tv Bloomberg Real Yield Bloomberg October 1, 2017 12:00pm-12:31pm EDT
♪ tom: from new york city, i'm tom keene in for jonathan ferro. with 30 minutes dedicated to the fixed income markets, this is "bloomberg real yield." ♪ tom: coming up, will it be low rate kevin as the president meets the former fed governor? in this hour, will chairman wars keep the real yield lower for longer? yellen speaks, the nominal yield spikes higher, a little transitory september gives way to an inflated october and december.
and a real yield hog. we consider the frenzy over the loan market. we start with a big issue interest rate risk in the bond , market. >> during the summer, it was almost as if bond investors were making another run at treasuries. they wanted to get the 10 year below 2% when wartime -- one more time and it is built on the base of market is never going to grow again, we will not see any fiscal policy, it and they had it completely wrong. >> the fed is moving towards regaining credibility with investors so we know what their plan is, we can make investments based on this and you will see people reacting. >> the fed has clearly said this is what we want to do. they want to reload their cannons. they want to get the balance sheet down and normalize the front-end of the curve. you see the betting odds on the december hike change dramatically. >> the fed views low inflation as a way to continue with a gradual pace.
the market thinks they shouldn't touch rates unless we are at 2% inflation. >> i believe janet yellen, that the u.s. economy is strengthening more quickly, and i do believe there will be a rate hike in december. it has been well signaled and markets will take it in their stride. tom: joining me today, we have a terrific lineup. three pros worried about the interest rate risk and the news this week on other potential fed nominees. jim king is chief investment officer at blackrock. joining me is rachel golder, the cohead of high-yield at goldman sachs. joining us, mark from pemco in newport beach, california. this will be a great reset into the fourth quarter this year. rachel, let me start with you. bring up this chart if you can. this is an equity chart. brian belsky, an equity guy, you
look at the equity quiet -- there is bond quiet as well. we are at a historic monthly low at the vix. how big a headache is that for you at goldman sachs? rachel: we think volatility is due to rise in the course of the next year. it is likely to be the result of the beginning of tapering. we are coming out next week with a client piece with the subtitle the long and winding road. globally central banks are going to be unwinding, not from the same starting point, but it will begin to tighten financial conditions into next year. we think between the financial tightening conditions and the potential for political risk and policy risks, there is likely to be higher volatility and therefore the trend in spreads will be higher. tom: mark to you at pemco, the basic idea of hard data, soft data, can we develop a theme?
do we have enough confidence in the path of the hard data? mark: you brought up a good point and the word confidence. if you look at what yellen said in her q&a and recent speeches, she is sounding increasingly confident and i think that is because the labor market is doing well in the u.s., the consumer is healthy, financial conditions are easy, and the global economy is doing better than a lot of people expected. this is giving the fed confidence that they can take a step back from this large balance sheet. the market has mispriced the fact that the fed will go a little faster than most expect. right now, the market for december is priced about 60% and cumulatively until the end of next year, less than two rate hikes. you are going to see a little more aggressive fed versus what markets are expecting and therefore, the trend to higher rates is likely and we will
likely see the fed move and also other central banks over time start to step away from the support for markets. tom: i want to bring this in, published on friday. this is the great stephen engle and he really pushes against the fed certitude. the market is greatly overestimating the votes and the commitment to hiking at the fomc, and then he turns within his research note and says the next inflation print has to deliver the bounceback to normal inflation. how urgent is it within the fed linkage into the real yield market to finally see actual inflation data, as mark mentions? jim: there was a lot of long-term secular headwinds to sustainable inflation. i do think inflation is definitely picking up and i agree with mark's point. you are at a point in time where it makes a lot of sense and gives the fed confidence with regards to where we are, the underlying economy, the labor markets, that they can reduce
their balance sheet. that being said, there is a lot of aggregate debt in the system that will put long-term headwind on to inflation. i still think there will be an outline by the fed and they will reduce their balance sheet and hike, but at a moderate pace relative to the underlying economy. tom: this is an incredibly important chart. i am looking at the ferro bloomberg terminal to make us wiser, and i want to go to all three of you. i usually don't do that, but it is so important into the fourth quarter. this is the inflation-adjusted fed fund yield. stan fischer in the lower right corner, looks at an altar accommodative fed that will weigh down the zero mark. if chairman shows up tomorrow, where are we in the continuum from altra accommodative to something called normal?
