The best returns in a decade, but how long can the rally continue . We begin with the big issue, markets betting low rates are here to stay in 2020. It is hard to see the yield breakout from here. Bond yields moving sideways. We cant generate any inflation right now. Still attractive but certainly not breaking out. 1. 20 by the end of the year. If we get to 1. 2 on the 10 year, we are looking at a global recession. We are going to test 1 . A lot of things have to be going incredibly wrong to get to 1 . Unless the market begins to price in additional cuts, the 10 year, at most, will drop down to the 1. 60 range. The fed will probably not cut again. If there is any weakness in the data, you will see an outsized rally in bonds. The path to least resistance has been lower, and i see no reason to see that change in 2020. Taylor can we break out of the range set in 2019 . Joining us from new york are collin martin, peter tchir of academy securities, and in pasadena, john bellows. I want to get your 10year forecast from each of you for 2020. Collin we think it will rise modestly in 2020, somewhere in the 2. 25 range. We think shortterm rates will stay anchored. The fed will stay on hold. With signs of stabilization across the global economy, as well as in the u. S. , pickup in inflation expectations, we can get close to 2. 25 for the 10 year treasury. Taylor peter . Peter i think we will see 2. 25 as soon as january and february. Higher yields, deeper curves as the Global Growth curve gets priced in. More stimulus out of europe. John the better growth optimism is an argument for higher yields, but i would highlight two other components. Inflation continues to be very subdued. 2019 was supposed to be a year of higher inflation. Not only did that not happen but inflation moved lower across a set of measures. The second component is the fed. They have adopted an asymmetric reaction function, unlikely to raise rates given the low inflation area environment. There is a chance they cut rates, whether in response to a growth downturn, which would be a straightforward reason to cut, or even if inflation is too weak, chance that they cut. Against that, subdued inflation and asymmetric and accommodative fed. Our view is those things will matter more and keep yields low for the foreseeable future. Taylor i wanted to talk about the fed. The wirp function on the bloomberg shows no movement in either direction in the first half of the year. I know it is far out, but what is your take on fed action, at least in the first half of 2020 . Collin we think they will be on hold. We like to say for the foreseeable future. That is what the markets are pricing in, what fed officials are telling us. With the three cuts they did this year, they have successfully uninverted the yield curve, and now financial conditions remain easy. Barring a major change in the economic outlook, there may be a risk off environment where we see stocks fall. We think they will be on hold. Taylor peter, i want to get your take now that phase one of the trade deal has been sort of resolved. What do you need to see in the Economic Data to get the fed to move in either direction . Peter i dont think the fed will do anything in rates unless there is a big change in sentiment, very positive or negative. We may see as early as january, then containing how big the Balance Sheet will be. A lot of this rally started in october when they started regrowing the Balance Sheet. Looks like we will make it through the year end without any refunding in the shortterm market. They may start to set expectations that we cannot keep growing at this pace. That will be a headwind on stocks, ok for the rates market. Taylor i want to go back to the steepening yield curve. That is bringing some optimism to a lot of the markets here. Listen to what Morgan Stanley is saying, that it is a step in the right direction. I take confidence from the steepening of the yield curve. That is a measure of success, confidence in the future. We are talking about an endogenous rise in longterm rates. The market is more optimistic about the future. Taylor james athey giving a little bit of a different take. This is what he had to say. You dont get a recession when the curve inverts, you get it when it comes back, dealing with the problems that have built up in the expansion phase of the cycle. Essentially, if i were to look at the curve today, i would say this is classic prerecessionary behavior. Taylor your take on a steep yield curve, the steepest since 2018 . John i think the resteepening of the yield curve, the fed deserves credit. Beginning of 2019, the yield curve was inverted, sending a clear signal that short rates were too high, monetary conditions too tight, and the feds cuts have addressed that. However, it is premature to signal an all clear here, declare success. If you think about the level of yields, inflation breakevens on the 10year are 1. 75, well below the 2 mandate, below where we were six months ago. A lot below where we were 18 months ago. The yield curve is not inverted, and that deserves credit. But we are a long ways from an all clear. The level of inflation breakevens is still worrisome and demands attention from the fed. Taylor we are showing a chart of the feds Balance Sheet, you were highlighting this, the togetherness of the feds actions and the Balance Sheet, and how we see a steepening yield curve. Is that different this time around . It is a good sign given rates are rising on the long end versus the last time we saw a steepening of the yield curve. It is bets on the short end of the curve. Peter i want to take one step back. August is when we got the inversion. There were a lot of technical factors in play. A bunch of inflows into long dated treasuries, a shortage of sellers. Some of that flattening was purely technical. We reversed that. We wrote back in august, steepening the yield curve should be the fed and Treasury Departments job. The fed has done a lot for that. What im for now is the Treasury