tv Bloomberg Real Yield Bloomberg October 15, 2017 12:00pm-12:30pm EDT
♪ lisa: from new york city, i'm lisa abramowicz, in for jonathan ferro. with 30 minutes dedicated to fixed income, this is "bloomberg: real yield." ♪ lisa: coming up, what will be the pin that pops the bond market? perhaps it will be the central banks as ecb firms up its plans is to taper. leverage levels are creeping up all over as the imf focusing on the risk to financial stability. the largest u.s. banks report earnings and revealing a less creditworthy the american consumer. how big of a concern is that for debt markets? we start with a big issue,
markets continue to shrug off risk. >> it's really surprising when you look at all the events that have gone on in the markets have become so jaded. they don't react like they used to. >> i don't know about you, but i'm nervous. and it seems like when investors are nervous they are prone to being spooked. and nothing seems to spook the market. >> central banks are keeping the pedal too much on the gas and we are sucking out volatility that is not conducive to long-term growth. >> in this case, i don't think it is a really overwhelming bubble, i just think there is a disaster risk the markets are not taking into account. lisa: lots of existential angst. not a lot of action. joining me around the table in new york is michael cloherty. head of u.s. interest rate strategy at rbc capital markets. bonnie wongtrakool, portfolio manager at western asset management and scott kimball. the portfolio manager at core
plus bond fund. i want to start with the ecb. since we did get news overnight giving more details about what , their tapering plan might look like next year as they tear back their monthly purchases. i'm struck by the fact that the market rallied. people bought bonds on the idea of them buying fewer bonds. can you explain this? >> sure, the consensus going in to the last night was that the ecb would probably finish tapering around the second half of next year. what's been talked about now is a little bit beyond that. i think that is why you saw the rally. we are not surprised by that. we came into the year feeling constructive on the eu. we actually went along the air -- the year and felt it was underpriced. and now we have seen them recover quite well. the growth has been pretty good, inflation is ok. still not on target. but at this point, we actually think growth is going to decelerate a little bit. we don't think is going to reach
the eu's forecast. we think growth could be even less than 1.5%. as a result of that, we think the ecb will have to remain in the market, actively buying and doing qe for longer than the market expects. lisa: so if you see europe decelerating, you see the european central bank continuing its bond purchase longer than it is currently priced into the market. michael, given that backdrop, nothing can cause u.s. treasuries to sell off? michael: that is the problem. every time rates go up, we look really cheap other countries. we see foreign buying has picked up and come much further out of the curve than it used to. a lot of foreign private investors used to buy two-year and five your treasuries are buying ten year or longer treasuries. that has a long-term goal and a depressing effect on our yields. to get a really big move in the market, what we really need is inflation to pick up a little bit. for two reasons, one is the obvious. my cash flow is worth less if inflation is up.
