tv Bloomberg Real Yield Bloomberg October 12, 2019 10:30am-11:00am EDT
it's groundhog day for trade talks. >> this is groundhog day, groundhog week, groundhog month. >> we have seen this before. >> a ping-pong ball going back and forth. >> every few times we make some progress and roll it back. >> it is becoming exacting -- exhausting. >> except for late february, trump did not meet with chinese officials and there were press conferences afterwards, and they agreed to have the chinese by a -- buy a little bit more soybeans. two days later, trump declared a truce. that never really led to anything. >> we have been wrong optimistically the entire time. >> they have had a couple of years to try to come to compromise. >> we are right where we started 18 months ago or so. >> applause is good, but until i see a rollback of some of the tariffs that went on recently, i have to go with our leading indicators, which are still pointed downwards. jonathan: joining me around the table in new york are our guests
-- george bory, mike purves, and andy charlton. the first question to you, george. same issues, same people, same countries. do we get a different outcome? george: in terms of trade, i don't think so. trade is in a perpetual state of negotiations and we expect that to continue. we are not expecting a major breakthrough anytime soon. in the financial markets, things seem to be changing a little bit, yields moving up and the yield curve steepening are actually a material change. it seems like the fed, the fed's rhetoric, the fed's action is starting to meaningfully impact the technicals in the market. when we think about fixed income in general, one of the biggest challenges the fed has faced is an inverted yield curve. the fact that they are getting the yield curve to steepen is a meaningful positive, and i think that is something that is very different than what we saw back in the middle of this year, when trade talks and trade issues really became meaningfully problematic and started to push down yields.
jonathan: mike purves? michael: it is days like today where i am sometimes convinced that there is somebody in the basement of the white house that has an algorithm that fuses trump's approval ratings, the impeachment narrative with the vix, credit spreads, and ceo confidence about the economy, and says ok, now it is time to soften up. but i do wonder whether trump is really effectively trying to collar risk appetite more broadly right now. and where this impeachment narrative goes, is it really going to drive him to get something more definitive and real? i completely agree that there's not really -- just, come on, we have seen this movie before. jonathan: in february, there was talk of an fx pact, talk of buying more soft commodities, they hailed the deal and then it all exploded several months later, which makes me wonder, andy -- if we have not tackled the big issues, did we really tackled anything at all? andy: no.
this yo-yo doesn't help anybody. you want a concrete certainty for corporate america, to feel confident in investing for the future, and the noise we get day-to-day in the market is somewhat irrelevant. the corporate investments need to come back and for that, they need certainty. jonathan: looking at the market right now, wondering what is noise and what is signal. my colleagues as well pointing out we really have had two halves to this week, george. the first half incredibly negative, but we did not get a big move lower in treasury yields. george: right. jonathan: second half, positive and a big push higher in treasury yields. what does that tell you about how tough life is down here for 10-year in and around 1.50%? george: the signaling from our perspective is that it is very politically driven. you have tail risk, whether it is trade or maybe talking about brexit later on. jonathan: i hope not. [laughter] george: but these very big overhangs that have been weighing on the market are dissipating just a bit. whether or not they get better is maybe an indication that they are not going to get any worse.
