tv Bloomberg Real Yield Bloomberg August 25, 2019 5:30am-6:00am EDT
lisa: from new york city for our viewers worldwide, i'm lisa abramowicz. denver jonathan ferro. -- in for jonathan ferro. bloomberg "real yield" starts right now. ♪ lisa: coming up, move over, jackson hole. tariff fears dictating markets with escalating trade fears -- trade tensions extending the rally in treasuries. chairman powell saying the u.s. economy is in a favorable place but faces significant risks, reinforcing bets for another rate cut in september. and zero rate 30. germany regretting the size of its bonds that pay nothing as the option flops. let's start with the big issue.
fed officials at jackson hole grappling with how the trade war is impacting the u.s. economy. >> trade uncertainty is sort of a fact of life now. >> trade policy uncertainty has been weighing on the outlook. >> business investment is not held back by the cost of capital. >> we have seen already some business spending be weakened because of the tariff situation. >> what is holding it back is uncertainty around policy, particularly trade policy. >> the uncertainty of the trade -- tariff situation. >> the fulcrum, the center of gravity is u.s. economic policy, not monetary policy is trade uncertainty. >> i don't think there is resolution likely anytime soon. >> trade uncertainty will be with us. what i see some businesses do is become more cautious. >> this trade war is triggering other actions around the world, other countries thinking about reevaluating their own trade relationships. so this could easily get out of control and easily feed back to the u.s. lisa: there should be a little ding every time they say "uncertainty."
joining us now is matt toms, investment management, luke hick more joining from the edinburgh, , and here in new york, jim keegan. i want to start with you, jim. one thing i'm struck by, yes, we are seeing bets for a rate cut being priced into markets. it is not giving a boost to risk assets. what do you take from this? jim: i think you have to look at how risk assets have performed. if you look at 2018, it looks like we have had a peak in growth rates, inflation, interest rates, and risk assets. i mean, if you look at stocks for instance, globally, stocks peaked in 2018, and the s&p is up very little from where it peaked initially at the end of january 2018. you have basically collected the dividend. so at the end of the day, i think that fed policy has just created asset inflation, which is why i think you have got this divide on the fed where there
are several people concerned about financial stability risk. because if you look at asset inflation, it leads to asset bubbles. if we mean revert, which the laws of mean reversion have not been repealed yet, it tells you where assets could head. lisa: luke hickmore, come on in here, because the concern for asset bubbles has been prevalent for a long time, has not stopped the fed from pursuing easy money policies. how concerned are you about that, and how many times do you expect the fed to cut rates? luke: i think the market pricing around four cuts seems about right. it depends somewhat on the pace of that. we are only expecting 25 basis points in september, but the risk of a 50 could be centered around how risk assets move from here on out. the move into q4 this year seasonally could be pretty tough for risk assets.
and equity markets in particular. the setup right now feels quite shaky for equity markets coming into the end of this year, and that could be what pushes the fed into upping the pace of their rate cuts. but you know, it does feel hard at the moment to see rates much below say .75% in the u.s., but we could get there quicker if equity markets selloff. lisa: matt, what do you think? do you think the fed will cut four times? matt: we think three more gets you to 1.5%, and there is an influence higher. however a feedback loop on growth expectations is not there, and that has historically increased asset prices, is that stimulative product. that is not being pushed in by the market, and that is why the yield curve has flattened. we have also had fixed income assets not sell off. so there is not a trade to bounce back in high-yield when you are already below 6% in yields. lisa: i am glad you brought up the yield curve. st. louis fed president jim bullard keeping a close eye on this yield curve, telling bloomberg he is not shrugging
off the inversion. mr. bullard: if you have a recession prediction model, it is going to use the yield curve to try to predict that. our job is to get the yield curve to be un-inverted, so those recession probability models don't work anymore. that would be a great thing to do. i am not interested in testing somebody's theory about this time is different about the yield curve. lisa: jim, how many times does the fed have to cut to avoid a yield curve inversion? jim: [laughter] depends on which part of the yield curve you are looking at. lisa: let's say 2/10. jim: they have got to do another 25. more than that, they would have to do 50 or more. lisa: luke? what do you think? how much to avoid inversion in the 2/10? luke: right now at the moment, that is difficult to say. the market is really pricing in, and moving toward recessionary probabilities being very, very high. what they do now may not change that yield curve move in the short-term.