two is that, the last few years we have seen these people piling into risk assets in order to reach a yield target. i can't afford to keep my house off of buying a treasury yield. that is not going to generate enough cash flow to keep my house, so i have to pile into risk assets to take more risk. when rates start to rise people start to pull out of this risk -- these risk assets and they can hit the yield bogey in a safer way. every time it looks like rates are going to take off we see , some jitters in corporate bond markets. the fed backs off, they get much more dovish, and we rally right back to where we were. that will continue to happen as long as inflation is low. what happens if we start to see inflation pick up? all of a sudden, the fed cannot have that put their -- there for risk assets and you have the potential to jump to a much higher yield. lisa: you think that is possible, that we will see that
inflation? michael: not soon. i think we'll see a little higher than today, higher than the recent run rate, but not a dramatic jump. lisa: scott, are you piling into 30 year bonds? scott: the way we position the bond fund is to take advantage of what my colleague was talking about. as interest rates rise, we see some trepidation of people that have owned those risk assets and maybe rotate back into more traditional asset allocation tools like core fixed income. and part of that is owning longer dated securities. we found a lot of value in owning seven, 10, and 30 year corporate debt, particularly in sectors that might get beat up on the headline news side of things. so yes, we have been turning out a bit and bringing our portfolio duration back toward neutral, with the expectation the upside case for rates is continuing to dwindle with lower inflation. lisa: i'm struck by the fact we are not seeing that much inflation. we are not seeing that much growth. people are piling into risky stuff. people are starting to get
nervous. the imf talks about financial stability, and you have the yield curve that continues to flatten, suggesting growth will only slow down further in the future. at what point, bonnie, does this make you very concerned about the financial stability we are looking at if there is a downturn or an exogenous risk? bonnie: i think the yield curve is not necessarily by the flattening suggesting it will have a greater chance of a recession. i think it is flattening in part because of what mike was talking about, that we still see levels of yield but the absolute is kind of low. people have to go up the curve. i think you see the curve flattening because we are seeing a little more inflation. there is a little bit more chance of the fed having to hike and going ahead with their normalization. that is why you are seeing the yield curve flattening. >> so you think people are misinterpreting it? bonnie: it's not inverted. i don't know how many people
believe the flattening is pretending a recession. lisa: michael, do you think the curve will invert in the near term? michael: no, no, if the fed starts to tighten more aggressively, we think will steepen relative to the curve. perfectly flat. we really need to have an imminent recession. if you look at consumer balance sheets right now, they are extraordinarily strong. consumer spending should hold up, even if we had a little shock to it. today we saw a solid report on the consumer side. so with that, the biggest piece of gdp, we have decent growth going forward. yeah, no recession soon. lisa: scott, would you agree? scott: we would agree. we look at the underpinnings of what is going on with the yield curve. it is emblematic of a disagreement. we think the investor community is having given the fed. we use the word "transitory" to describe the lack of inflation since about 2013.
the market is interpreting that. particularly some of the comments from the fed governors earlier in the week about that particular word. there is a bit of wrangling going on with exactly how much longer we are going to wait before the word "transitory" is removed and the word "structural" comes in. we think the flattening of the curve reflects the market, foretelling to the fed that there are structural underpinnings you need to ignore knowledge. but gdp in the u.s., consumer spending, it has been very strong. we think it was probably an upside case to be made for inflation to accelerate in the next 12 months. lisa: bonnie, who matters more? the ecb or the fed at this point? bonnie: when you talk about quantitative easing, the ecb. the fed has already communicated what they are going to do to the balance sheet. they have been transparent about it. we know it will be very gradual. so there is not a lot of room around there to have movement. lisa: michael, how many hikes do you think we will see from the fed next year?
michael: i think we will get sort of a quarterly base going forward. we will see three or four next year. because again, the solid growth backdrop -- the fed is still easing -- even if inflation is below where they would like it to be, that is the norm. inflation is only about 2% about a quarter of a time going back 25 years. so you still need to take some insurance out, moving back towards a more normal policy rate rather than if you wait until you see inflation, it is too late. you have to be much more aggressive to catch up. that causes much more damage with the rapid tightening. and especially because everyone is piled into more risk. markets seem less liquid. people have more risk on the desk than they used to because of the lack of volatility. if the fed doesn't something and goes hard, they are much more likely to break the system. lisa: we will talk about that inflation. everyone is taking with us. everyone is sticking with us. michael cloherty, bonnie wongtrakool, and scott kimball.
