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tv   Bloomberg Real Yield  Bloomberg  October 21, 2018 5:00am-5:30am EDT

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>> jonathan: from new york city, for our viewers worldwide, i am jonathan power with three minutes dedicated to fixed -- 30 income. this is "bloomberg real yield." ♪ coming up, the fed determines to keep hiking, sending two year treasury yields to 10 year highs. a booming leveraged loan market getting even bigger, overtaking high-yield debt. and italian bonds ending the week on a better note. the eu striking a conciliatory tone. we begin with the big issue -- investors on edge. >> it is not a fantastic world out there. >> the market is vulnerable. >> you are seeing stocks and bonds act differently than they have in the past. >> it is very hard to be too
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optimistic at this point. >> investors got too complacent, they thought nothing could go wrong. >> the sugar high from the fiscal stimulus will absolutely fade. >> we fell in love as a community wrongly with the notion of a synchronized pickup in global growth. >> as long as credit is hanging in there, it looks like more of a technical equity correction. our thinking is we have not seen the top yet in this cycle. >> bonds are no longer that anchor to windward. and if rates are moving up, that is a significant headwind that investors have not faced in decades. jonathan: joining me around the table here in new york city is guy lebas, fixed income strategist from janney montgomery scott, kathy jones, chief fixed-income strategist from the schwab center for financial research, and from illinois, matt freund, head of fixed income strategies at calamos investments. guys, it is great to catch up with you all. let's begin with you, kathy. there is an idea that has captured the attention of a lot of people this week that the fed
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is going to keep going until something breaks. is that where this is going now? kathy: that is what usually happens, so it is a realistic expectation. i would say we are already starting to see things maybe not break, but crack a little bit. emerging markets have already come under a lot of pressure. and you know, eventually, if they continue to hike at a steady pace, we will see some other markets come under pressure. but that being said, i'm not 100% convinced they will go as high on the fed funds rate as they are projecting. guy: and not only are emerging markets cracking around the edges, but you see some economic conditions also starting to be influenced by higher rates. my favorite example is auto sales deteriorating. we shifted as a culture from buying whatever it is, a $30,000 car, to a $400 monthly payment. as rates have risen, financing costs have increased, the appearance of inflation in auto prices has slowed sales. so you see that at the edges. what you have to keep in mind is
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we are seeing 2017 rate hikes influence auto sales today. we have not seen the effects of 2018. jonathan: should housing be a concern? guy: also on the margin. housing has become much, much smaller as a portion of the u.s. economy. in the mid-2000's, it was driving 25% of economic growth. even two years ago, much smaller. i think 6%-10% of economic growth. slowdown will not be as broad. jonathan: the federal reserve is showing us that they are a little more concerned about financial stability. there are two ways you can do this. you can keep hiking because you are afraid of bubbles but then if you keep hiking, you can cause financial stability issues elsewhere in the economy. are they doing the right thing at the moment with this approach? matt: yes, they are absolutely doing the right thing today. the question is really, will these continued actions be right tomorrow? i think it really comes down to, as you said, financial conditions in the neutral rate.
