'Bloomberg Real Yield' (04/22/2022)
Live from New York City for an audience of worldwide Bloomberg Real Yield starts right now. Kelly got pricing getting more fed action gearing up for the ECB to hike rates as the OJ refuses to throw in the towel. We begin with a big issue a global bond market rally. We are in the bond bear market that's for sure. There's a bit of a bond sell off. The Fed officials are coming in with more and more hawkish talk to said being forced to get more hawkish LaMarcus question an awful lot for 50 basis point hikes priced in there. Now suddenly 75 basis point hikes are being talked about. They're pricing in a very aggressive pace of rate hikes. The Fed is able to catch up to the market narrative. The yields
keep going higher. Everything that moves along end of the Treasury curve is starting to move higher. But growth is weakening. It is weakening all around the world. We're seeing slowdown in global growth and tightening global probably all at the same time. We may get a policy mistake an even bigger policy mistake. Joining us now to discuss this Goldman's lofty Karoo a page James Roberts had and when he sees her at credit sights. First to you Rob. I was thinking of you earlier this week. Robert sent for you a bond with treasuries yet. We know we're in the middle of the cycle here you know as best we can tell you're at the point where you know the market has gotten way ahead of the Fed and typically there's consolidation. I'll take the one thing that is different though than it's been
for 40 years. Is this level of growth and this level of inflation. We have accelerated in terms of job creation and the inflation numbers have broadened and and getting sky high. And that combination is higher than it was in 2000. It's higher than it was in 94. The peaks of the last 2 six six and a half percent Fed funds rate cycles. So we're going to have to see if this pace of growth is not dented by this first handful the next handful of moves by the Fed. You know we may be in the middle of the round not the end. The conversation we're having at the moment over the Fed is the speed at which we get to neutral. Isn't it by 50 basis point
increments maybe even 75 Nomura. Talk that up. They're looking for a 50 basis point move in May. Then seventy five in June. Seventy five in July. What. I'm trying to have a bigger debate about the ultimate destination. Have you changed your thoughts on where that ultimate destination is the peak of the Fed funds rate and this rate hike cycle. We haven't necessarily changed the destination. We are still a little bit lower than the market is pricing in at least for the next twelve months or so. But we are changing the pace. Just like the broader market is pulling forward rate hiking expectations. The Fed is threading a very narrow needle of trying to tighten financial conditions while inflation is still
running very hot. And similarly before we've seen the big downdraft in terms of the pace of economic growth which is likely to materialize in the second half of this year and into next year. So the Fed has very little wiggle room in terms of timing. Kind of get to that destination which we ultimately think is not going to be as high as the market is currently pricing. Lofty your view. You think there's a narrow path for a soft landing. Why is that view changed over the last few months. I think it's genius because as Rob was saying this time is different. I think you're in a situation where you have a hiking cycle that is potentially the most aggressive we've seen since the mid 90's and an economy that's our right in at full employment. And so the job of the Fed is essentially to figure out the right dose of monetary tightening that should slow down
the economy back to trend rebalance the labor market. But at the same time avoid a situation in which corporations essentially start cutting the workforce. And arguably that is a lot narrower as a path and only a couple a couple of months ago. What's interesting is that when I look at credit which is an asset class I look at very closely the magnitude of the widening in spreads just doesn't seem right relative to the risks looking ahead. And that's one of the reasons why we think that the
direction of travels with spreads on a forward basis is still wider as we continue to build up more premium as a compensation for these risks. I'd love for you to characterize this through the year as a tug of war between a strong micro and challenging macro backdrop. Why is it the latter. That's called the upper hand now. I think up until now you're absolutely right. I think the strength of balance sheet fundamentals I've had the upper hand you know on on a challenging top down macro picture. The other thing that I would not underestimate is really the power of