maybe there is sort of a cap on how far we have gone with respect to trade tension. this might be an extended period of negotiation. that seems to overshadow the data, it came in pretty weak this week and last week and got people anxious. but now the fed is riding to the rescue. liquidity solves all problems in today's markets. this extra dose of liquidity, this term repo agreements and the new, non-qe qe is certainly helping risk appetite. i think about it in very selfish fixed income terms. there is a liquidity squeeze that has been building up for a variety of reasons and the fed is stepping in to basically unclog that squeeze. that in and of itself is a positive. jonathan: we have to have some debate over whether it is qe or not qe. for me what matters, what are they doing? what is the objective, what are they buying, and what are the consequences? we found out today they will be buying up to $60 billion of t-bills pretty much every month
into 2020, it might be higher, it might be lower. what does that mean for you? what we have seen with the treasury curve, three-month bill versus the 10-year, finally a little bit of steepness, some positive spread. do you expect that to continue? george: we do expect the curve to continue to steepen. i think what it signals, as i mentioned before, there is a sort of liquidity squeeze buildup that has been mounting over the last several weeks as we headed into the end of the quarter. you saw it in the repo market, you are hearing about it in different parts of the fixed income world. i think that is a function of a flat, inverted yield curve, the structure of excess reserves, there are a variety of things. the fed is focused on breaking the logjam, and in doing so that releases a lot of tension in the market, and i think that's a positive going into year-end. michael: i think another facet of this whole discussion, about the torque that has sort of built up in the markets, the squeeze potential, goes back to the eurozone and china to some degree. if you measure the spread
between the em equity etf, the volatility metric relative to the vix, that is year-to-date lows right now. look at some of the economic data coming out of the eurozone, not getting obviously better, but it is seeming to bottom. play a scenario out here where the bund yields, if they do march back to zero, that is going to re-steepen our curves over here pretty sharply. andy: keep in mind, the fed's operation at the front end, we almost see this as a reverse operation twist. they were getting sick and tired of the self fulfilling prophecy of an inverted yield curve. how many times has it been discussed on this show? by buying all that short end paper and providing that liquidity that george referred to, the curve steepens. the models that tell everyone recession is around the corner, no one is talking about it anymore. you've got to be careful. there is some smart strategy going on. jonathan: that is helping the three-month to 10-year, and let's talk about the rest of the yield curve. this is shaping perceptions of
what the fed will and won't do at the end of this month. if these trade talks go well, and for everyone watching this over the weekend, we are recording this ahead of the conclusion of these trade talks. if these guys get it wrong you can throw mud at them on monday, but we do not know the outcome just yet. george, it is interesting to me when i speak to economists and ask them the following question -- if it is a truce but the tariffs do not come off, what does it mean for the economy? they turn around to me and say, not a whole lot. we have a short-term squeeze in the market, which makes me wonder, if the market is reassessing the chance that the fed moves, based on the end of the month with what happens with trade talks, are we making the judgment that this fed is managing the markets and not the economy? george: i think they have had to walk a pretty tight line in the sense that, up until recently, they have not talked a lot about the technicalities of what an inverted yield curve does to their funding and their operations, and there are some economic consequences, but there are a lot of financial front end
consequences. they have finally started to dial in on that. their view that this is a midcycle adjustment would suggest that this is really more their economic view, they are not intending for this to be a sustained rate cutting cycle. now they have left the window open if the data continues to deteriorate, but if they are able to sort of cut rates one more time, steepen the curve and allow the markets to adjust, they could be on hold for a little while after the end of this month. that is our central view, they do not do anything until maybe the next, next quarter, that they are on hold through the end of the year as the rate structure sort of stabilizes and these liquidity provisions start to kick in. michael: i think there is another dimension to the fed's calculus, which they cannot really talk about. i guess i can -- as we are looking into the election year, if they do start cutting aggressively and let's say a lot of the economic data, the trade
war comes to a defined resolution sometime early next year, things are better overseas, and inflation is starting to stoke back up, they are faced with having to raise, perhaps, into november 2020, which typically, the fed is not fond of doing. you can only imagine the amount of tweaks that will be needed. [laughter] jonathan: i am not too fond of that idea as well, michael. what is your take, andy? andy: i think the market is going to bully them if they have to move in october. i do not think anything substantial is going to come out of the trade talks to change that direction. we talked about it before, the way the fed has a third leg of their mandate, which is to continue the expansion, which is what we see on our bloomberg screens every morning. i think that piece means they definitely do 25 and then may be on hold. they want to keep some dry powder in case it is much worse than we think. jonathan: guys, you are sticking with me around the table in new york city. coming up on the program, leveraged loan borrowers find air as the index falls to a fresh nine-month low. that conversation coming up next.