rachel: we will be normalizing and there is a temptation to continue to tighten. there is a recognition we are quite loose even though inflation is not yet present. i actually agree with my two co-panelists. tom: we have to stop the show, they all agree. we don't do that at bloomberg. we have to massively disagree. let me go to you, mark. you stated further this is a fed that will lead the market forward. where are we within the rates, even on the edge of normal? can i daresay it is 2019? mark: i think we are headed from zero to .5 percent, but this is really striking and brings up an interesting point. if you look at developed markets in the u.s., europe, japan, you have negative real yields out to 10 years in the case of u.k.,
europe, and japan. this is in sharp contrast to what is happening in emerging markets where inflation is falling in some countries. their central banks are lowering rates. you have central-bank divergence between some emerging markets and most of the developed world. our view is you want to be more cautious on developed market interest rate exposure and if you are going to take interest-rate exposure today, have it more in floating-rate form as well as select exposure. tom: we will talk about floating-rate issues later in the half hour. i want to bring up the screen right now to give you an example of where mr. kissel talking about europe different. bring the camera in here to the upper right corner, if that is possible. you have negative yields in switzerland, two year, three-year, four-year, five-year seven-year, nine year,, 10 year. we used to have negative yields to that 0.3 620 your note. that is how artificial the
market is and doesn't suggest the fed is more normal than anyone else. jim: it's a good point here. we are entering a new phase here post the financial crisis. we had a cycle where everything correlated to one and the central-bank response and fiscal response came at the same time. we have gotten to a point where the economies are in different places and there are different levels of cyclicality in different regions. you have sections of the world acting more regional and you will continue to see volatility be low. that being said, i think we will see dispersion being high. whether different industries or regions around the world, as they balance the cycle. i do think in a longer period of time where you will have low rates and normal still means low. tom: we heard this week, the idea of central banks in
different locations in the cycle is key. rachel, i look at the real yield, the nominal yield, where does goldman sachs think that dynamic is going? deutsche bank suggests a better real economy, even with subdued inflation. where is the real yield nominal yield dynamic going to work out over the next 12 months? all in 20 seconds, can you do it? rachel: we think they can press against each other. both nominal yields will continue to rise, but we will begin to see some inflation coming through. we are believers that there were temporary inflation factors pushing inflation down that will be coming back into the market early next year. while we believe there is going to be a lower terminal rate towards the end of this cycle, there is upward room. we are short u.s. while we are relatively more positive in europe. tom: we will talk about that. i know everyone wants to jump in. a nice opening section on real yield.
of bonds. the maple bond market -- the always interesting. maple leafs bond market on track to be the busiest since the financial crisis. meanwhile in the middle east and saudi arabia, they raised 12.5 billion from a second dollar bonds shale as the kingdom bolsters its finances amid an economic overhaul. we heard much about it this week. the yield for this $26 billion to your note sale at the highest level since october 2008. rachel golder with us from goldman sachs and mark kissel out at pimco. mark, let me begin with you on the appetite for paper. real yield is not only about the strategy and economics, but the demand for paper. is it a frenzy yet? if yields are going to go up, and mr. kissel is going to tell us yields are going to go up, it's like everyone going out the theater door. what is the appetite for paper right now?
mark: the demand for high-quality income producing assets is huge in the world, and simply put, it is overwhelmed by the supply. even though you have had a trillion dollars of investment grade corporate bond issuance here today, it has been met with significant demand and credit spreads have tightened throughout this year. what you will see going forward is more range bound spreads. i don't think you will see tighter spreads going forward, but most investors have underestimated how strong these technicals are. the demand for income in the world. central banks at the margin will gradually normalize and that can cause technicals to change at the margin, but right now, these technicals are very strong. tom: this is of extraordinary interest. years ago, i heard sir john templeton say quietly in a meeting, there will be shortage of paper. that is where we are.
explain to our audience who hasn't read, explain why there is a shortage of paper. where is the animal spirit from where i've got to load the boat on fixed income paper? jim: i think honestly, the equity market, as well. we are in a different environment. if you went back 10 years ago, and you wanted to be conservative, you can cash and -- you can own cash and still receive 5% to 10%. around the world, if you are going to own fixed income assets, you will own something that is below your long-term retirement goal. so we do see a demand for high-quality assets, but that is also because you have an improving economic environment that has been buoyed by fiscal and monetary stimulus around the world. asset prices have risen, but the risk profile still looks pretty good relative to the underlying environment. tom: rachel -- and all of you are sort of from the same idea that i don't want to lose money.