negative real yields because the other anchor I think that has allowed spreads to be fairly resilient up until now is the fact that the entire term structure of real yields has been very negative. That is about to change because as much as I think that the risk shows are a little bit more balanced for nominal reared certainly relative to the last three months. I do think that risk is still skewed to the upside for real yields. And that's where you got to test a little bit that that new tug of war. So that's where the micro funds for the macro I apologize for from a micro perspective. We've also seen a clear shift particularly among higher quality companies a move away from call it balance sheet prepared both into more appetite towards active forms of shareholder friendliness whether it's buybacks or. And so even from a micro standpoint there's more willingness
I think to pivot away from a bondholder friendly posture into something that is a little bit friendlier to shareholders. Can I just turn to you on the similar theme just on positive real yields briefly on a 10 yet this week it didn't last for long. Is that something you anticipate it's going to build up again. So we are expecting that the tenure is going to start to plateau a bit in the latter months of this year our official forecast is actually that the 10 year Treasury is going to close the year a little bit lower. So we're not necessarily a big believer in kind of this positive real yield story playing through for a
long period of time. And that's driven in part because of our more kind of dovish Fed expectations with a real pull forward of activity sooner rather than later and that kind of plateau off. Robert Simms come to you on treasuries as well. This week the two year yields had a move at 25 basis points at one point more than 30. That's got everyone's attention. The Federal Reserve and Chairman Powell talking up a 50 basis point move in May. That's got everyone's attention. Nomura toking up five. That gets your attention say. Roberts What people aren't talking about enough I don't think is the fact that break evens have picked up in the face of that conversation. What explains that for you. Robert what's going on there. Why are we talking about
a more aggressive Federal Reserve at the same time in the bond market. We're looking at break evens break Connecticut. Yeah I think you know there's a creeping realization coming into the market that the growth is actually more durable. You know some of the statistics have been changed ex post starting early in February with the revision of the payroll numbers which had been showing that a decelerating pace of job growth. Those were revised to a flat very high level of job growth. The job growth has accelerated this year. The commodity prices have remained strong. The Russian invasion of Ukraine happened at the very end of February. The impact that had yet to come through. So when you compare those with the mid 90s or 2000 again this rate of
growth job creation inflation is head and shoulders above those levels. So when power comes in and basically if he had just said yeah we could I could see 50 basis points that would be one thing. But he emphasized yes it's better to go early and that there was a window open for a number of 50s I think. Was that the subliminal message that came out of this. This is a totally
different cycle than last time when we did a series of 20 five's bigger moves are on the table for this cycle. And you know when the market reflects on that they see that unless you get an attenuation of the rate of growth an attenuation of the rate of inflation this Fed has room to go. And that's why you see continued movement in the front end. So Rob how does that shape your thoughts about the longer end the relationship between the front end and the long end and the shape of the curve. Because
if we'd have the share of mistakes in the start of the year and I said because I had a crystal ball and could predict the future with precision that this was going to be the conversation going into May. In the May meeting I would have anticipated a conversation about a flatter curve and inverted cap in the last month. Given everything you've just said something cast has been developing care Robert. And I just wonder what you think the relationship is between this rate hike in Seattle and had a long and shapes out. Absolutely. So you know if we were doing this in January or at the end of last year it looked like that soft landing was already beginning to play out. But at this point it looks like you're still in kind of a full steam ahead even in
Europe. I think some underlying signs of growth are stronger than people had expected. So when does the curve get flatter than what we're looking at right now. It's incredibly unusual. It's usually after the Fed has hike rates a lot like in the late 70s or at the end of 89 when there at nine and three quarters and the funds rate and it was clear you were headed into a hard landing. That's when you get the big five 30s inversion on the yield curve. That's not where we are. We're more in a place in the cycle where the Fed is getting ready to move. The market expects the move. The market is is pricing in a soft landing.