Department to issue more duration. This department is focused on issuing a lot of tbills and frontend bonds. The value is skewed a little to the front end. I would like to see them come out and issue more 10year, 30, maybe introducing a 20year. I think the steepening yield curves gives comfort. It is really the yield curve that leads the discussion, rather than the discussion leading the yield curve. Taylor collin, do you agree, are you comforted by the steepening of this yield curve . This time is different with every steepening after the initial inversion. Collin i agree with john, this is a success by the fed. I do think its important to put this in perspective. It is still relatively flat if you look at the threemonth, 10 year, you are still in the 25, 30 basis point range. When you look at the broad yield curve, still a relatively flat trend. If you look at the past mid cycle adjustments of the 1990s, that was also followed by a steepening of the yield curve. We do think it is a success, but we need to see more before we see an all clear sign. Taylor john, as you look at 2020, is the pain trade higher or lower yield . John if i could respond to something that collin said about the midcycle adjustments. Its important for investors to understand this is not the 1990s anymore, the fed is doing Something Different than what theyve done in the past, not responding to something global. They are responding to low inflation here in the u. S. They have made that clear. Powell has tied future rate hikes to inflation explicitly. This is not something that we think will be reversed in the next two years. As long as inflation remains low, the fed will be on hold. Its important to emphasize, this is not 1990, this is not about inflation. One thing that strikes me about the pain trade, what is the consensus . One consensus that we hear all the time is the steepening of the yield curve. That could, will happen if you see some kind of readmission of Global Growth and optimism, yields move higher on the backend. But if inflation did not move higher and we didnt see an increase in global optimism, then i think steepening the yield curve would be a pain trade in the sense that consensus is there already. You could see a flattening as a result of that. First point, this is not 1990. Important for investors to understand that. Secondly, the steepening yield curve is a consensus trade. Taylor everyone is sticking with me. Coming up next is the Auction Block. The Treasury Department selling 113 billion of longer dated notes in the final full week of 2019. Strong finish for the Corporate Credit markets. That is all coming up next. This is bloomberg real yield. Taylor im tayler riggs. This is bloomberg real yield. I want to go to the Auction Block and begin with asia. Japan saw just under two trillion yen of negative yielding twoyear bonds. The bid to cover ratio was 7. 4 times closed. Italy sold to billing euros of 2 billion euros of zero bonds due in 23 months. Investors offered to buy 1. 8 times the amount sold. The bonds were sold at a slight premium with a yield of. 005 . Here in the u. S. , the Treasury Department holding three auctions this week for 2, 5, and 7year notes. Demand of 32 billion for sevenyear notes rose from the last auction. Demand for two and fiveyear notes was lower than average. Elsewhere, Corporate Credit is looking to finish the year on a high note with highyield rallying for 16 consecutive sessions. Wells fargo weighing in on the recent performance in the junk space. Across highyield, you are pulling in 2020 returns into 2019. There is a yearend squeeze going on as people scramble, looking for that recovery trade, where can i get the incremental yield, incremental return, how can i set myself up for next year. We have seen a meaningful squeeze in the market. Taylor still with me are collin martin, peter tchir, and john bellows. Collin, i want your take on some of his comments, that we have pulled a lot of those returns in the ccc space specifically back into 2019. Do you see that as being the case . Collin we do to we think it will be difficult to mimic the returns we saw this year in the credit markets, especially highyield. We have gotten to a point where spreads are low, prices are high, and the returns we saw this year, frankly, will be difficult to follow, unless we see spreads go to alltime low levels. Our guidance for investors is to be very defensive, suggest underweight in highyield bonds, especially the junkiest part, like cccs. The outlook is to earn your coupon. Coupon payments will make up most of the return in 2020. Taylor peter, your take on credit in 2020 . Peter we came into december looking for this squeeze across the board. The first step is figuring out which credits benefited unfairly by the squeeze, start selling those. There will be a return to weakness for those weaker credits. We like cyclicals, autos, commodities. Certain names were beat up that are set to come back. I think those can continue. It will be difficult for managers to figure that out, but that is what youre supposed to be doing with your portfolio now. Figure out which of those weaker names have upside, adding to them, and then cutting losses on those that have a surprising rebound. Taylor the dallas fed president Robert Kaplan weighed in on the credit market, saying those tighter spreads might be cause for concern. B and bb credit spreads are so tight. Bbb spreads are very tight. If i see the market is distinguishing between lower quality credits and better credit, i think that is an encouraging sign. My bigger worry is, you have got increasing pe, historically low cap rates, tight credit spreads, and im just keeping a close eye on excesses and imbalances. Taylor john, do you agree, tight spreads, a cause for concern . John one think he has highlighted, there has been differentiation. Higherquality has outperformed, cccs have lagged, a recovery in december, but disappointing performance this year relative to the broader market. That is an important point. In that environment, managers that have the ability to do the fundamental credit work and differentiate between names and sectors, are really best positioned to outperform. Our team has done a great job on that. That will be the key going forward, to do that differentiation that president kaplan is talking about. It is not just buying the highest yielding bonds. You have to do that differentiation, have to be a fundamental manager in order to perform well. Taylor what is the highyield market telling you with spreads at 3. 