tv Bloomberg Real Yield Bloomberg September 17, 2017 1:00am-1:30am EDT
♪ jonathan: from new york city for our viewers worldwide, i'm jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, global reflation shows signs of life. chinese ppi beats estimates, u.s. price pressures grind higher. central banks react. the bank of canada gives a surprised hike. the bank of england gives off its first in a decade. the reach for yields shows no sign of ending. austria with a yield of just 2.1%. we begin with a big issue. global reflation showing signs of a comeback. >> inflation remains well below 2%.
core cpi is 1.7 or 1.6. it allows the fed to go slow and not disrupt market conditions. >> gradual push-up in inflation back to normal, we don't see anything that will push inflation to levels where it becomes a market issue or forces central banks to accelerate any rate hike plans they may have. >> you should probably start to tighten when you see the whites of the eyes of inflation. 1.4 core pce ain't anywhere near the whites of anybody's eyes. >> the biggest risk is clients getting in and eyeing duration right now. we want some duration on portfolio, but too much duration is risk. we don't think this trend is going to be structural. it is transitory in nature. we think investors should be rewarded for going on the other side of that. >> the bond markets continue to be distorted. it is extraordinary to see. we just talked about u.k. inflation heading up, putting pressure on inflation rates all over the world. the bond markets are still not responding, and appear very stretched.
jonathan: joining me around the table is george rusnak of wells fargo investment institute, kathy jones, chief fixed-income strategist at financial research, and coming to us from atlanta is matt brill of invesco. great to have you with us. kathy, the prince for inflation for the week, which one was the most important? chinese ppi or u.s. cpi? kathy: i would say u.s. cpi. it is hard to translate chinese wholesale prices through to the finished goods in the united states and the developed world. i think the u.s. tripping up a little bit was significant. jonathan: george, just globally, the reflation team making a comeback. 10 year yields last year just north of 2%. north of 220 several times
through the week george: i think. a lot of that was the result of the whole back we had with the risk off trade coming back. you are seeing that now, risk off coming back and yields are creeping up more than inflation, we think. jonathan: just in terms of the chinese number at the start of the year it was critical for the reflation trade. a lot of people make noise about it. will it be important in the coming months, and can we maintain that trend? is anything but a commodity rebound fueled by a weaker dollar? and that's just what we are seeing in the data. kathy: i think that is what we are seeing in the data. we had a pullback in the dollar against the chinese yen, and that has given us a rebound in commodity prices and hurricanes thrown in there. that gives commodities a little boost, as well. i don't think there is much more to it than that. jonathan: matt, in terms of inflation data globally, the u.k., china, the u.s., it has started to grind higher. what interests me is the bank of canada has started to make a move, and the bank of england is talking about making a move. we can discuss that later, but no one has really calibrated or readdressed what they think is going to happen with the federal reserve.
why do you think that is? matt: we think the fed is going to hike in december. we think they will take until then to hike. you had five consecutive cpi prints that disappointed the market. yesterday, we got one that met expectations. i think we are a little ahead of ourselves to get too excited about it, but we expect the fed to come around by the end of the year. jonathan: in terms of communication, kathy, it has been remarkable. the fed spent so much time trying to talk to the market, the boe spends years talking, about the possibility of a rate hike. the bank of canada just does it. why doesn't anyone else just do it? kathy: this is part of their strategy to try to not shake things up. the problem now is we have dudley saying one thing, i think rate hikes are still on the agenda and reynard saying something else. it is hard to interpret when they are all saying different things. jonathan: we go into a said meeting next week -- a fed meeting next week. we will get the summer of economic projections in the federal reserve, what is it worth?
