That is putting the fed in a bit of a bind. It creates the risk of a policy mistake. The fed will not make a policy mistake if everything is fine. If the data does not get worse. Which people are forecasting. You could have a second half where the economy is bouncing back. The second half we should see that fade. The fed is actually going to surprise to the downside on the Balance Sheet. They should not continue that Balance Sheet expansion. Is the market going to see that as the end of qe, quantitative tightening . The fed playbook is to cut big and fast and signal qe if there is weakness. Thats a big risk for the market. Jonathan joining me around the table is greg staples, lisa hornby, and ken monahan. Lets talk about it, ken. Your thoughts on that, is it or isnt it qe . Ken i know mr. Kashkari is trying to throw cold water on the idea that it is not, but even being in minneapolis, he doesnt have enough water to throw on it to convince the market it is not. I think the market call is correct on this. Jonathan why . Ken i get his point, they are substituting one instrument for another. The way the market is looking at this, this is providing more liquidity to the market. That is driving Prices Higher for risk assets. Jonathan lets take that tweet. Neel kashkari, the minneapolis fed president wrote, qe conspiracists can say this is about Balance Sheet growth, someone explain how swapping one shortterm risk free instrument reserve for another risk free instrument, tbills, leads to equity repricing. I dont see it. Lisa hornby. Lisa you have to look at the market and say it doesnt matter whether you believe it or not, markets have reacted to years of liquidity being poured in by Central Banks, and this is another example. Whether Neel Kashkari wants to say it is true or not, that market has spoken for itself. We are at equity alltime highs. Bonds cannot even selloff a few basis points. We are at alltime highs on equity markets. Chairman powells guidance would be if there is no forward guidance, there is no qe, but the perception of the market is the reality. The real question will come in february. Let some of that term repo rolloff. Jonathan is that the point, that perception matters . If enough people think it is, that is all that matters . Not where we are at. Greg i think that is where we are at. We are coming off of a great 2019. This is setting the tone for 2020. Ken its like watching the fed dots. They are in a different place from where the market is. I think the markets judgment is correct. The fed may be saying one thing and trying to guide in a certain way, but the market is taking its actions differently. Jonathan one crack in the resolve from the Federal Reserve came from robert kaplan, speaking on bloomberg. Take a listen to what he had to say. Robert there are three aspects. Rates are lower. Then there is the perception that the bar is higher for future rate increases. The third issue is in order to address this repo issue, we have grown the Balance Sheet. All three of those actions are contributing to elevated risk asset valuations. I think we ought to be sensitive to that at the fomc. I certainly am. Jonathan this audience for this program is incredibly sophisticated. I imagine a large portion of it will take the view of Neel Kashkari. Is there a risk of being too smart about this problem right now, if we can call it a problem, and the readthrough of what the fed is doing into broader Financial Markets . Lisa the risk is markets have become accustomed to us liquidity. Whenever the fed tries to pull it away, they create problems. We saw that at the end of 2018, beginning of last year. They had to reverse the hiking cycle. At the end of the day, growth has not changed much. We had fiscal stimulus and strength in 2018, it came off in 2019, but we are still at 2 growth rate. It wasnt a growth problem, it was a markets problem. Monetary policy cannot solve all ills of the market, and that is why they are beginning to pull back. We are conditioned to believe Central Banks will solve everything. We have only 175 basis points of rate cuts to go in the u. S. Before we are at zero. They have to be careful in their messaging, but equally, whenever they try to pull back, markets react very negatively and they are forced back in. Jonathan we have been conditioned by the Central Banks who are doing this. Ken, i think that is worth exploring. Maybe the Federal Reserve is missing the broader picture here. There is a huge green light to take risk in Financial Markets. The Federal Reserve is shining that ever brighter. Effectively the message they sent is the economy this year is ok, its in a good place, and even if it gets better, we are not pulling back. But if it gets worse, we will be ready to do more. We are going to spend time talking about credit and risk talking credit in cccs, leverage loans, later in the program. Is that the broader picture that you think the fed might be missing at the moment . They are flashing a green light to say load up on risk. Greg i think thats what they are doing. That may not be the intended message, but thats the message the market is taking away from it. The fed will have a difficult time weaning the markets off of this idea that there will be constant stimulus. I dont know how that will be done. Greg im not sure that there is a better policy. You might argue they are making a policy mistake by being too soft or too dovish, but what would be the alternative . As lisa pointed out, if they are more hawkish, the markets react negatively. Jonathan i dont want to talk too much about what the fed should or shouldnt do, but what it means. You talk about treasuries, yields have hardly moved. 