lisa: i'm lisa abramowicz. this is "bloomberg: real yield." i want to head to the auction block now. this week the u.s. treasuries sold nearly $190 billion in bonds. we are focusing on the 30 year bond sale. the yield of 2.8 7% with a bid to cover ratio of 2.53%, the highest level since september 2015. walmart sold bonds to refinance debt. the world's largest retailer
issued $6 billion of unsecured bonds in six parts, with the longest portion a 30 year security, yielding 75 basis points. john frieda companies are raised -- have raised over $14 billion this month. the second half of october usually sees a second month of issuance, making it very likely it will had a five-year peak for sales. still with us, michael cloherty, bonnie wongtrakool and scott kimball. i'm struck by what you all are saying to me and what we hear again and again. we just don't see the risk. people will continue to buy bonds. we saw yet another inflow that was the biggest weekly inflow over the past week since 2015. it makes me wonder why not lever up? why not just get as much leverage as you possibly can and pour your money into absolutely anything risky you can find? michael? michael: sadly i think we have seen a few people doing that.
unfortunately, it is the people under the most stress. retirees that need some income, other people like that who are at least able to sustain the loss. pension funds, other folks like that, small banks. lisa: are you seeing pension funds lever up? michael: taking more risk than they would have before. lisa: what markets? michael: it is really corporates, things like that. you are forced to chase yield because you have to meet some target. you have to pay retirees. you have to meet some earnings targets. you can't do that buying treasuries, so you are forced to slide out the scale. lisa: scott, have you been more willing to use leverage given the backdrop we are looking at? scott: our core plus bond fund does not use leverage as a tool. we move around between 80% mix of investment-grade securities with the opportunity to do with the 20% below investment-grade. the opposite of the trade you have outlined, which is we are
more willing to move further out the yield curve and investment-grade to capture yield as opposed to trying to stay low on duration and buy high-yield at a low high-yield premium. so effectively, our viewpoint there is we think there are better opportunities ahead look at some of these risk assets. right now we are more on the investment-grade side of things. bonnie: i'd say similarly, we also don't use leverage in our core plus bond funds. but in terms of valuations, we think the fundamentals are very good but we also think the valuations are relatively full for credit. so what we have done is cycled out of some of that and been very selective about where we have those holdings and then move them into other markets we think have more value, like emerging markets. lisa: i want to pick up on emerging markets in a minute. i just want to ask both scott and bonnie, do you see investors engaging in behaviors that concern you as far as how much leverage they are taking on? in other words, borrowing short-term in order to invest longer-term, as well as more of the risk spectrum than they
would like to? scott: i think this is sort of the corporate bond or credit bull market that is the most hated in history. people have been trying to predict its demise since the day it started. so very candidly, when we look back at our own expectations for credit risk and credit return, they continue to surprise to the upside. at this point, we don't think the risk premium is high enough to own super subordinated structures and take on too much risk. particularly, further your risk out the curve. but at the same time, there are a lot of investors engaged in that. that is one of the concerns we have about when this credit cycle ends, when the cushion pops. it may be more pronounced. bonnie: we have seen investors in this search for yield as spreads have compressed in certain sectors moving their allocations to other sectors. but i would not characterize it as over-levering. lisa: i am struck by the lack of assets. people talk about the amount of cash. i think the flip side of that is
there are not enough bonds for people to buy. you see synthetics come back, synthetic cbo's coming back in -- and people creating contracts to go around risky bank bonds in europe. i'm just wondering, is this natural? is this still small potato stuff? or is this becoming a more prevalent issue as people search for something to buy? >> again, is it a systemic risk, no? we are not anywhere close to that amount of outstandings yet. we have seen looser language on some corporate bonds. less security. people stress for yield and they have to give up something. so you are seeing a little bit of a slide there. overall, the economic backdrop still looks bright enough you will not expect a massive wave of defaults coming in that would be seen in a recession that would really hurt corporates. what worries me most about corporates is this huge move towards passive investing.