for next year and the year after one hardly any of us have a clue who is going to be at the fed? george: that's right, there are some changes coming on board with chair yellen's position coming up. the reality is expectations have not been as good of a predictor of what is going to happen. they have been coming down dramatically. we expect you could see them forecasting three interest rate hikes next year, that could come down to two next week when they release of those numbers. jonathan: matt, meantime we have the bank of england talking up a rate hike. what is interesting to me is unemployment in the u.k. is at 4.3%. a lot of people are questioning the phillips curve and when wage growth is really going to take off. why should the u.k. and the bank of england have so much conviction, so much faith, in those old economic models that in the last several years don't seem to have been working so
well? matt: they have not really worked for anybody so i'm not sure why they would have so much conviction in it now. the devaluation of the pound post-brexit, so i think we have to see a few more numbers to figure out what the actual trend is. we are expecting the u.k. to hike in october, but from there, what you will see is a little pullback in quantitative easing. we have seen it already, where they have stopped buying corporate credit. jonathan: in a couple of months, kathy, we will get the inflation report from the bank of england. i have seen this movie several times since 2014 when governor carney first went to the mansion house and talked up the prospect of a rate hike. why is this time different?
kathy: other than the devaluation of the currency, i don't know why this one is different. certainly financial conditions are loose, but it again is driven primarily by the currency. so, we will see if the economic prospects post-brexit don't look so good. i would be surprised if they follow through. jonathan: gilts are certainly adjusted to the prospect of rate hike. i sit here grappling with it, because you mention politics, nevermind the summary projection of the fed, the forecast from the bank of england, i don't know what they are worth either when no one knows what the relationship with the european union will be. how can these guys hike on the npc when they don't have any clarity on what the future holds? george: it has been a dramatic shift, right? because when you think about where they were, they were in a waiting phase until march of 2019 when brexit actually gets executed. we were holding off on rates, now it is switched to may of 2018. now most recently, they have actually moved it now to this year, october or november of this year. i think what you are looking at is inflation from 2.6% in july to 2.9% and above 3%. it is moving up directionally and pretty significantly.
jonathan: matt, this is what doesn't really make sense to me. why can we have a similar unemployment rate to the u.s., compared to the united kingdom, yet the market is seriously thinking about rate hike for the bank of england, but not so much at the federal reserve? why is the market pricing in more rate hikes for the bank of england than the federal reserve? matt: i think it comes down to the inflation data, and you just haven't seen inflation in the u.s. until you see inflation pick up in the u.s., people aren't going to buy it. as i mentioned before, in the u.k., inflation is mainly caused by fx. there are wage pressures in the u.k. that are real. so from that standpoint, you are not seeing that in the u.s. and you are seeing a little bit there. i think the u.s. has been such a tough problem in the past, they will be more accommodative in the future. jonathan: you are sticking with us. george rusnak, kathy jones, and matt brill. coming up, the auction block, and what a week it was. austria offering europe's first benchmark sized century bond. that is not the headline. the headline is the yield. that is next. this is "bloomberg real yield." ♪
♪ jonathan: i am jonathan ferro. this is "bloomberg: real yield." i want to head to the auction block where we had eye-opening debt sales this week. what a week it was. the yield for the 10 and 30 year treasury auctions both nearing levels we haven't seen in almost a year. that is this is the lowest since november. the 30 year yield the lowest since october.
this week, that country saw demand for the $500 million of its 10 year notes that were so high. it knocked about 90 basis points off the initial price guidance. that allowed them to sell at 7.125%, allowing them to sell at the country sold 3.5 billion euros of debt, the biggest ever sell of bonds out of europe. in austria, this was the big one. the sale that are lots of attention through the week. first euro member to issue a century bond, 3.5 billion euros of debt maturing in 2117, the biggest ever sell of 100 year bonds out of europe. a yield of 2.1%. still with us is george rusnak from the wells fargo investment institute, kathy jones, and matt brill from invesco. kathy, best century bond out of austria -- your reaction? kathy: i am stunned. it seems as if people believe in almost a deflationary trend persisting for decades in europe, otherwise institutions that need to own long-duration, i don't know why anyone would buy it. jonathan: why would anyone buy it? not just that, $11 billion, that
was the size of the order book. so clearly, a lot of people wanted to buy it. kathy: i think it was desperation for any sort of positive yield. when your choices between negative and positive, they will take positive all day long. you can see the pension funds, insurance companies, banks desperate for positive yield. jonathan: george, just in terms of the duration risk, we can do a quick calculation on the austrian debt. you can see on the 100 year, what it would take to get a 5% or 10% move? we just need to back out 20 basis points, and you will get a 10% move on price. i mean, the duration risk people are taking is really quite significant. george: it is. i don't know if they are looking at it totally from a return respective. but may an asset liability management. i think there is just a tremendous demand for duration assets, and this is feeding that demand. i don't think it logically makes sense to be buying 100 year debt at 2%.