1. 80 on the u. S. 10year. Equities ripped over the last 12 months, and here we are at 1. 80. Why . Lisa if you had asked me a couple weeks ago, i would say that we should be higher in yields, but this tells us something about positioning and demand for treasuries in u. S. Fixed income. It is still out there. I think that tells you if there is a selloff, it will be muted. Ken i think treasuries have run as far as they are going to run at this point. If we see improvement in growth, we are looking for improvement in growth in europe, and the message will be that the market will adjust. Are we going to go dramatically higher . No. But i think we are at the low end. Jonathan it is like chinese water torture, drip, drip, drip. Ok data from the u. S. Chinese data doing ok. That chinese data to close out the week was really terrific to compared to what we had 12 months ago. Here we are, yields are up by a basis point. Does that make sense . Ken i would argue it should have moved more, but there is this tremendous damper on the system that is the fed. That is what you are seeing. Greg their version of qe is still supporting with 20 billion euros on one end. It seems like the market consensus is the fed is out for 2020. That leaves you with the 10year at 1. 80. Breakeven is 1. 75. I dont see anything breaking us out of here. Jonathan we have to talk about the treasury, 20year issue coming to the market. My question is whether the average duration is being pushed out, or whether they take some out of the 30 and put it into the 20, rob some from elsewhere. How do you see the average duration of the treasury . Lisa it would be smart to increase the duration given how relatively flat and low yields are. In the near term, they may do some tweaks because they dont need the funding this year, but they will need it next year. Whatever they do this year i think will be temporary to try and get the issue well absorbed. Next year, we will see normal auction sizes. The 20year, i think this will be a consistent part of the curve for as long as we are in markets. Jonathan was that a signal for a steeper curve . Lisa i believe it was. I have been on this show talking about this topic. They should have done 20 years. I think they could do longer debt at this point. It will be bought, there is demand. Theres no question about that. But i believe the treasury and the fed and Central Banks around the world want steeper curves. They realize what happens when the market gets into an inverted curve cycle, how bad it is for growth and future prospects. They are doing everything they can. Buying bills is one way to steepen the curve. Issuing a 20year is something they can do. All tweaks at the margin, but curves are flat. Why not . Greg you talk about liability driven investments. Long insurance companies. I think it will be accepted in the marketplace. Jonathan final word, ken. Ken go long. Jonathan go long, steeper curve. Short and sweet. Coming up on the program, the Auction Block. The relentless bid for european debt raging on with another breaking week of sales. That is coming up next. This is bloomberg real yield. Jonathan im jonathan ferro. This is bloomberg real yield. I want to head to the Auction Block and kick things off in europe. The primary market had a record month. Needing sales of another 50 billion euros to top the january high. Unprecedented demand for sovereign debt in italy and spain, receiving record amounts. In the united states, the persistent bid for investmentgrade debt continuing. High grade sales of 35 billion topping projections with thursdays deals more than two times oversubscribed. Sticking with credit, some investors growing increasingly cautious following a stellar year of returns. Kkr cutting its weakest investmentgrade debt, bbb, to underweight, writing, the Macro Economic and geopolitical environment could trigger a wave of fallen angels or investmentgrade credit falling back into the highyield category over the next 12 to 18 months. Colin martin of Charles Schwab pushing back a little bit. Colin with more than half of the market comprised of bbbs, there is no stigma anymore. They are ok with that. They believe they have the tools to defend that if need be. With yield so low everywhere, they are ok with bbbs. Through the years, if you have been an investmentgrade Corporate Bond investor, that is highgrade. Over time, it has gotten riskier. Still investmentgrade. You are taking on more risk today than you were 10, 20, 30 years ago. Jonathan lets get thoughts from the guys. Ken, in credit, bbbs