Markets operating on the long end of the curve. I dont think it is that problematic, but it is telling s that there are different players in different parts of the yield curve. It is not just the shape of the u. S. Curve. It is the differentials in other curves as well. That, to some degree, is a testament to the influence of other Central Banks beside the fed. The rest of the world is still printing money. Ecb, bank of japan. The ecb has promised us they will do that until september of next year. All of this money is hurting duration and credit risks. They ultimately end up in the u. S. , and that is a very important driver. One of the weirdest things as about the curve flattening here is we are doing it against the backdrop of the fed and potential tax cuts next year. You got hundreds of billions of extra supply coming into the u. S. Treasury market next year. My guess it will be much more difficult for the curve to continue to flatten in the next year. If we dont get some pickup in inflation and the fed stays on its hiking path, in two years years it will go higher in the curb will go flat. Jonathan joining me in new york is vishwanath tirupattur, lisa hornby, and coming to us from london is iain stealey. E want to go straight to a chart of the 2 10 end of the curve and the curve rolling over and getting flatter. What you see is how supportive the Federal Reserve has been at the front end. The twoyear it has inched has inched higher and igher. The 10year has stayed in there as the gap has narrowed. Is there a signal in a price section . Vishwanath i think there is something here. We expect this flattening trend will continue to be there and it will extend the 10year point in the curve is what we think. There is a clear expectation about inflation. The market is telling us that it does not believe that there will be substantial pickup in inflation over the course of the next several months. That is what is driving the shape of the yield curve. Jonathan the two 10 is below 62 basis points. Is that what you take away from it, the message . Iain, that was a message to you . Iain yes. Yields are pretty stable at the long end. They are being pulled down by what is going on in the rest of the world. Low yields in europe, ecb is still buying a lot of bonds, bank of japan is buying a lot of bonds. The treasury look attractive. The front end is being impacted by the fed, who will continue this normalization process in december and into next year. Jonathan lisa, how important is that . I can bring up the universe of fixed income debt with a universe of negative yield around 9 trillion. When you think about that, is it any wonder at this rate weighing that this is weighing down on the long end of the yield curve in the United States . Lisa that is something we have been focused on for many months. It is not just affecting the rates market, it is affecting the credit market as well. Credit purchases by nondomestic investors is basically gone up by 50 since the crisis. That is all because yields are so negative or so low abroad people have been basically hopping into our markets and have been for some time. Jonathan with potential changes to the tax codes, have they done anything . We just erased it all. The tax overall is happening. They are inching forward in d. C. , yet the treasury market is not moving the way people expected it would. Vishwanath our expectation is both looking at the house bill and the senate bill, we are not going to go beyond the 1. 5 trillion deficit number that has been talked about. The expectation that somehow we will have a very substantial fiscal boost coming in here is not what seems to be in the cards. The ultimate fiscal impact is relatively modest. There will be some fiscal impact, and we can talk the impact on the credit markets in greater detail. The expectation is we will not see a pretty massive increase in the deficits. Absence of the deficit financing is actually what is keeping the yields where they are today. Jonathan how much flatter can the curve get . Two 10 at 62 basis points. Vishwanath it will get more flatter. Jonathan what are we talking . 30s, 40s, 20s . Vishwanath its hard to come up with a number right now but it will be flatter. Jonathan iain, look at what the Federal Reserve is said to do next year. If i take this dot plot and look at the forecast for next year, they are looking at Interest Rates the median forecast, take it with a grain of salt if you want to we are at 2. 215 2. 215 for their median and of the year forecast. We are 20 basis points north of that on a 10year treasury, right here, right now. Can you try to make sense of that for me . Iain thats exactly what i have done this year. They did what they said they were going to do. They wanted to raise rates three times. They will do that in december. They will continue to normalize rates, continue to take rates, at least so the real rate is close to zero. But the long and long end continues to be anchored by forces around the rest of the world. On the dot plot, they also say 2. 75 is where they think the terminal rate is. A 10year treasury at these levels is not one million miles away from thats a maybe that is that, so maybe that is right. Onathan if you get that dynamic where they go with a with where they are going to go and treasury yields do not push higher, is that a policy mistake . Something they can ignore . Iain the reality is treasury yields will move higher. In reality, the curve will continue to flatten. When you look at with happening with what happened in previous cycles, 2005, in april of 2005 we were around these levels. It took us until december to get own to zero. It didnt took another two years to go to recession. So we are still a long way from the recession fears people say it is indicating. Jonathan lisa, your thoughts . The policy statement of the fed . Lisa one interesting thing i was going to point out is we are looking at the dot plot, but the fed composition in 2018 going to look dramatically different than it does today. There are four governor appointment that needs to be made, including the vice chair, and on the fomc, of the five voters we know dudley has to retire