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most people are talking about the neutral rate as if it is stable, but it is not. it's very hard to measure and it changes over time. it is our belief the neutral rate today has been raised temporarily by things like the stimulus bill, with the new tax bill, like what other central banks are doing. the problem is, as the impacts fade, kathy got it absolutely right -- as those impacts fade, the market is going to react differently to fed hikes in the future. we see a couple more hikes, two or three, but if those influences fade, we think the market is going to become much more concerned, even with the same type of hiking. jonathan: kathy, let's look at the front end of the treasury curve, 2.90 on the 10 year. where do you see this peaking? kathy: we are looking at a peak in short rates right around the 3% area. we think the fed will get close to 3%. but we see the curve flattening out. i mean, now, the 10-year is
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above 3%, most of the rate hikes that we expect are already priced in, so i don't think we will see much lift at the longer end of the curve. just a lot more flattening. jonathan: we have had a little bit more steepening coming through the last few weeks, the trend quite clearly, looking at the chart, is for a flatter curve, the spread between 2's and 10's. where do you see this going? guy: flatter. in a word. following up on kathy's point. how long it takes, is a little bit of a different question. from roughly 100 basis points down to 30 basis points, 2/10 spread, the way that curve flattening trades work, there is a lot of profit in that. but as we get to a flatter curve and particularly higher rates, that flattening trade becomes a negative carry trade. a very aggressive negative carry trade. so you tend to have fewer of the technical factors to drive rates flatter. it has to be more about concrete, measurable changes in economic conditions, such as slowing inflation. that really drives that last 30
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basis points. jonathan: inflation has been absent in this treasury selloff. you have been looking at the breakeven rates. they have been really stable, they have accelerated. they have been really stable, they have accelerated. -- have not accelerated. do you actually see it going the other way, kathy? kathy: going down? i think it will. at some stage of the game. it is very tough, because the fed was under the 2% inflation target for so many years. i think they would love to see inflation above the target for a couple years to make sure it is symmetric. but i don't think that will happen. we are already starting to see those numbers roll over on the inflation front. so i am guessing that 2%, this 2% is the upper end. jonathan: i'm wondering if the water is safe over in emerging markets to get back in. is it? matt: well, you know, emerging markets are really hard to handicap today. i think that the combination of the dollar, and that is notoriously hard to forecast, and what we see with energy really is putting emerging markets in the spotlight. we think there are some emerging markets that we like very much.
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certainly mexico, latin america, and actually our emerging-market team is very positive on china, despite the slowing. that being said, we generally prefer emerging-market equities to emerging-market debt. jonathan: let's talk about the debt, kathy. china decelerating. you pointed out in the past, 20% of the dollar e.m. index is chinese bonds. it's a big deal. kathy: it is a big deal. and it is a huge change from where we were five or six years ago. and given the lack of transparency there, the slowdown in china, crackdown on excessive credit growth, it is really hard to get very positive on e.m. jonathan: but the deceleration, very clearly it has been captured by the price. could it just get a whole lot worse, or is this an opportunity now? guy: i think we have gotten through the dramatic headlines of the e.m. breakdown, really in august. you cannot talk about this without bringing turkey up. what is remarkable about that
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situation, though there were a great deal of worries, not a lot of evidence of contagion. those risks did not spread so dramatically with the exception of one or two other e.m.'s that had current account deficit issues. as a result, i have more confidence in the sector today than i did in august. and you cannot deny the pricing is a good deal more attractive than it was. and on a relative value basis, e.m. debt, selective e.m. debt looks attractive. kathy: the spreads have widened somewhat, but not to the point where we would be really eager to jump in. i would rather see 400 over the spread than what we see today. jonathan: let's bring down the index a little bit. when you talk about getting back into e.m., what are you looking at, specifically? guy: sure. i think the sovereign sector is one that is broadly speaking, more appealing. lat am, for example. i think many of the political pressures that have been so dramatized over the course of
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the last months in the brazil two election are largely overblown. on the margin, non-china, southeast asia. jonathan: great to have you with us. you are going to stick with us. along with kathy jones and matt freund. coming up on the program, the auction block. uber's first ever bond offering. demand was so strong it had to boost the size of the sale. that conversation on high yield and leveraged loans, coming up next. this is bloomberg. ♪
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jonathan: i'm jonathan ferro. this is "bloomberg real yield." i want to head to the auction block now, where the u.s. treasury continues to swell its issuance. they had its first sale of eight week bills. the $25 billion auction drawing
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a yield of 2.17% with a bid to cover ratio of 3.13%. amid the political turmoil, turkey attracted over $6 billion in bids in a sale of dollar bonds, the government offering $2 billion of five-year debt with a yield of 7.5%. in corporate, uber increased the size of its debut bond offering as orders for the private placement swelled. the sale included $1.5 billion of eight-year notes and $500 million of five-years. still with me, guy lebas and kathy jones. matt freund is also here. matt, let's start with you. is this uber deal going to start looking a lot like that tesla deal did from, say, 12 months ago? matt: i don't think so. so the uber deal, as you described, there is a large equity cushion below it. it was priced very well and placed very well. and we have seen the bonds really outperform over the last
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couple of days. so we think that the uber story -- again, we really like it from an equity side and the risk reward, but there is a lot of solid and positive fundamentals there, especially on the shorter piece. jonathan: kathy, is another example the equity like attractiveness being captured in the debt market when it should not be? kathy: yeah, we are seeing a lot of people on the fixed income side taking equity-like bets in the market, and that is usually a late cycle phenomenon. i mean, consider the duration of those bonds in the high-yield space. that is a fairly equity-like investment. jonathan: i cannot tell you what will happen to uber in eight years. i cannot tell you what will look like in five years. guy: were they even around eight years ago? jonathan: 7.5%, 8%, does that get it done for you? guy: on a nominal basis, sure. looks great in today's market but i don't have familiarity with uber financials. in fact, it is a very narrow group that actually do. kathy and i were talking about that during the break.