almost if they cut four times before the end of the year, we think we could be inverted because the market will then panic, what does the fed know that we don't? lisa: that raises an interesting question. luke is suggesting that markets are going to invert the yield curve regardless because people are feeling really pessimistic about the economy. do you agree? matt: i disagree with that. the market will not assume that the fed knows anything more than it does a day or two ahead. a proactive fed helps the market and the yield curve. it does not instill fear for more than a short-term amount of time. in our opinion, three extra cuts gets you 21.5% on the cash rate, allowing the -- gets you to 1.5% on the cash rate, allowing the 10-year to steepen, if some of the trade uncertainty goes away. it is hard to see below 1.5 on the 10 year when the inflation expectations have a hard time getting below that level. that would mean a negative real yield on 10. 1.5 is a key level on us for cash and on 10. lisa: matt, it is interesting you say you don't think the market is thinking, what does
the fed know what we don't know? certainly, the fed is wondering what does the market know that we don't know. loretta mester telling bloomberg, she may not agree with the signals from the bond market, but they cannot be ignored. ms. mester: there is no doubt that bond investors have a more pessimistic view of the u.s. economy than perhaps the economists and i do. and we have to take a signal from that. we can't just ignore what is happening there. lisa: jim, do you think that the bond market is appropriate in sending a signal that is basically telling us there will be a recession within the next 12 months? jim: yeah. if you look at various financial markets for instance, the three-month 10 year, the new york fed recession probability model is telling you on a normalized asus it is about a -- basis it is about a 72% , probability. five year treasury is saying it is in the 50% area. if you look at investment grade corporates, 13%. high-yield about 10%.
equity is about 8%. historically, the bond market has been much a more accurate reflector of inflection points, so i think it is reasonable. and global growth has clearly slowed, and there is elevated global recession risk. china is in a secular slow down. not a cyclical slowdown. they don't have the current account reserves that they did previously to stimulate. they have got a debt problem. germany looks like it is going into recession. it is totally tied to trade and exports. 47% of germany's economy is exports. 18% of those exports go to asia and most to china. so 9% of germany's gdp is tied to chinese exports. lisa: yeah, we are going to see how that plays out. of course, we have the trade wars heating up, which is interesting to watch the price action. markets seemed somewhat calmed after what jerome powell had to say, but less so after president trump tweeted out, writing, my only question is who is our bigger enemy? jay powell or chairman xi?
i just have to wonder, luke, what would president trump like to have seen out of this meeting? and how much does this risk the fed's independence at this juncture? luke: you wonder whether he would like an intrameeting rate cut. and jay powell is saying we are going to do everything it takes to get inflation back to 2% and support growth, a very mario draghi kind of approach. but that is not going to happen. i think trump is going to continue to lay on the pressure. it has been a fascinating move away from a completely -- from completely independent central banks, to ones that are getting increasing political pressure. still independent, but that political pressure has got to weigh on them over the long-term. lisa: everyone will stick with me, and we will be talking more about all of this coming up. the auction block. the world's first 30-year bond offering, a zero coupon, weak demand. diving into negative territory.
♪ lisa: i am lisa abramowicz in for jonathan ferro. this is bloomberg "real yield." i want to head to the auction block. let's begin in sweden where the country's oldest lender tapped the market for so-called additional tier 1 bonds for the first time in almost three years. the bank received orders for more than nine times the $500 million, yielding just over 5.6% as record low interest rates continue to lure issuers. in the u.s. the treasury sold $7 billion in 30 year tips.
at a yield of 0.5%, the lowest in nearly seven years. primary dealers took home the smallest portion of the auction on record, with demand the strongest since 2017. where is inflation? some people are hurting for it. the world's first 30-year bond without coupons struggled to find buyers, prompting germany's debt agency to admit the sale may have been too large. the nation failed to meet a 2 billion euro target, signaling that negative yields across europe may finally be taking their toll on demand. bunds rebounding since that auction, so maybe not. increasing uncertainties sparking a move into havens, credit suisse saying there may not be too many alternatives to negative rates. >> clearly, yields are not attractive, they are very low, but they are reflecting a reality. institutional investors of today they are worried about the economic outlook or perhaps risks that are more broadly around. they do not have much more alternatives than piling into already unattractive government bonds.