jonathan: i'm jonathan ferro, this is "bloomberg real yield." i want to head to the auction block now and begin over in europe, where greece became a member of the region's negative yield club, the country selling 487 million euros at 13 week bills, drawing a yield of -0.02%. in the united states, the government's $16 billion auction of 30-year bonds was awarded a yield of 2.17%, the lowest 30-year auction on record, and in leveraged loans, eight deals launching for a total of $8 billion this week, despite several cracks appearing in the market as the index fell to a fresh nine-month low.
the recent shift in sentiment leading investors to flee, some to shakier issues. note the following -- people want the wealth of falling loans and are more wary of taking chances on the situations that have turned negative. with me around the table to weigh in, andy charlton, michael purves, george bory. what is happening with loans right now, is it anything more than just saying, you know what, leverage loans? i do not want floating rates right now, the rates are going lower. is there anything more than that? george: there is more than a rate story. there is a component of it, but there are signs of stress within the leverage loan market. that is the headline bad news. the underlying story, it tends to be concentrated in specific sectors and very specific vintages of when these loans were originated. late 2017, early 2018, energy-related notes, maybe retail related notes -- these were cuspy credits when the loans were made, and when that loan, that company, if they miss
on earnings, those bonds go from 90 to 60 in a flash. it is the reality of how, what the quality of the underwriting was a year or so, two years ago. that is what is starting to bubble through. the challenge, there were a lot of loans that were originated then. it is a sizable group of companies, so you take some weakness in the energy sector, some consumer-related weakness on a bad vintage in a big series, and it looks bad. there are some challenges, but it is not as systemic as people think. jonathan: you mentioned 2017 and 2018 and i think it is important for our viewers out there who are maybe not too familiar with the fixed income market, this might sound counterintuitive, when rates were going up, some of the bad issues really came to market. this was in leveraged loans because people want a floating rate. that is what i want to talk to you about. that specific pocket, the amount of debt that came to market possibly placed too richly and with very little covenance around that.
is this a problem that's brewing now? are we starting to see this materialize? george: if you look at the downgrade to upgrade ratio in single-b and below loans, the riskier parts of the loan market, you have an upgrade-downgrade ratio -- sorry, you have a downgrade to upgrade ratio of three to one. there are some fundamental weaknesses that are emerging in this basket of companies. the market is very what we call bifurcated or segmented. if you go up in quality or away from that particular vintage of issues, prices are holding pretty steady. the companies are functioning and those loan coveting packages are a little bit stronger. there are places to go within the loan market, and loans are inherently illiquid. so migrating your way into those positions is not an easy trade. we talked about repo and liquidity in the broad market,
you try to do that in an illiquid market and it gets accentuated. jonathan: andy? andy: you mentioned that the demand for the asset class back in 2017, when you have an excess of money chasing finite opportunities, quality is compromised. one thing you can take from what is happening in europe, where we have had low negative rates for a long, long time, it does not excuse bad companies with bad balance sheets. not a bad company, a bad balance sheet. i think that is the thing that is going to come to bear. when the quality is compromised because of that technical mismatch, problems will arise. jonathan: we are seeing those cracks right now. george, are we seeing this problem just in leveraged loans or consistently across the fixed income universe? are you seeing it bleed across? george: if you look at triple c's in high yield, you'll see some pressure there, are a lot of stress. energy companies in the triple-c universe, also in the clo market. again, there is that segmentation, the lower rated
parts of the clo market have come under pressure. also, there are different qualities of managers. so the managers that maybe just launched at that particular point in time, when those loans were being originated, hold pools of loans that are basically experiencing more risk, more challenges than others. it manifests itself, the loan market is pretty broad, very deep, and spans across a wide range of industries, companies, and managers. you can see where the week spots are, and i think that is what is coming through right now. jonathan: what is interesting right now, the index level across the range of asset classes, you do not identify many problems until you lift up the lid and poke around. then you start to see some cracks and some nerves. michael: that is part of the divergent story from the very lower quality. there is a huge escalation in