And therefore the long rates are by and large except that we get a continued rise in the front end. They're going to keep pace with those increases. Back. It's very unusual to get a five year 30 year part of the curve much more flat or inverted than what we've seen lately. Rob if we go from central bank to central bank and has just finished on this segment here if you take the
Federal Reserve if he believes it's a green line. If I look to the ECB there are movements to hike interest rates at the same time as some real concern about what's happening in China. So perhaps they're constrained to some extent. Then you've got the BMJ who does not want any part of this tightening effort. The Federal Reserve on the unwanted QE from the ECB. How sustainable do you think that is Rob. Right. So the Bank of Japan and in China they have low inflation and they have a growth picture that you know that they want to boost if anything for the Bank of Japan is fighting to maintain this 25 basis point ceiling. And they're clearly looking like they're having a hard time
capping the yield on the 10 year GDP a 25 basis points. I'm not sure how that's going to play out but I would I would I would think the odds are in their favor. I think in Europe it's going to depend on whether the energy supplies get cut off or not or whether they shut off the purchases of gas from Russia. That happens. You're in stagflation immediately in Europe
and that's going to change their calculus. But if energy keeps coming into Europe they may have a good ongoing growth and they may be in a situation that is not that different from the Fed in the sense that inflation is well over target. The growth picture is that and they end up moving assuming that that growth momentum continues. Roberts is sticking with us with when he sees it. And love. Cary. Coming up on this program the auction block. Up next the big banks driving high grade issuance pass 50
billion dollars off their earnings. That conversation up next. A flight from New York City I'm Jonathan Ferro. This is Bloomberg Real Yield. It's time now for the auction block where we kick things off over in Europe. The Easter holiday week rounding out with the lowest two week volume this year. Financials dominating sales and pricing nearly 90 percent of weekly volume in the U.S.. The big banks driving high grade issuance which sounds exceeding expectations and pushing past 50 billion. Bank of America pricing the biggest sound of the week
so far. And the junk bond market heading for a third weekly loss pricing just 900 million in the slowest April coming all the way back to 2000 and eight wanking on the credit market. J.P. Morgan's Bob Michael making the case to buy. Emotion tells you to hate credit. It's in freefall but you have to appreciate the repricing that's happened. That combination of
wider credit spreads and higher yields means you're not buying high yield below 5 percent anymore. You're buying it at close to 7 percent. You're not buying investment grade at 2 percent. You're buying it at close to 4 percent. I'd rather take advantage of the repricing and credit. That's one view. Let's get to where he sees it for another view. Wendy do you share that view. Have we repriced enough sufficiently to make you a buyer. Well we didn't rerack our recommendation on investment grade back to a neutral. We had started in the doorway and we are
looking at a much more attractive carry trade in AIG than definitely to start the year. As Bob pointed out valuations have widened out pretty significantly both from a spread and yield perspective. The net north of 4 percent for IAG that feels like a pretty attractive carry trade. But being a bit more mid cycle you have to be very specific in your sector split reaction where you want to be on the curve you know want to be out swinging for these really big compression trades just as you have a macro picture that's shifting so significantly. Luckily I know you're on the other side of the trade. You've alluded to that in the
last 50 minutes or so. Build on that for us. You've talked about this repeatedly that credit quality is past its cyclical peak. Typically when you pass that in a cycle what the pricing would look like. How does that develop in the months quarters years after that point. Well sorry I don't disagree with this idea you have at the level of youth support and credit markets hasn't. No question about that. ISE yields for example are above 4 percent for the first time since 2018 where I think there's room to
further re prices on the spread side. To answer your question about credit quality and how does that basically have an impact on index performance. It's not so much an impact that will be invisible for headline spreads but I think it's generally a catalyst for more dispersion across you know names or sometimes even sectors. And that's been the other big theme. I think this
year even though it doesn't feel that way when you look at the modest repricing in spreads that we're paid the amount of dispersion or differentiation and returns that we've seen has picked up quite materially in my view. And a lot of that reflects shift in capital management priorities at the at the issuer level. I think that's something that will persist as the business cycle and the credit cycle both continue to age. Let's say I was looking at where some of your underway slide. And it's pretty forward across ISE and high yield. But it was this comment that on the consumer and I'm trying to work that out. I
looked at the data in the UK today that came out this morning that was really challenging. The consumer looks like it's getting hit around by higher inflation. Is that something you're looking to maneuver around within credit within high yield companies. The industry is exposed to that consumer. You're right. We're underweight consumer retail