lisa: matt toms, luke hickmore, and jim keegan still with us. luke, since you are in europe right now, what is your take on the outlook for negative yields and the attractiveness? i mean, do you take a signal that we are reaching peak negative yields from the german bond auction? luke: i don't think we are, bearing in mind september ecb, we are looking for a 20 basis point cut. that will take us to a 60 negative depo rate. so you know, getting into a 70, 80, 90 negative number for the german ten-year could be quite easy from here. you think, a lot of people are buying these assets for capital appreciation and for extra duration in their portfolios. if you are u.k. investor buying euro assets, you're getting a positive pickup from the foreign exchange as well. there is still plenty of demand around. we are going to get a wave of new issuance from corporates in a couple of weeks. it will get taken down very well.
lisa: matt, what is your perspective here when we look at the incredible amount of negative yielding debt out there? are you finding it attractive, i mean, are you going into those areas that have negative yield? do you view this as a bubble? how are you sort of reconciling this with the history books? matt: basically, if you need to own it, you need to own it. if you can swap back into another currency and still have a positive yield, yes, it makes sense and we do that. ultimately, we think the experiment has some problems with the outcome mechanism. we have not seen growth or inflation revised. we ultimately think you'll see a bottom to negative yields, how far they can go negative, because there is a cost in negative yields in the banking system, savers, ultimately investment. the end will be when people realize there is an offset. there is a benefit but there is an offset to negative yields. lisa: president donald trump reacted to the german bond auction, tweeting, "germany cells 30-year bond fell. our federal reserve does not
allow us to do what we must do. they put us at a disadvantage against our competition. strong dollar, no inflation. they move like quicksand. fight or go home." jim, do you expect to see negative yields in the united states at some point within the next few years as the u.s. faces a slowing economy and perhaps a downturn? jim: at this point, i don't, and i sincerely hope not. because you can look to japan and europe, and they have not worked. we talked about they have not increased growth, they have not increased inflation, they have not increased credit. they have increased savings rates. they have created more zombie companies. that is deflationary. we have got an excess capacity issue globally. and all of these easy money and negative interest rates does is increase the ability of these companies that should be out of business to stay in business. lisa: which raises an interesting question, luke. if there are all of these zombie
companies getting fueled by and being kept alive by the negative rates, what is your perspective on buying corporate debt in the eurozone in a time of a slowing economy? are you saying, at least we can pick up some extra yield, and there is a buyer of last resort, the ecb, or are you staying away? luke: look, i think the landscape is changing pretty rapidly over here. that whole zombie argument has been around a while, and i'm not sure it applies anymore. the kind of companies that are struggling to get financed at the moment, b, ccc, are struggling to refinance. these are not businesses that can go to the market and get lots and lots and lots of new debt. the place that we think is interesting is the investment grade in the bb area. because if nothing else, the ecb can be buying 20 billion of that possibly as early as january next year, every single month. now if you have that kind of big buyer in the market, there is lots to go for still in european credit. sterling credit works as well. and i think actually, even in the u.s. market is a haven asset
which has still got some yield around it. you are going to find investors forced into that space, too. that may all be wrong from an economic long perspective, but in an investable timescale, i would still very much be in credit. lisa: i would say in the past couple of weeks, there has been a paradigm shift from low rates pushes people into riskier assets, into yield, to low rates indicate a slow down, pushing people away from some of the riskier assets, and you have seen a diversion between the lowest rated debt highest rated and the debt, and how people are trying to hide out in stuff that seems better -- more credit worthy. how are you viewing that? are you seeing opportunities in the lower rated credit, or are you also going into higher rated debt in a, basically -- to gird for what could be a downturn? matt: the opportunity has been to be crowded into the higher-quality spread alternatives to government bonds. the single a, bbb is a nice way to diversify and get some extra