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so i cannot say with confidence that is a reasonable bet. jonathan: can you say with confidence that high-yield press -- spreads are about as tight as they are going to get in this cycle? guy: i think so. late cycle, typically, buyers can expect a high probability of negative returns over a 12-24 months period, and at some point, this party ends. jonathan: do you think we have seen the tide end? high-yield u.s.? matt: we think we are clearly bouncing along the bottom. but i will tell you, a story that has not been told is how strong the fundamentals in the high-yield market are. so the high-yield market today is approximately the same size it was three years ago. and i think the other panelists are right, there has been some inappropriate risk making it into the market over the last couple months, but for the most part the underwriting discipline has been really solid. in fact, the problem is supply is down. so when you look at high-yield,
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we view it -- again, there is some concern about poor covenants, some underwriting standards getting stretched, but we are much more concerned about what is going on in the triple b space of the ig market, parts of the loan market, than we are in the broad high-yield market, where fundamentals are good. jonathan: you are pointing out supplies. that was one picked up on by many people. jpmorgan pointing out that the supply of high-yield is on course for the smallest year since 2009. of course, very different from 2018. the loan story, leveraged loans this week in the u.s., overtaking u.s. high-yield. that is where all the demand has been. huge demand in loans. have you been behind that demand? kathy: we have been in favor of a floating rate market on leveraged loans. we are concerned about the credit quality. particularly as things have gone forward over the last year. but it is where all the demand is. everyone wants to be short duration and they want yield.
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they are finding that in the leveraged loan market. but a lot of deals are just not making sense right now. jonathan: i understand why people are buying into this market because the returns have been so good. and as my colleagues at bloomberg news pointed out, it is the junkiest part of leveraged loans, and high-yield loans have actually generated some of the best returns out there. guy: that is what you would expect in the good-ish portions of a credit cycle on a fundamental basis. really my concern in that sector is twofold. number one is the way in which it's being sold to some retail investors via phones. -- funds. that sounds an awful lot like -- it sounds awful lot like about what we heard in 2006, 2007. the subprime mortgage markets. the second piece that concerns me is the growth in this market means that, on average, credit quality has been deteriorating, so in the next downturn, it's likely to be more severe. and if we are selling these and structuring these, lending on, hey, this sector did reasonably
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well, fundamentally, doing the global financial crisis, we are structuring the sector to the last problem, not to the next one. jonathan: and matt, that is the view of a lot of people out there, actually. recovery rates were so good last time around relative to the other things, the performance were better relative to other things. is it going to be different? matt: no, i wish i could disagree with the panelists. i think they are right. when you talk about broad sectors, broad strokes, broad parts to the market, we think that if investors are not paying attention to the risks, they'll get disappointed. what i push back to is that we are really finding select opportunities in high-yield and in loans and in ig credit. so while i certainly wouldn't say all loans are cheap, or all high-yield is cheap, i think there are still some really attractive opportunities that we are taking advantage of. so it is really making sure you are being well paid for the risks you are taking. and that is great for active
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management. jonathan: let's talk about that. in investment grade, there are some areas that have been quite beaten up through 2018, and some people say with good reason. what have you been looking at, what have you been picking up? matt: within the investment grade part of the market, we were really looking to go up in quality. so we do like bbb's. the conagra deal we thought was attractively priced. energy names were really beaten up, and mlp's energy service has a long way to go. but for the most part, the pickup that you are getting over higher-quality corporates, cmbs, is now getting tight enough where we are looking for things to go up in quality, in the ig space specifically. kathy: i would agree with matt on that. up in quality is where you need to go in credit this year, and up in liquidity. if you look at the leveraged loan area, liquidity is a big
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concern. bigger issues, up in quality, we think that you earn the coupon and probably have a decent return. but nothing to write home about. jonathan: kathy jones from the schwab center for financial research, sticking with me alongside guy lebas and matt freund. let's get a market check on bonds. 2's, 10's, and 30 year treasury. the picture looks like this. up another six basis points on the u.s. two-year note. stable on the 10-year. 3.20. 2.91 is the yield on the two-year note. still ahead, the final spread and the week ahead, featuring a rate decision from mario draghi and the ecb. that is next. this is bloomberg "real yield." ♪
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jonathan: i'm jonathan ferro. this is bloomberg "real yield." time now for the final spread. coming up over the next week, a really busy one. a week of earnings and central-bank rate decisions.