you can go through the analysis, clearly it doesn't. if you have to have it, this is the way. jonathan: it certainly makes sense for the issuer, does it make sense for the investor? matt: i'm not really too concerned about austria doing a 100-year debt deal. i think argentina doing a 100 year debt deal and having bonds seven points, that is really the story here. it is a reach for yield. insurance companies need duration. could take a stand -- kajikistan is pretty interesting. at invesco, we have a simple rule, if you cannot find something on the map, you don't buy it. i have no idea where tajikistan is, so we did not buy the bond. mexico city airport, mexcat came this week about 4.5%. that is a lot better to buy for the term. jonathan: you touched on the point. it was in the prospectus, they actually put the map of where it
is in the prospectus. yet, people still sucked it up and bought it. you mentioned some names. some credit there, matt. why do you think people are still gravitating towards duration risks in austria for yield or the kind of risk you would buy from tajikistan? instead of just buying u.s. credit? matt: we think they should be buying u.s. credit. that is the area we are overweight. we are not doing what these other companies are doing. you either have to sacrifice credit or liquidity. when you buy 100-year bond, you are sacrificing liquidity. we do not want to do that. we are willing to sacrifice a little bit in terms of yield and we think we will be better off in the future because of that. jonathan: i caught up with hugh hendry, after 15 years, he shut down that fund. i did get a final trade from him. this is what he thinks is the most distorted market on the planet. take a listen to this. hugh: inevitably there will be an air pocket. where is your protection?
so, in protection terms, i think the most distorted asset class in the world is the two-year german bond. i would be short that. people are willing to lose 75 basis points a year for security. you know what? you don't need that security. it is the wrong price. jonathan: kathy jones, the two year, that is a stubborn trade. kathy: the problem is we have been saying that for how long now? jonathan: quite a while. kathy: yeah, and so people get tired of fighting the trend. they are starting to stand back, but it doesn't make sense. i am not willing to pay the government of germany for the privilege of buying their debt. jonathan: certainly not 70 basis points. george, i would ask the depot rate of the ecb is -40. we have an ecb talking about pulling back, pulling back on qe, as well. yet, bund yields have not really moved. george: they are pulling back on
qe, but not necessarily on their rates. you are looking at a relative value. you are right, negative seven basis points doesn't make sense, but it does when -40 basis points is your alternative. from a relative perspective, it makes sense. but an absolute perspective it does not. i do think that at some point you get through quantitative easing, then you address rates, and at that point, that is where you see a significant move. jonathan: is that something that will necessarily happen in the next several months when the ecb finally communicates what is coming next? george: i think it is more a 2019 story. i think the 2018 will be more removing qe. they are setting the path for that. they will be picking up the pace in 2018, and 2019 they will start addressing rates. they will go into that very slowly. jonathan: matt, when you look at credit, how much risk is in investment grade credit? given the fact that ecb has been has not just been buying sovereign debt, they have been buying corporates, you see how europe is priced. certainly some of that has bled across into the u.s. market, too. matt: we have definitely seen a domino effect where the ecb has been buying up assets in europe. they have been buying 10% of all new deals.
they have been tapering already within the corporate market. they were buying 10 billion euros a month earlier in the year. now they are buying five. yet, credit spreads in europe continued to go lower. there is a structural demand for credit. there is a structural demand for yield. even when central banks are starting to pull back, we don't think you will see a complete unwinding of the situation. jonathan: stick with me. george rusnak, kathy jones, and matt brill. we want to get a market check on where treasuries have been through the week. twos, tens, and 30's. yields much higher, 15 basis points on the 10-year. getting back to 220 after kissing year-to-date lows just last week. still ahead, the final spread, the week ahead featuring janet yellen and details on shrinking the fence balance sheet. at least that is what you might get. this is "bloomberg real yield." ♪
♪ jonathan: i am jonathan ferro. this is "bloomberg real yield." it is time now for the final spread. coming up over the next week, a week full of politics and monetary policy. president donald trump will make his first u.n. appearance. the general debate of the general assembly. data comes out on u.s. housing, we get rate decisions and a news conference from the fed and boj. we will have interviews from the number world business forum in new york. look out for that on bloomberg tv over the next week. still with us to discuss what is coming up, george rusnak from wells fargo investment institute. kathy jones from the schwab center of financial research, and matt brill from invesco. i want to begin with you kathy and look forward to next week. what is your sense of the treasury market positioning going into the federal reserve meeting? sense of the treasury market -- where we could get the unwind of that monster balance sheet? kathy: i think we are still long-duration, even though we have a pretty sizable bounce off of the lows of this week.