issuance in leveraged loans, coupled with weakening standards. if the economy is going to be in 2020 and beyond sort of what the equity market and broadly speaking, the high yield market, are sort of saying, there will be a 2% growth, 2% inflation environment, more of what we have seen, the damage is pretty minimal. if the treasury market is right, if you will, and they have been telling us -- maybe not today, but they've been telling us it is more a 1%, 1.25% story next year, there is a higher chance of some sort of recession. that is when you really need to be in the higher quality stuff. i think that is why this divergence will be continuing, because simply, no one knows whether the equity and credit markets are right, broadly, about 2020 or if the treasury market is telling us something we don't know. jonathan: what is the market call? george: when we look under the hood, the market call for us is, do you want to own one single-b loan at libor plus 450, or a
triple-b trench of clo's at libor plus 400, where you have diversity and a much broader range? the upper-quality bias is likely to persist as this shakes out, but the value argument across the market is starting to emerge. the advancement, one nice thing about rating cycles, you ultimately work through them. we are in the eye of the storm right now, especially going into year-end, when liquidity is thin. being a liquidity provider at a point in time where quality is compromised, that is a value trade. jonathan: you guys are sticking with me. coming up on the program, the final spread. the week ahead, featuring eu leaders gathering for a two-day summit in brussels. this is "bloomberg real yield." ♪
jonathan: i'm jonathan ferro. this is "bloomberg real yield." time for the final spread. coming up next week, we get some data out of china, trade numbers going through to monday and then on tuesday, additional tariffs on chinese imports are sent to take effect, plus u.s. bank earnings kicking off. wednesday, the imf and world bank meetings begin in washington and on thursday, eu leaders meeting in brussels for a two-day summit. andy charlton, michael purves, and george bory still with me. i promised you that we wouldn't talk about brexit, and i have been trying to avoid this for a little while. we will get to that in just a moment. your thoughts on the trade story and the global economy at the moment? a little bit more data out of china in the last couple of weeks. we get more in the next couple weeks as well. people are trying to understand, george, to what degree the trade story is responsible for the global economic slowdown, given the fact that the slowdown started and predates the actual tariff hikes.
how do you get your head around that issue at the moment? george: like you said, trade has been slowing for a few years now, and i think the rhetoric and the emphasis on it has been accelerated by trump and by the discussions around it. how do we get our head around it is really trying to figure out, for the u.s. economy specifically, how vulnerable it is to further deterioration of trade and what is the negative feedback loop? what we have seen, obviously it is impacting the industrial manufacturing side of the economy. there is a two-speed economy in the u.s., industrial manufacturing, very weak, and the consumers doing pretty well. if it starts to affect consumer sentiment, it becomes problematic. it has really not fully dented or meaningfully dented consumer sentiment, so we have been able to trundle along, but lately we are seeing some signs of that. number two, the fed has moved. the drop in yields and the very
meaningful loosening of monetary conditions here and in europe, it will help. maybe not as much as it would have three or four rate cuts ago and cycles ago, so it becomes less potent, but it will help. there is a six to 12 month lag. so our expectation is by the time you get to the end of this year, what we are seeing is a deceleration, i call it slowing but growing. you are seeing the slow, but you start to bottom out and it is into the beginning of the next year that growth starts to pick up again. jonathan: quickly, andy? andy: outside of the fed, developed markets have basically reached the limit of their effectiveness. with an absolute sense of any fiscal response, the trade issue is that constant negative. until that gets truly resolved, which i did not mean this close to the election here, we are going to have this low enthusiasm in the market and in the economy, because fiscal, we
need fiscal in europe and if we haven't got that, we need trade sources here. jonathan: some enthusiasm to close out this week. let's close out the show with a rapid fire round, three quick questions, three quick answers, if we can. brexit -- this is the only part of the program we will do brexit. brexit deal or no deal before month's end? deal or no deal before month's end? george: no deal. michael: no deal. andy: deal. jonathan: do you buy a trade truce or do you sell the risk rally? michael: you sell the risk rally, but not as much as you might have six months -- jonathan: it's got to be short. andy: sell it. george: sell. jonathan: the fed cuts through 2019 -- one more, two more, or none? 1, 2, or none? michael: one. george: one. andy: one. jonathan: guys, great to have you with me -- andy charlton, mike purves, and george bory. thank you very much . from new york city, we will be
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