for two reasons. One we are concerned a little bit about the prospect of income real income growth for households. We think the best is probably behind us at this point. And then there the liability side to that equation which is supply chain disruptions. I think the jury is still largely out as to the full ramifications of the Ukraine. Russia conflict. Retail and consumer looks particularly vulnerable to us on the supply chain side particularly given at least by and large you know the relatively weaker pricing power relative to some of the other more defensive sectors. And so that's really the main reason why me moved to an underweight allocation on consumer retail. Robert Chip what are you you on the more constructive side with both Michael Barr or the less constructive side we'd love. Yeah I think you've hit the range bound stage and I think there is risk
in the market. Clearly the tone in credit is soft issuance having to get pulled back on the high yield side. As the rates go up money moves out of the market and that dampens the liquidity on the spread markets and they're hit disproportionately pushing up the spreads even though arguably the fundamentals that maybe pass the peak but they're still pretty solid. So I think what's typical at this point in the cycle what we're seeing here is that there are some taper tantrum strains that push spreads out temporarily and then you go into a range. So I think we're going to be range bound for
this first two thirds say of the rate hike cycle until we get to the part where we can see if it's a soft landing hard landing or otherwise. When can I get a final word from you just on whether Kutty is a factor here in your thinking. But Michael pushed back against that. He said the 2018 was less about cutesy in the way some people think more about the trade wall that went into 2018 and pushed us towards the recession fair at the back end of 20 I'd say. Would you long a market price and a credit at the moment winning. I think that Kuti is definitely a consideration that we need to
keep in mind. But when you look at how some parts of the market have repriced particularly MVS it's been a pretty significant shift as the narrative around Kuti. The information that the Fed has has been putting out has been a lot provided. A lot of guidance in terms of how they're thinking about what they want to do not necessarily the specifics. But I think investors are pretty well anticipating a May announcement as soon after that commencement of Kuti and kind of understand the mechanics. This is not the first go around in a Kuti program. Now that
being said I think it is a mistake to say oh it's all priced in. Everything is fine because like in 2018 you have these macro economic complications that could ultimately weigh on fundamental expectations. And if the Fed is consistently pursuing its Kuti program while at the same time you have this erosion of fundamentals in the US and globally that could definitely be problematic for spreads. So I would say that in general we're expecting kind of this
pattern of wider wives and wider titles in the ISE market. But on a yield basis things are looking much more attractive even when keeping Kuti in mind. Say a final word on that Kuti dynamic. Yeah. Look I don't disagree with what we're doing. I do think that when it comes to unity and more generally the stance of monetary policy the interaction of that with the broader economy is ultimately what matters. We actually like some parts of the fixed income space that overpriced a little bit due to risk failure. That's the case for the agents. Yes. Market. We
actually recommend that investors rotate into an overweight allocation on agent CMBS versus AIG product. Partly because we think that premium has gotten quite attractive and we think the market is overpricing. The likelihood of outright sales by by by the Fed of its agents CMBS portfolio. But a general look it boils down to the
interaction of QE and how the broader economy is doing in terms of the mix of growth and inflation and the cute CFO. This time around is so much bigger than last time around. Lotfi could really sticking with us with Robert said and when he sees it coming up on the program. Still ahead the final spread a busy week of earnings with big tech the headline act. That conversation just around the corner.
Live from New York City I'm Jonathan Ferro. This is Bloomberg Real Yield. For those of you fed up of being whipsawed by Fed speak. I have good news reports. Winter the quiet period. The final spread starts right now. The week ahead looks like this. Coming up France rounding out its runoff presidential election on Sunday. Big tech earnings continuing with alphabet Microsoft on Tuesday Facebook on Wednesday Apple Amazon and Twitter all on Thursday. A ton of numbers from the big tech names. And finally another read on inflation in the United States and in the eurozone as well. Europe's got some big problems on both the
inflation side and on the growth side too. Let's get to the Rapidfire around. Three quick questions three quick answers with lots we can do. Robert said when he sees a first question to the three of you the Fed funds peak to handle a three handle or four plus two three or four plus Robert Tip I would say three plus Winnie. To love feet plus second question high yield spreads from here. Tighter or wider. By year end just tighter or wider from here by year end. Lotfi Weiner winning.
Hater Robert. Tiger final question. As you look at the yield curve right now your two year yield is 271. Your tenure yield is about to 90 ish to ninety one. I'm going to give you a choice. What finishes the year higher from here. The two year yield or the 10 year yield. What finishes the year higher from here. The two year or the 10
year yield. Roberts hair trigger. Laughing here. When a. To hear the three of you thank you fantastic panel this week. Thank you very much. Well he sees a rocket ship Lotfi Karoly from New York City. That does it for us. I see the same time same place next week from New York for our audience worldwide. This was Bloomberg Real Yield. This is IBEX.
2022-04-29 00:56