at the moment, the story coming in from 2019, the narrative that builds is the csuite could defend their credit rating. Do you think they still can . Ken i do. In 2019, we saw something for the first time in my 30plus year career. We saw at t, that people had been concerned about being downgraded to below bbb to highyield, its board of directors put in something into its management compensation scheme, where management is being judged partly by its ability to keep debt below a certain level. The reason for that is the board is cognizant of the fact that a reduction in rating for at t in the highyield would kill the stock. The board has done something to protect itself. I think youll see more and more of that. Are there going to be no fallen angels whatsoever in 2020 . No. There will be a number of them. But will the results be as dire as some of the prognosticators are predicting, like our friends at kkr . I dont think so. I think thats an overly conservative call. Jonathan the reason i find this kkr call slightly more compelling is the call on policy, and to point out that within investment grade, within bbb, health care and energy make up a decent slice of the pie. You are exposed to a change in policy. If the long trade last year was about being long and the csuite getting their hands around issues, in health care and energy, you are exposed to things you cannot control. A policy change. The argument being as the year gets longer, as the politics come into sharper focus, particularly on the left, whether that will be a problem for this credit market. Lisa i am cautious on credit. You look at overall valuations, you have to be more cautious. You are playing for a handful of basis points. It is not like where we started one year ago. I do think there are opportunities in certain bbbs. At t is a great example, there are a number of others. They are doing the right things in terms of deleveraging. We actually saw payout ratios in bbbs coming down last year. Whereas singlea rated companies are paying out more to shareholders. They are going in opposite directions. Certainly there could be policy changes. That is something we are cognizant of as we go through the year. What you have to think about is not the president ial part of the election but congress. If the democrats were to win the white house, you have to have a call that the democrats will win the senate as well, which seems less likely to happen at this juncture, to get meaningful policy change done that would impact these sectors. Greg bbbs are now trading where singlea was a year ago. We have done a complete reset. Highyield has gone 200 basis points. Everything has tightened. Bbb are only a quarter of the market. Are there subsectors that will be at risk . Absolutely. To broad brush the entire bbb marketplace and say it is all at risk, i dont think so. Jonathan cccs south of 10 . Some big calls coming in at the back end of last year to rotate to the junkiest of junk. Pgim was one of those that did that. It has paid off fantastically. Big rally through december, nice followthrough in 2020. What should you do now, especially if you made that rotation . This is kathy jones at Charles Schwab weighing in. Kathy we dont like the ccc area. The reason is, you have to have this constant flow of liquidity and turnover in refinancing in those companies. After the big rally, anything that gets in the way of that could cause some real problems in the sectors. Jonathan ken, your thoughts . Big rally, what now . Ken you have seen a big rally, and you had an enormous lag up until december. Cccs rallied until december and then have continued, outpacing highyield so far this year. Having said that, i think this is an overly conservative prediction. If you look at the ccc market in particular, there is a large portion that is energyrelated. She is correct, a large number of those Companies Need access to the Capital Markets to survive. Within the bbb space, theres also an enormous number of companies that have very specific, idiosyncratic risk. You have to look at those individually rather than say all cccs have too much risk or refinancing risk, we will ignore them. Jonathan the joke is that everyone always thinks they hold the good ones. Joke. I have the good ones. That is always the joke. I have the good ones. It will be ok. I will get out when i need to get out. Is there a big Liquidity Risk . Ken that is a broader question as it relates to the highyield market and the Corporate Credit market in general, as to whether or not we could be in a state where there is Liquidity Risk. We are mindful that you have to manage your liquidity. Jonathan everyone around me has said this is qe. People screaming at the tv saying it is not, but you think it is. Lets go with that. If the fed backs away from its Balance Sheet in a couple months halfway through the year, and youre sitting on a ccc credit and the market starts to tighten up, or spreads start to blowout, not a good place to be, is it . Ken if you are owning a ccc jonathan can you simultaneously say this rally is built on the Balance Sheet expansion of the fed