i want to make a coupon and find some total return. high-yield has had a wonderful run. are you more high-yieldy, are you on moderately speaking terms with your corporate desk at goldman sachs, or are you high-yield all the time? rachel: we are cautious on high-yield right now, although we don't see the end of the cycle anytime soon. we think valuations are pretty tight given there are increasing pockets of risk in the market and also the view that as financial conditions tighten in 2018, you'll see a steepening of the quality curve. tom: let's do this. this is important. ferro can't do this, i can. put your hands up like this to describe it. you have got full faith and credit down here. this is their yield. you are watching high-yield coming in, tight. but then they both move. what happens to high-yield if janet yellen's inflation becomes less than transitory? do they go up together? how does that dynamic work? rachel: historically high-yield has had an inverse relationship
with treasuries. that's usually because rates are rising when the economy has already been strong, and spreads are tight, so there is not a lot of room for spreads to go. and furthermore, we think that rising rates is going to tighten financial conditions, so we think spreads are likely to leak wider. not taking away the total return of the asset class, but slimming it. tom: mark, i know everybody at pimco eats kale and you haven't been to mcdonald's in three years, help me. we saw the mcdonald's auction deal. when a aaa blue-chip corporate like mcdonald's comes, how does that deal get done? how do you get the paper you want? mark: well, tom -- and i haven't eaten fast food in 10 years, so probably not biggest mcdonald's fan out there. obviously, investors are out there competing for supply. what is happening right now is the issuer has the advantage because the financial conditions are so easy.
many of these corporate bond deals are being met with incredibly strong demand, two or three or four times oversubscribed. so what we are doing is being a a lot more selective. we talked about high-yield earlier. we have reduced risk in high-yield. we are being more selective. we are owning more senior parts of the capital structure. we are not buying as many new issues as we were six months ago. we are owning more investment grade, less high-yield. we still like non-agencies a lot like the u.s. housing market. also emerging markets on a relative basis to us look quite attractive. tom: we still have the final spread. the week ahead features in the united kingdom -- they are arguing. jobs report in the united states. that will be a big deal as we move to that december fed meeting. stay with us. this is "bloomberg real yield." ♪ ♪
tom: i am tom keene in for jonathan ferro. this is "bloomberg real yield." time for the final spread. coming up over the next week, chair yellen will be speaking, a very important speech this week, in barcelona, the regional government, they hold a referendum. we had a great report on that this week. in the united kingdom, prime minister may headlines on conservative comfort -- a conservative conference. in the united states, we stagger forward to the friday jobs report. i want to go deeper, or as deep as i can with my brain. jim keenan of blackrock, rachel golder of goldman sachs, and mark kiesel at pimco. rachel, i want you to give some wisdom. there was a great article on the
frenzy in your world of loans. describe how institutions buy loans. rachel: loans are seen as a higher-quality high-yield opportunity set, within fixed income and a safer way of getting yield. there has been a massive issuance in the last few years, but most of it has been refinancing oriented, a lot of it absorbed by clo's, which are doing very well. tom: what is a clo? rachel: collateralized loan obligations. tom: jonathan ferro would not have done that, what is clo? rachel: collateralized loan obligations. the bank loans have a floating rate. the liabilities are also floating rate. tom: we have jim keenan. explain floating-rate versus fixed-rate, and why you need to float now as you go into 2018? jim: it is around the duration risk.
fixed income has a variability of rate risk associated with it. bank loans give you credit risk. senior secured credit risk that are tied to the front end relative to what you would get in fixed income. i do think it is important. the bank loans, the secured market is giving you a good risk-adjusted return profile. one of the things we did talk about before is the volatility has been low. but dispersion has still been high. whether you are looking at loans or high-yield or emerging markets, the underlying economy at low growth, there is still huge divergence between winners and losers. i think that is an important part, whether you are looking at high yields or loans in having a balanced credit portfolio. tom: what is important here is the exogenous shock. is german -- is the chairman warsh chairman hubbard, can they
be an exogenous shock to the certitude of the floating-rate market? mark: i think they can. i think under bernanke and yellen we have had a robust environment for financial assets. you have seen not only bonds do well, but equities do well. the challenge is because the global economy is doing decently and because it is likely you you are going to start to see inflation in developed markets gradually pick up, the ability of central banks to provide that tailwind for financial markets, i don't think it is going to be as robust as it has in the past. and by the way, that is independent of the new chair. but the new chair is going to create a potential volatility for markets. so it is something i think that is going to be a headwind for asset prices. tom: jim, i want to go to you with the last question. the non-sophisticates out there say yield higher, price lower. is anyone looking for an almost bear market in bonds? is there anybody out there calling about price downwards
upwards painful? jim: i'm sure there are some people looking out there. look, we are all getting used to the sense that there is a lot of debt in the system. it sits at the corporate level or the central banks and they are starting to remove that from the system. couple that with technology, demographics, i think there is a longer term trend of downward growth in inflation. tom: this has been too smart for surveillance. jonathan ferro look you to do -- lucky to do this each and every week on "bloomberg real yield." my thanks to jim keenan, rachel golder, and mark kiesel. from new york, that does it for us. we will see you next friday at 12:00 new york time. this is "bloomberg real yield." ♪
so we need tablets installed... with the menu app ready to roll. in 12 weeks. yeah. ♪ ♪ the world of fast food is being changed by faster networks. ♪ ♪ data, applications, customer experience. ♪ ♪ which is why comcast business delivers consistent network performance and speed across all your locations. fast connections everywhere. that's how you outmaneuver.