on the longer end of the yield curve. i still think the expectation is what janet yellen says will be dovish and that the unwind of the balance sheet will be slow and gradual and not have a big impact on the short run, leaves us vulnerable to surprise on the upside. jonathan: george, at 220, are we more appropriately priced going into this meeting them last week? george: i think so. our forecast for year-end is roughly round 2.5%. so, we think things could back up a little bit before year end. but again, this particular meeting will be focusing on the balance sheet and not necessarily raising rates. the next question about that will be in december. jonathan: what is the main thing you are looking out for, matt? in the news conference with fed chair janet yellen. matt: we think they will continue to be transparent, walk
you through every step of the way what they are trying to do. they don't want any surprises. it got them in trouble in the past. we saw the temper tantrum. they don't want that. we are listening to what they have to say and they will try to end things. jonathan: here's the thing i don't get, kathy. will we get the summary of economic projections? we have laughed about it before. we don't know who is going to be at the fed. on the base case for year end 2018, they are seeing rates pretty much where the 10-year is now for the fed funds rate, just north of 2.10. we are at 2.20 on the 10-year. either someone is really wrong, the treasury market or the fed, or the yield curve is just going to look like this. dead flat. which one is it going to be? kathy: someone is wrong. i think the fed will probably bring down some of their dots. we will get 2020 now for the first time as well. jonathan: for whatever that is worth. kathy: well, for whatever that is worth. and as you said, who knows who is going to be in charge.
but i think the market is too complacent about the risk of fed tightening. i think the market is just not discounting enough based on the history of the fed being run. -- fed being wrong. jonathan: will there be conditions? i wonder why they are complacent now. where is it going to come from? kathy: if we get more of a bounce in inflation than the market is expecting now, and the market is not building in any premium for inflation. george: perfect time for them to transition to their balance sheet. which is what they are doing. we expect them to move up their dialogue around that. they have wanted to talk about this for a while. if they do it right, it could steepen the yield curve. which is exactly maybe what they want to do. jonathan: matt, i want to get away from the conversation were price sets narrative. yes, treasuries have not done much in anticipation of this balance sheet move. can we really believe unwinding a $4.5 trillion balance sheet is not going to create ripples in the treasury market? matt: yes, that is fair. we are underweight mortgages. from a treasury standpoint, we think 2.20 is not the right number.
you go to 2.50, 2.60, we think that is possible. we are just not in the camp you go three-plus percent on the 10-year, we don't see that happening. jonathan: we will look back on the last week and 20 minutes and ahead to next week as well. a rapidfire round. one question, one word answers or limit those if possible. first of all, the next central bank to hike, the bank of england or the federal reserve? george: bank of england. kathy: the fed. matt: bank of england. jonathan: buy and hold to to year-end, tajikistan 10-year or austrian bond? kathy: tajikistan. matt: none of the above. jonathan: you've got to pick one. matt: i am selling january 1. jonathan: is shorting the german two-year the new widow maker, yes or no? george: yes. matt: yes. kathy: yes. jonathan: thank you for joining us, george rusnak, kathy jones,
and matt brill. we count down to that reserve decision with janet yellen next week, full coverage and special programming right here on bloomberg tv and bloomberg radio. from new york for our viewers worldwide, that does it for us. we will see you next week. at 12 new york time, 5:00 p.m. in london and if you're in hong kong, watch the replays over the weekend. do something else. this is "bloomberg real yield." ♪
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