cut rates. their rates are much lower than ours. so the market is bringing the fed to that, and the slower they go on the front end, the quicker the back end goes down. jonathan: that is the story. do you feel uncomfortable holding duration? everyone has said to me, i have heard nothing this week that makes me uncomfortable holding duration. do you want to lock in your profits on treasuries? no. i don't want to give up that coupon, that is the response i get. i found someone, though, that does want to give up the duration position. walk me through your position. oksana: it is simple, with the curve shaped the way it is, what is the incentive for taking on more duration risk? the 60-day libor or 30-day libor is still 60, 70 basis points above the five-year. maybe more now. i have not checked in the last hour. what is the incentive for taking on 30-year risk? the fact that it will continue to rally further on some additional accommodation from
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the fed, going from ultralow rates in an environment that doesn't really call for extraordinary measures? by the way, i made a comment earlier about the fed fashioning themselves after the worst students in the class. when we talk about the fed being able to support the longer end of the curve, create a steeper curve, revive the economy, or give it more escape velocity, we have not seen that in europe. not only have we not seen that in europe, we see consumer confidence being hit in europe. we see that from a rising savings rates, despite of the negative yield that investors are facing. savings rates are coming back to precrisis levels. yet another reason for why these policies do not work. and in the u.s., the fed has the luxury to be data-dependent and you choose not to. priya: i will take the counter to that. the reason to extend our duration is that three-month t-bill, if you invest now, it
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may be much lower. if you are trying to buy the 10-year, it could be significantly lower. global demographics, we are seeing this in europe. it is all moving saving rates higher. that is creating this reach for yield. if we look at the bloomberg ag index, 25% of that is in negative yielding territory. there is something that forces this reach for yield out there. look at how high risk assets are. they should be a lot lower, because what is my only hedge against risk assets? duration risk. so i would say go maximum long duration risk. jonathan: they are all itching to carry on the conversation. we will continue the conversation. coming up, the auction block with big demands in europe. that conversation up next. this is bloomberg "real yield." ♪
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jonathan: i'm jonathan ferro. this is bloomberg "real yield." i would like to head to the auction block and begin in europe, where investors offered to buy almost twice the amount of 10 year bonds the german treasury sold at auction. the demand taking the yield on the notes below the ecb key deposit rate for the first time. in the united states, boeing selling $5.5 billion worth of bonds in its largest ever dollar-denominated offering. the largest portion of the offering, a 30 year security yielding nearly 1.5 percentage points more than treasury. the third and final issue, daimler getting more than 6.5 billion euros of bids in its second multi-tranche offering of the year. the automaker raising 3 billion euros in a 4-point deal with pricing tightening at least 10 basis points on all the tranches. staying in europe, the battle between the weaker fundamentals and qe continues.
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skybridge has a warning for investors. >> fighting the fed or central banks has always been a losing battle post-crisis. so pretty much every short position you have had including lower quality deteriorating fundamental credits has worked against you. briefly in 2011, 2015, q4, fundamentals mattered. but since the start of this year, they haven't. jonathan: with me at the table is oksana aronov, priya misra, robert tipp. let's talk about that. the battle in europe in credit between fundamentals and qe, how difficult is it to get your hands around that in europe? oksana: they have divorced each other completely. there is no relationship between fundamentals and prices in credit in europe, which is why we have essentially stayed out of it. but that is what happens when the european central bank provides an inordinate amount of demand for the credit market. you have high-yield names, junk rated names trading at negative
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yield. it is really unclear what puts a stop to this. but in the meantime, how do you analyze something that is a junk rated name and is showing a negative yield? what is the opportunities? jonathan: we've got to talk about the investment-grade names. this is really difficult. let's have one example in the auto sector. you saw the daimler issue. big demand for that daimler issue. there is a company that has had profit warning after profit warning through 2019. if you take it as a sector not to pick on daimler, but euro denominated auto issuers right now up until this week, those spreads were tightening. they were not widening. when the fundamentalists suggest they should be wider, they were tighter. can you make sense of that? robert: in aggregate, when you look at credit quality dynamics, even in high-yield in europe, in investment-grade, you are not seeing a wave of downgrades. so the economic outlook is threading the needle. it is bearish enough that the ecb is providing this liquidity, probably too much, and with a negative yield, probably dampening the outlook. the euro bloc is a savings bloc
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and they are forcing everybody there to pay to store their money. i don't think that will be a stimulus. that is bond positive. but the economy is not so bad that the credit fundamentals are deteriorating. and the spreads on high yield, investment-grade are comparable to dollar-denominated. so i think as a result, you will see this search for yield ongoing in the governments, continue to feed out into the corporate bonds, and lead to probably solid returns. oksana: the default situation with credit in europe has always been very different than in the u.s., because the path through restructuring is much better defined with the u.s. credit than it is in europe. in europe, a default is basically a death sentence. it is a much more difficult process, number one. secondly, in the current environment, the idea of of rising default in europe is preposterous. you have the ecb supporting zombified businesses essentially. they don't have any catalyst for going through a default cycle. what we see in the u.s. in high-yield this month has been a