26, down from 5. 50 a year ago, collin . Collin investors are not being compensated for taking on at high risk that they offer. You look at aaas down to b, if you look at the tiers of each market, they are close to the post crisis lows. The only types of bonds that have spreads above that is ccc. You are not being compensated. With high yield, it is not out of the ordinary to see spreads move sharply. The lower they are, there is less of a buffer for investors to offset some of that. Taylor peter, we were looking at the chart. It is shocking to see highyield at 3. 26, and then Investment Grade at 97 basis points. What looks more overvalued to you . Peter i am fairly comfortable with credit here. We all talk about reversion to the mean. You go back to the early 1990s, we spent all the 1990s at these credit levels, most of the 2000s at these spread levels. It will turn out that investors were overcompensated to take credit risk the past seven years, and we could normalize. We will see a world of bbb credits, where singlea moves down to bbb, bbb holds at bbb, and maybe if we get a recovery in the economy, bb getting upgraded. We will look back and say, what was the problem about bbb spreads . We saw this year, as companies were going through the debt diet, those companies that got in at the Investment Grade level could turn themselves around. I think we will probably not see a ton of spread type thing from spread tightening from here, but i dont think we will go back to widening. People will have to find the opportunities in those beaten up cyclicals, those names that were undervalued. People will be searching for yield, and that is where they will find it. Taylor john, i want to read something from pimco who thinks the strength in high credit is here to stay. He says there is not enough highquality income producing assets to meet the demand. That is the reason credit did so well this year, not just the fact that the fed and other Central Banks cut rates. It is just that there is that much demand. Does demand continue in 2020 . John i think the fed is a big component of this. They are accommodating in policy. The moves will lengthen the cycle which is reducing one of the major risks in credit, reducing the recession risk. Another thing the fed has done by bringing down rates is reducing the hedging costs for Foreign Investors who want to buy credits. I think both of those are positive. The fed is definitely a part of the procredit story. I want to come back to the idea that there is differentiation within the credit market, and managers can take advantage of that. We have noted that Energy Credit has really lagged. Energy credit has lagged even though management teams are being very prudent with their Balance Sheets. You see asset sales in order to manage their maturity schedules, bring down leverage in some cases. And yet, spreads are still quite wide to the markets. Energy would be a case where prudent Balance Sheet management from the leadership and those companies is a positive. Spreads are not reflecting that. That is where you could take some risk. Taylor everyone will be sticking with me. Still ahead, it is the final spread. This week features manufacturing data out of the u. S. And china before closing out the year. This is bloomberg real yield. Taylor im tayler riggs. This is bloomberg real yield. Time for the final spread. Coming up over the next week, monday, chinese pmi and u. S. Wholesale inventories. Tuesday, the bond market closes early ahead of new years day on wednesday. Thursday, china manufacturing pmi data. Friday, minutes of the feds latest meeting. Still with us around the table are collin martin, peter tchir, and john bellows. Peter, Tony Crescenzi told us that 2020 will be a year of coupon clipping. If you look at returns, is it price or coupon in 2020 . Peter for the total return investors, youll have to be careful. It may be a coupon clipping. For spread investors, you can do well. You will have to be aggressive, as john talked about. Energy could outperform. You have to be overweight. Those sectors still have juice in them. You have to time the market. There will be opportunities to buy and sell, rebalance your portfolio. Taylor it is time for the rapidfire around. How many fed cuts in 2020 . Collin. Collin zero. Peter zero. John i will be a little more bullish and say one. Taylor what is the upper bound for the 10year in 2020 . Collin we think 2. 25. Upper bound, 2. 5. Peter 2. 75. John for the 10year treasury . Taylor upper bound. John 2. Taylor what part of highyield outperforms . You know what, i will just get one answer there. Collin martin, peter tchir, john bellows, thank you. This is bloomberg real yield. Here, it all starts with a simple. Hello hi how can i help . A data plan for everyone. Everyone . Everyone. Lets send to everyone wifi up there . Uhh. Sure, why not . Howd he get out . a camera might figure it out. That was easy glad i could help. At xfinity, were here to make life simple. Easy. Awesome. So come ask, shop, discover at your local xfinity store today. Im taylor riggs in for emily, this is the best of bloomberg technology, this is where we bring you the top interviews from this we contact, coming up, the tesla turnaround, one analyst says it looks credible. We will hear from dan ives of wes bush, who raises the price target on tesla to 370 from 270. And 2020 picks, we are covering the big tech in the new year,
vimarsana.com © 2020. All Rights Reserved.