because this looks like qe, and have the confidence to be in the riskiest parts of credit, when what youre telling me is that this rally is built on Federal Reserve stimulus and pretty much nothing else . Can you simultaneously have that trade on . If your framework for this market is this is a qe trade and the fed is telling you it is not qe, and there is a real risk that the Balance Sheet expansion ends this year, do you want to be sitting on that credit . Ken the answer to that question is you are right, the fed is supporting the broader rally taking place in the marketplace. That doesnt mean that i cannot select granted, as a portfolio manager, you think you are selecting the best. We are very focused and confident in our credit selection skills. I look at what propelled us forward in terms of returns last year. It all came from credit selection. Jonathan i dont want to question anyones homework around the table, but if you have made argument to me that this rally was built on fundamentals, better fundamentals, and you wanted to own the riskiest of risk, loans, cccs, whatever, because it was built on better fundamentals. I would sit here and say that makes sense. But if you are telling me the rally is built on qe and Balance Sheet expansion, i struggle to get my hands around that. Ken arent we seeing some improvement elsewhere, evidence of improvement elsewhere, in europe . Arent we seeing evidence of improvement in china . Wouldnt we expect exports to potentially increase as well . There are some things beyond the fed holding this altogether. Jonathan still ahead, the week ahead, featuring a slew of Central Bank Rate decisions. That is coming up next. This is bloomberg real yield. Jonathan from new york city for our audience worldwide, im jonathan ferro. This is bloomberg real yield. It is time for the final spread. Over the next week, a lot of looking things happening, including the kickoff of davos, the World Economic forum in switzerland. Some Central Bank Decisions in the mix and pmi as well. Lisa, lets talk about it. The following week, ecb next thursday. What are you looking for . Lisa not a whole lot, to be honest. I think it will be pretty dull. I think lagarde is coming in with this notion that fiscal needs to take over. Monetary has done as much as it can do. I dont think markets are expecting very much, to be honest. I cannot disagree with that. Greg absolutely, ecb will be a snooze. The real question is if boe does something. Jonathan boe, thats a live meeting. On the ecb, is the pressure building on Christine Lagarde to defend where Monetary Policy is right now, defend the concept of negative Interest Rates . Ken i think she got a fair amount of support as super mario left the picture and made it clear that the policy that the ecb has followed has been the right one. He also brought up the message that we can only do so much lifting. What needs to happen next is the fiscal side of things. We have not seen that. We have to get germany to get off the dime on that and make moves in the right direction. Jonathan do you think thats going to happen anytime soon . Ken i dont think so. Lisa things have to get significantly worse before we see a real move on the fiscal side. Jonathan seems to be the take. Greg i have strong connections in germany, and the consensus is it is not going to happen. Jonathan some people on this side of the atlantic think it is going to happen. Greg not going to happen. Jonathan that seems to be the consensus at the moment. Lets get to the rapidfire around. Three quick questions, three quick answers. First question, is it qe, or isnt it qe . I know where we stand on this now. [laughter] lisa qe. Greg perception is reality. Qe. Ken qe. Jonathan twentyyear issuance coming out of treasury. Does it lead to a steeper yield curve, yes or no . Greg yes. Lisa yes. Ken echo the sentiment, yes. Jonathan third and final question. Big rally in highyield through last year. Spilling over to cccs from december into 2020. Do you stick with the ccc rally . This is a massive question for anyone that has rotated into ccc, especially if they caught the wave in december. Do you stick with ccc or start to fade the rally . Stick with it or fade . Greg fade it. Ken stick with it for the first half of the year. Lisa get out. Jonathan great to catch up with you. From new york city, that does it for us. We will see you next friday, 1 00 new york time, 6 00 in london. This was bloomberg real yield. This is bloomberg tv. Brad he grew up in what he calls the peoples republic of berkeley, a liberal city on the east shore of the San Francisco bay. As a child, he played football while reciting rap lyrics and solving equations in advanced calculus. This ability to multitask and see the world through different prisms has helped him become an entrepreneur, ceo of a tech company, and eventually one of the most wellknown and respected investors on sand hill road. With Marc Andreessen by his side, he has invested in some of techs biggest names in the last decade facebook, slack, airbnb, lyft, and dozens more
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