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nearly 1% pickup in defaults. we are now, at the end of july, looking at 2.5% of defaults. not that far from 3.5% annualized average that we have seen over the last couple decades. in spite of that, you see $15 billion of inflows into high-yield bonds in the u.s. you continue to see inflows in europe as well. so certainly, there is a tremendous amount of complacency out there. with respect to risk, at a time when bb's are at 2.40. high-yield overall is in the mid-threes. what are you going to make on these positions in the absence of central bank support? priya: from a macro standpoint, and i am a government analyst, i'm supposed to worry about everything out there, but what worries me is, are we going to go from a reach for yield to a default getting repriced in the u.s.? in th
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as that fades away and global growth starts to impact the u.s., does default risk sta getting repriced in? i don't see any sense of that getting repriced so far in the u.s. do you start to see the differentiation between high-yield and high-grade between the better companies? we all have to do far more credit work. we talk about liquidity being significant in the past, but i think that default risk has been underappreciated in the u.s. because of strong economic growth. robert: i think you'll see volatility remain high. since the beginning of 2018, we have had a slowly deteriorating economic backdrop with tremendous volatility. the stock market is up, down, up, down, spreads out and in. i think you'll continue to see that because of your proximity to the zero lower bound. if things get bad, there is nothing you can do about it, and leverage is pretty high. having said that, what usually brings about the secular end of the spread cycle is a solid downturn, usually brought by the
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central banks hiking aggressively against an asset bubble. and we don't really have that, i would argue. so i think you will see this highly liquid environment fueled by the bank of japan, ecb, the fed begrudgingly cutting, and a volatile but solid performance. jonathan: oksana, what do you think of the idea that credit can remain insulated from pretty much everything until monetary policy gets too tight? oksana: credit is already so tight that it is going to be hard to stay insulated from everything, because it is already priced for perfection. when we talk about credit, we can't just isolate ourselves in the fundamentals argument, even if we think fundamentals are still on balance, constructive. the volatility has been created by a completely changed liquidity landscape in these markets. that is my biggest issue with the "enjoy the ride" argument, and ride this out longer,
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because that argument is based on the idea that i will be able to get out before. the reality is, you won't. because liquidity is simply not there, because the five largest corporate bond etf's in total carry more assets than the street is inventorying in all of their corporate positions, and that should be a concern to all credit investors. jonathan: oksana aronov alongside priya misra, robert tipp. let me give you a market check. where treasuries have been through the week. what a week. 20 basis points lower on the week on the 10 year. and the bulk of that coming in the last couple of days. 1.87 is your yield to close out the week. still ahead, the final spread, the week ahead featuring a lot of asian central banks with rate decisions coming up. this is bloomberg "real yield." ♪
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jonathan: i'm jonathan ferro. this is bloomberg "real yield." it is time for the final spread.
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coming up over the next week, a lot of rate decisions coming out of asia and australia. you'll hear from st. louis fed president jim bullard wednesday. another rate decision this time from the rbi. plus pmi from china. and we will hear from the chicago fed president charles evans on thursday. trade balance data from china. and on friday, ppi numbers from the u.s., and gdp from the u.k. and japan. with me are oksana aronov, priya misra, and robert tipp. robert, going into next week, what are you looking for? robert: we have had a rally and the markets will take a lot of supply in the refunding. that is going to be interesting. it is always kind of a proof statement of how solid the footing the market is on. we'll be watching to see that. the way we are going out today, the bund market, looks like at yield lows. it looks like the market is very well supported. i would guess that will have an august of indigestion. the market will be dealing with
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the pending trade and it will be underscoring the case for lower yields in the u.s., and compression of u.s. yields, which will be abnormally high relative to the rest of the world, toward global norms, you know, very slowly but volatile. priya: i'll be watching the nonmanufacturing ism, looking for the first sign that the manufacturing slowdown is actually showing up in the services sector. also, all of the fed speak, can they clarify the reaction function? what is the threshold? do they stay here, will they ease again? i think we will hear them talk about this midcycle adjustment being one more cut. jonathan: i think a lot of people will be doing a post powell conference cleanup. let's get to the rapidfire round. you know how this works. three quick questions and three quick answers if we can. first question, a bit of spread widening in high-yield at the back end of the week. do you buy high-yield on that widening, or do you continue to de-risk, continue to sell it?
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oksana: i think i continue to be patient. there will be better entry points. volatility is still with us. priya: de-risk. robert: buy. jonathan: treasury rally. lock in the profit or cling onto that coupon? priya: cling on, buy more. robert: hang on. oksana: lock in your profits. jonathan: september expectations, 50 basis points, 25, nothing? robert: 25. oksana: 25. priya: 25. jonathan: guys, great to catch up with you, oksana aronov, priya misra, and robert tipp. from new york city, that does it for us. we will see you next friday at 1:00 p.m. new york time and 6:00 p.m. in london. this was "real yield." this is bloomberg tv. ♪
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