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the ecb and the bank of canada with their announcements as the fed releases its beige book, as well as european bank earnings and u.s. gdp. to wrap up the program is guy lebas, kathy jones, and matt freund. kathy, let's begin with you. the ecb next week -- what are you looking for? kathy: not much, don't expect them to do anything. they have pretty much already signaled what they will do for the next year. i think the big issue they face with italy is how they address that situation because the bond market is so huge. jonathan: the italian bond market is all over the place. we are talking about 30, 40 basis point intraday swings. guy: yes, a wide range and we are starting to see other peripherals dragged around for the ride. there is some risk it expands more systemically. if we look at what happened in may and early june, there was a pretty quick bid once we hit about that 3.80-ish spread or so. it doesn't seem like that is evolving now. it really doesn't. jonathan: matt, what are your thoughts on the italian bond
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market? matt: what i would point to is these things are great news, there is a lot of noise, lots of competing political narratives there. it generally takes more time for decisions to be made. so i would say we are going through a lot of posturing, but i think the final decisions, which way these things are going to fall, that is still a couple quarters away. so i think we will have more volatility, but i think at the end of the day, saner heads will prevail and we will find a workable solution. jonathan: so if we get to around 3.50 at the close of trade this week, do you like the italian 10 year around 3.50? matt: you know, our foundation is making sure that we are being well paid for the risks we are taking. and the only thing you can say about it at 3.50 is it is more attractive than it was at 3.00 or 2.50. i am not sure the risks are all
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priced in. we are expecting more volatility, we think there are some better places, especially for dollar-centric investors to go, but again expect more volatility in the weeks and months ahead. jonathan: and i know quickly, guy, you want to talk about the canada rate decision next week. guy: yeah. just out this morning, we had some weakness in canadian cpi, which is a little bit at odds with an economy driven by commodity exports, and the strength we have seen in oil prices. it is surprising. so i have a question for the bank of canada, which is how do they handle deteriorating inflation data in the face of potentially stronger growth from the commodities exports? jonathan: how do you think they manage the rate path? guy: i don't know. i want to find out. jonathan: you must have a forecast. guy: the cpi data this morning was unexpected, and i have not had the opportunity to revisit the outlook since this morning. jonathan: so let's wrap up with some quick final questions. you know how to play this, the rapidfire round. one word answers if possible. buy and hold for six months,
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what gives you the highest return? you can either buy uber or tesla debt of a similar maturity. guy? guy: uber. kathy: uber. matt: uber. jonathan: wow, a consensus. a consensus on uber over tesla. next one, u.s. high-yield or u.s. leverage loans, where is the performance over the next six months? guy: leveraged loans. kathy: high-yield. matt: high-yield. jonathan: high-yield and a bit of leveraged loans in there as well. let's wrap it up with this one. the u.s. 10-year or the italian 10-year for the next six months, if you had to buy and hold one of them? u.s. 10 year treasury or the italian 10 year? kathy is trying to figure this one out. i'm giving her some time. which one? guy: currency hedged italian 10-year. jonathan: oh, come on. guy: come on, it is like 6%. jonathan: no currency hedge. guy: fine, i will go nominal italian. kathy: u.s. treasuries. matt: i agree with kathy, u.s.
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treasuries. jonathan: great to catch up with you all. my special thanks to guy lebas, kathy jones, and matt freund. from new york city for our audience worldwide, that does it for us. i will see you next friday at 1:00 p.m. new york time. that's 6:00 p.m. in london. this was "bloomberg real yield." this is bloomberg tv. ♪
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