this year, richmond has to replace lacquer. There is a significant change in the fed. I do not know looking at these dots tells us a whole lot. They will continue hiking rates by the competition composition of the fed may be very different next year. Jonathan but this does not necessarily mean that the fed will change at all. Lisa i think it will be a bit more hawkish, especially if data continues to come in the way that it has. I do not think they will try to become aggressive and less inflation unless inflation picks up. If you see inflation here or abroad, that is the end of this bull run in risk assets we have had for a long time. Jonathan this year, i have heard a lot of people talking about the competition of the composition of the Federal Reserve and how it will change, but jay powell will be the chair, and Mohamed Elerian could be considered as the vice chair. These are the names people are comparable with. They understand the academic and banking background. It is not like the john taylors of the world could populate the bulk of that board. We do not really know. If you look at the debate that preceded the nomination of powell, john taylor is very much on the board until the very last moment. So we do not know what the composition is going to be of the fomc. I totally agree with lisa on this, the composition that that the competition we are thinking about what the fed is paying, what they are doing in the future based on the fed. That might not be the future point. That is not the fed we would have. Lisa there is some speculation one of the first orders of business of the powell set will be looking at the inflation target. Seeing 2 is actually the right place to be or should it be a little higher . That introduce term premium to the curve. A lot of people are positioned in flatteners because they affect the cycle that produces flatteners. But that changes the whole dynamic. Vishwanath in terms of premiums, the significant difference at the long end of the curve and the short end of the curve, negative term premiums at the flat of the curve. It is perfectly rational and makes sense to exploit that by continuing to flatten, absent a big change in the direction of the fed. Jonathan vishwanath tirupattur, lisa hornby, and iain stealey. Coming up on the program, the auction block. Canada taking advantage of its own flattening curve. The two 30 spread the tightest since 2008. From new york to our audience worldwide, this is bloomberg real yield. Jonathan from new york city, im jonathan ferro. This is bloomberg real yield. I want to head to the auction block. The United States not the only one with a flattening yield curve. Over in canada, taking advantage of it by selling auction blocks for the second time in three months. They auctioned off 392 million worth through 2064. An allocation yield of 2. 25 . Spain also went long, selling 1. 4 billion worth of euros in bonds through 2066. And with better demand for the previous auction as well. Despite the volatility in high yield, Weight Watchers at his at its first dissell been five years. Still with me, vishwanath tirupattur, lisa hornby and iain stealey. Can we have a conversation this year about what is happening with highyield . If you look at the fund flows, it looks like money coming out of highyield, money going into investmentgrade. It was like a flight to quality to some extent. Is that what you see . Is that the right trade . Vishwanath we have been advocating this for some time, what we call the upper quality trade. We see several challenges on the lower end of the credit pectrum. And we think the challenges are numerous. For example, the buildup of leverage over the course of the last several years has been a normous. It has not been in any one sector, it has been across many sectors with the buildup and leverage. And compensators are getting paid for taking on the everage. Spread per unit leverage it is is nearly at an alltime low. We think it makes sense to keep going up in the quality spectrum at this time. Jonathan j. P. Morgan asset management, for a while, has stayed bullish highyield. The message from bob michael is dont get greedy. Is that something you guys are still thinking about as you look at this situation . It is time to fall back, go up in quality. Is this just a buying opportunity for you . Iain definitely. When we look at yields a month or so ago, 5. 4 . It was probably a little too low. But we have seen a decent backup. Our yield is now rounding out around the 6 level. Spreads are about 40 to 50 basis points wider. We see this as a great opportunity. We see default rates remaining very low, Corporate Health is strong, and the u. S. Economy looks great for us. Jonathan lets talk about individual credit. You do not have to speak to the individual name, but i want to use sprint as an example. The deal breaks down for a merger, the debt breaks down. Debt breaks down as well. We traded north of 1. 10 and dropped below par, but i want to ask you with a Company North of 30 billion worth of debt in a and an uncertain future in a competitive sector, whether you compensate for the yield north of 6. 5 . Iain i think when you look at Companies Like that we have seen profits improving. We have seen the overall state of the economy should be good for this sort of company. The thing that happens to these big, large issues with the big omponents of indexes, when you see the sort of inflows or outflows we have seen from the etfs, they are going to take some pain, but they are going to get ahead. For us it creates opportunities and pick them up at higher yield and get better returns. Jonathan you could have had this debate throughout the year, and so far in 2017, iain would have been right. We could bring up the two previous bouts of a correction we have seen in highyield twice in 2017, and we saw this movie twice before. We saw it in the spring, spreads widened and then tightened. Then we saw it in august. Spreads widened and then tightened. And we are seeing it again. Why is it different this time around . Vishwanath we probably did have this debate with iain on this particular topic. I would say that our view, our conviction looking at