if we get a surprise default from somebody, our panelists know how to handle that. they know how to value that security. they can work their way out of that. some of the passive folks, i see that only index, i sell it, i move on. as the passive thing gets bigger and bigger and bigger the risk of a surprising fall -- it was before your days, but if we get that, it will be much messier. lisa: and bonnie, quickly, you you said you're going into more investment-grade then high-yield debt. investment-grade is also highly valued. bonnie: we are going into more emerging markets. lisa: emerging markets and high-yield, scott is going more into investment grade, right? scott: in the market we are can that continuing to see very strong flows. i have to echo michael's sentiment about passive versus active. obviously, core plus is an active fund. we do measure credit risk on an individual security basis, but
with passive you do not do that. lisa: everyone is going to be sticking with us. we will delve into the emerging markets more. michael cloherty, bonnie wongtrakool, scott kimball. let's get a market check on where bonds have been in this week. 2, 10, 30 all getting tighter. people piling into bonds cannot get enough of them. still ahead, the final spread. the week ahead features the 19th chinese communist party congress. the country's most important political events that only occurs twice a decade. this is "bloomberg: real yield." ♪ ♪
fed chair janet yellen takes part of a group of 30 international banking seminar. catalonia faces a deadline regarding its independence. greek prime minister alexis tsipras visits the white house. morgan stanley and goldman sachs report earnings, and china holds its 19th communist party congress, the country's most important political event. still with us is michael cloherty, bonnie wongtrakool, and scott kimball. i want to talk more about what you were talking about, bonnie, with respect to shifting away from high-yield credit in the u.s. and moving more to emerging markets. how are you doing that? recently, an increasing number of firms are putting more money into local currency, emerging markets debt, and away from dollar-denominated emerging-market debt. is that what you are doing as well? bonnie: so emerging markets, we did start to move into that earlier at the beginning of the year when we felt that was a good value. since then spreads have compressed, particularly on the dollar denominated debt.
at this point, local currency bonds do see relatively more attractive and we do have a decent allocation into that as well. i would say others are following on that, but it has more room to go. if you look at the differential and real yields between developed economies and emerging market economies, we think it still holds value. lisa: scott, are you also shifting more of your portfolio into emerging markets? scott: we have not really shifted our core plus strategies around e.m., greater allocation. but we're emphasizing looking for opportunities in em corporate. we do earn a yield premium due to the fact that the company is domiciled in emerging-market. lisa: michael, how concerned are you that this is a leveraged dollar bet? basically, as soon as the dollar weakens, emerging markets look better and better. but as soon as the dollar strengthens, people get a rude awakening? michael: right, so some of the bet is, do you think the fed will tighten really hard and fast or not? if you think you are going to
get an aggressive tightening here, that is probably not going to work out too well. i think it is unlikely we will get a really aggressive fed. that said, we have had this gap between what the market has been pricing at what the fed has been saying in its dots. with some of the new fed chair potential candidates coming in, you will probably see a narrowing of the gap. i don't think you will see wild actual differences in policy by the different fed potential chairs, but we will see a change in how the market reacts. lisa: bonnie, are there any countries that you are avoiding? bonnie: we're definitely selective. to mike's point, emerging markets is a market, not a monolith. you need to have an active manager to go through that. you don't want to have passive exposure. different countries have different risks. there is going to be geopolitical risk across the entire world, let alone emerging markets. but in terms of credit we do like, we do like argentina, brazil, india and indonesia.
and some of that is based on the risks to china, for example. china, we are confident china can kind of continue to decelerate growth, but we are cognizant that a little misstep could really rock the market. you need to become is of that -- you need to be positive of that and navigate accordingly. lisa: this is the period where we do rapidfire. you guys are supposed answer one word answers. quickly, number one, you think it is likely we will see recession in the u.s. in the next 18 months? michael: no. bonnie: no. scott: no. lisa: what is riskier in the next six months, u.s. treasuries or emerging-market debt? michael: em. scott: em. bonnie: treasuries. lisa: interesting. lisa: which is more prone for losses, german or u.s. government bonds? michael: u.s. bonnie: u.s. scott: german. lisa: german, interesting, and what is more overvalued? u.s. investment-grade bonds or u.s. high-yield debt? scott: high-yield. bonnie: high-yield. michael: high-yield.
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