income. that is absolutely the trade, we think that trade continues, and it expands into other sectors in the bond market that benefit from low rates like housing bonds, commercial real estate bonds for example. that is the trade that we think continues. lisa: do you agree, jim? jim: you have to be selective because we are getting to the point where there is elevated recession risk. at the end of the day, risk premiums are tight, whether you look at them on a nominal basis and then if you leverage adjust them. what is interesting about this cycle is the fact that typically at the end of a business cycle, when corporate profits and cash flow are peaking, leverage is at a trough, not a peak. but this cycle, leverage is that -- at a peak. we know why. it is because the largest buyer of equities has been corporations buying back their own shares, about $5 trillion worth, and a lot of that has been debt financed. if you look at spreads on a leverage adjusted basis, they are pretty much close to the all-time record high, the fourth
quarter of 2017. lisa: luke, final thoughts on -- from you. jim expects that we are getting closer to recession. would you agree? luke: yeah, absolutely. all the signs are there. you would now be really, really hard-pressed to ignore them and look for growth forever. the thing is, it could be six months, it could be a year away, but it is coming, and it will come in germany first. it will then come to the u.s., and it may be mild in the u.s., but i think saying any longer, we are just going to avoid that -- is hard to say. lisa: matt tom's, luke hickmore, you are all sticking with us. let's get a check on where bonds have been this week. we are seeing yields lower in the longer dated bonds. two-year yields rising four basis points, leading to that flattening, the curve flattening and the brief inversion between
♪ lisa: i am lisa abramowicz. this is bloomberg "real yield." time for the final spread. coming up over the next few days, president donald trump and u.k. prime minister boris johnson among the leaders set to meet in france for the g7 summit on saturday. tuesday we get u.s. consumer confidence data, followed by fed speeches from thomas barkan and mary daly on wednesday and thursday, and friday, look up -- look out for u.s. personal spending and consumer sentiment data. plus a policy decision from the
bank of korea. matt toms, luke hickmore, and jim keegan still with us. so much uncertainty. i just want to start with you, matt. are you expecting anything definitive from the g7 meeting that could potentially give a floor to bond yields? matt: unfortunately not. the g7 gives us a chance to fear what if the trade war expands from china more toward europe? it was forestalled earlier this year to clear the decks with china. there is actually more downside risk, should there be negative tweets or headlines out of g7. we fear it is more of a downside case as opposed to stability. lisa: luke, do you agree? luke: that has probably got to be a central case. g7 has struggled to come up with a communique which reflects a more settled joint opinion from the last couple of meetings, and this one does not feel any different. and actually, prime minister johnson in the mix there as well is not going to make anything any easier down in biarritz. lisa: jim, do you think the pressure is for yields to go lower here?
jim: absolutely. lisa: for government bond yields? jim: absolutely. absolutely. especially long-term rates, it is a relative gain. to the extent that we talked about where the ecb will be the deposit rate even further, that is going to put downward pressure on yield. the u.s. is the best house in a low yielding neighborhood. lisa: all right, it is time now for rapid fire. we have a lot going on. my first question to you all is when do we get a recession in the united states? matt? matt: 2021. lisa: luke. luke: december 2020. lisa: wow. jim. jim: when the fed goes from a midcycle adjustment to a full easing cycle, that is we know we are in recession. lisa: all right, second question, will we see negative yields in the u.s.? i am going to start with you, jim. jim: short-term, policy rates? lisa: yes. jim: no. lisa: luke. luke: 10-year yield i think you are asking, lisa, yes.
lisa: matt. matt: no. lisa: the next question, em debt, buy or sell? matt? matt: i'm a buyer here. lisa: you are a buyer here. luke. luke: i cannot buy it. it is too expensive, it is dollars. jim: the dollar is getting stronger and that is going to put pressure on e.m. lisa: my thanks to jim keegan, luke hickmore, matt toms. from new york, that does it for us. real yield is back next friday 6:00 p.m. in london, focus very much on bonds. from new york, this is bloomberg "real yield." ♪
>> coming up on "bloomberg best." the stories that take the weekend business around the world. markets keep calm while global carry on. >> we'll have to see the chance to form an alternative majority in the new government. >> germany ponders stimulus as recession looms. be found.h can >> civil unrest and government pressure keeps hong kong on edge. >> we're all breathing sigh of relief that we didn't see violent cs.