the fundamentals and how much you are being compensated for taking on this leverage. We dont see the corporate fundamentals in exactly the same manner. We think there is a tale tail that continues to deteriorate. And if you look at year to date, triple c bonds have underperformed than double b bonds in the highest space. So on year to date, they transferred lower. That is basically what the market is telling you. You are not getting paid to go down that triple c. Not down that end of the spectrum. Jonathan the message in the previous segment was about sovereign debt and the weight on the long end of the yield curve. Does the same apply for Corporate Credit . Do you have to think about of the amount of foreign flow that are coming to the United States, fueled by, spurred by action from the ecb and president draghi . Lisa that has been the story of the last several years. You know, 40 of the i. T. Market, the Corporate Credit ig market, Corporate Credit is now owned by foreigners. Any change in the dynamic, the relative value dynamic because of the cross currency basis or because of spreads in the u. S. No longer offering value have to be watched closely. We could see an exit of demand. Jonathan i want to put this final question to you on this particular segment. Goldman sachs in their top 10 for 2018, late cycle imbalances. They are not talking about leverage this time, they are talking about illiquidity. How much concern do you pay to illiquidity in spaces like highyield and do you promote a much more active approach with these kind of things Going Forward from here . This is, for many, the late cycle story . Iain i think this is the perfect environment for credit analyst to do their homework, analysts to do their homework, make sure you are in the right credits. We are not daytrading bonds. We are longterm investors. We want to buy companies we think are going to give a return to capital and income over the next five to 10 years. So i think there are some worries out there. There are definitely some names you want to avoid. We like the market overall. Again, credit selection absolutely critical late cycle. Vishwanath i agree it is critical. Also, i think it is important to note that the market has not appreciated how much the feds qe program has enabled credit. We have just embarked on a if youd take that perception, that the qe has credit, and we are embarking on it because of qe. There has to be some extent an important effect. We think that the liquidity we are in a market where liquidity has been infused, it an adequate liquidity remains very substantial. We begin to see some of that liquid taken out of the system by the fed. Lisa we completely agree with your view. We just did some back of the envelope numbers. If you look at the difference between the purchases by the central bank this year and by the central bank in 2018, there is about 1 trillion in debt to absorb by the market from what was in 2017. That have to have an impact on valuation. Jonathan you guys are sticking with me. Vishwanath tirupattur, iain stealey, lisa hornby. I want to get you up to speed on the Market Action this week in treasury. 210 and 230, a much flatter yield curve. Up at the front end by six, down at the long end by 10. We are around 278. After this, the final spread. This is bloomberg real ield. Chatter from the ecb and the fed. Jonathan im jonathan ferro, this is bloomberg real yield. It is time for the final spread. It will be a shortened trading week in the United States with the thanksgiving holiday coming up. We will have details of the recent meetings by the Federal Reserve and the ecb. Fed chair janet yellen will be speaking, and Philip Hammond makes his budget statements and the Holiday Retail shopping season kicks off with black friday. Our guests are still with us. Lisa, i want to wrap things up with you and get an idea of where you think the opportunities are right now. We have had a bit of a correction, bounceback. Is there anything i should be looking at the pickup . Lisa we are cautious on risk generally, but but right now but right now its about balancing, taking risk down and having some carry on in the portfolio. You can get relatively short dated maturity bonds, high quality, and pick up 80, 90 basis points over reasuries. That is one area. Vishwanath i agree with lisa. Both of those things have been what we are recommending to our traders and investors as well. Jonathan i imagine iain disagrees with you both. Where are the opportunities in london . I agree on the local side. I think there is some value there, and there have been decent real yields across a lot of countries. Overall it looks good. I have to say this, this is a buying opportunity to pick up some bonds, 6 yields trading 60, 70 basis points lower. Jonathan what do you say what if you still have the hunger to buy and you can see where the dips in the market are. It is the timing again. Vishwanath i look from the portfolio managers, the index to the broad benchmark indices. What has happened over the last several years have been underweight credit and underweight mortgages. They could have been bought by them. That is changing now. We think you will be forced to reallocate away from there to mortgage. Jonathan we will wrap things up with the rapid fire around. You know the drill three questions, short answers if you can. Two versus tens. Do we see zero before we see 100 again this year . Vishwanath yes. Lisa no. Iain yes. Jonathan long credit risk or longDuration Risk . Credit risk or Duration Risk . Highquality credit risk. Lisa highquality credit risk. Iain definitely credit risk. Jonathan we have a bit of a selloff in highyield, and a bit of a bounce back as well. I have picked out two credits that have taken a beating over he last couple of weeks. I want to know which one you would pick up. Pick up the pieces of sprint or tesla . Vishwanath tesla. Lisa tesla. Iain i will take the sprint. Jonathan there we go. Guys, great to have you with s. Selling, he is buying for you are everything. Vishwanath tirupattur, iain stealey, lisa hornby. That does it for us here in new york. We will see you next friday at 12 30 new york time. 5 30 p