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00:00From New York City for our viewers worldwide. I'm Katie Greifeld in for Jonathan Ferro. Bloomberg Real Yield starts right now. Coming up, the edge finally comes off of US inflation, and that's followed by a downshift from the Federal Reserve, and that's all as a twenty twenty three recession becomes the consensus. We begin with the big issue fighting the Fed. Bond gives giving the same message. They still have more work to be done. He kept pounding away at the market. They're simply not there yet. Seventeen of the 19 dots are above 5 percent. I do believe him, but the market does not. The market's calling the Fed's bluff, not really listening to the Fed. The markets just said it was still not even going to price into a terminal funds rate above 5 percent. We can say the top what is relevant, but when has the day off happened? Right. The market saying, look, we've tightened a lot. We have seen the drop in the CPI. The consumer is rock solid right now. Markets to some degree are looking for central banks to react as they react to when economies have gone into recession over the last two decades. When inflation wasn't a problem, they lowered their GDP to zero point five. This is closer recession as they ever get. The Fed is effectively saying we're really serious guys. More than NASDAQ market ignores the Fed. All that's going to do is force the Fed to keep rates higher for longer. You fight the Fed on this at your peril. Joining us now, Brandy Wines, Tracey Chen and Matt D Arc of Merrill and Bank of America, Private Bank. And Tracy, the bond market right now is pricing in about 50 basis points of cuts in the second half of next year. And if you rewind and look at what the Fed's new dot plot says, doesn't say anything about cuts. So who wins here? Yeah, I think the market has been misinterpreting Fed's message for quite some time. The Fed is the Fed. The recent Fed speech, he's very hawkish on the terminal rate levels and very dovish on the pace of hiking. And I don't think the rate cuts next year and the market has been pricing at least one cut. So I think there will be adjustment in terms of price going forward, especially on the short end of the rate. So I think it will be a kind of repricing of that and try to the market should try to price that out. And Matt, there's a good reason why don't fight the Fed. Just one of the most overused phrases in financial markets. Is there any chance that this time is different? So there's always a chance this time it's different. You know, it's usually assume that there's always the chance. You know, what we're we're seeing now is a very interesting paradox. And so if the Fed ever says, hey, we might cut it back in the next year, or that might be necessary, the more they start to talk about something like that happening, thus less likely it can become true. Right. Because if they start talking about potentially cutting next year, if they need to, the market will get ahead of it. If financial conditions will ease, they'll make it that much, much harder to do. Paradoxically now by saying, hey, we're getting higher, we're saying higher for longer. We don't see rate cuts, labor market strong. It's not going to soften by saying all those things. They give the market more credence that they're fighting inflation. We'll get more credibility and they'll actually create the conditions, tighter monetary conditions, tighter financial conditions that might make cuts at the back end of next year. A lot more money. Right. Even the Fed thinks right now. You bring up financial conditions. And actually, that was the first question to Jerome Powell during Wednesday's presser. He got a question about whether the easing of financial conditions in recent weeks is a problem. And he pretty much brushed that off his short term moves. But we got a reminder from former Fed chair Richard Claire to weighing in on that behavior, saying that basically if markets keep easing financial conditions, the restrictive policy loses its bite. So on that note, Matt, at what point do financial conditions easing become a problem for this Fed? So my sense is the Fed is not happy with how easy financial conditions have been and have gotten, I mean, I got to say that directly, but I think that is why Chair Power is alluding to. When you say we don't look at short term moves, we want to see a trend. But as we said a couple of times, investors need to mind the gap here. There is a significant gap between what the rates market is saying, obviously deeply inverted yield curves, highly predictable recession, all the economic data, leading economic indicators, money supply growth, which has gotten negative 2 percent negative, almost largest negative print in terms of my supply declining over six months. We've seen since 1959 the history, the data. So certainly a lot of things that economic siders say recession with the labor markets not saying that yet. And credit spreads, for example, are not saying that at all. Right. Brad Stone great credit at 130 high yield about, you know, four and a half percent APR. Those are not near recessionary levels at this point. And so at some point, you have to think they will have to soften more next year as the labor market softens and catches up to their data. And that trust me, we're going to get to the different message that the credit markets are sending versus the Treasury market. But let's bring in George BOERI now. He is from all spring. And George, we're talking about what we learned on Wednesday. And one of the things we learned is that Pell isn't backing away from that 2 percent inflation target, even though there's a lot of daylight between 7 percent and 2 percent. How long does it take to close that gap? Well, we think it's going to take awhile. And, you know, as we just mentioned, you know, confidence is critical. And that's clearly in our impression of what the Fed is trying to maintain. Is is a is a hawkish bias to sort of convince the market that it is going to be able to get inflation down to its target. We don't expect it to be a straight line. Next year is going to be a challenging sort of divide, the sort of the trend. And maybe three thirds of the first third going from, say, seven down to say about 5 percent will be sort of reasonably achievable and somewhat easy to get to the next sort of third from, say, five to say three and a half percent. That's going to be a challenge. That's really where sort of the expectations for the middle of next year. We have some questions about and then that final third all the way back down to 2, that will really be a cast of the of the Fed's kind of resolve and whether they're willing to sort of pressure in the market and really push the economy to those kind of levels. So from our perspective right now, the most important thing that the Fed can do is they need to get Fed funds above above the spot rate of inflation. And we're not there yet, you know, sort of the P.C. numbers. And if you look at, say, core CPI still hovering just below 6 percent, you know, Fed Funds is at four and a half percent. Those numbers should cross as we get into 2023. Once that point occurs, the Fed can become a lot, much more, much more purposeful and they can be viewed as kind of ahead of the curve. But we're not there yet. And the Fed has to keep the market's confidence that they're going to get there. Well, charge, let's talk about when those two lines meet. Does that happen when Fed funds? Is it 5 percent or does that happen when Fed funds is maybe closer to 6 percent? Yeah, we think it's 5. You know, we think that, as you know, given the sort of the trajectory and inflation, as I mentioned, getting inflation back down towards, you know, into sort of the 5 and sub 5, that that is, we think, achievable. And so once that occurs, which we think could happen in the first half of next year, the Fed can be much, much more patient. That messaging doesn't have to be exclusively hawkish. We don't have to have this ongoing game of cat and mouse. Howls somewhat dovish one day and then very hawkish the next. And he's sort of toggling back and forth. We'll get, I think, a more balanced kind of message, but put in till we get to that point. It's it's that they can't afford to do it because as we mentioned before, that that confidence element is so critical and he has to preserve confidence. Our view is that, you know, the bond was very encouraging yesterday. You know, that the bond market basically held in, you know, that effectively, you know, stocks were off. Bonds were flat. That's actually a pretty good story. And we think that, you know, you're probably getting to the point where you could say the bear market in bonds could be over simply because the Fed is heading in that direction. Inflation's falling. And the Fed is still tightening. Those sort of dynamics are pretty powerful for a bond investor. Well, charge, that's a big call that we could be at the end of this bear market in bonds. But, Tracey, I want to come to you on a big wild card and what the Fed is trying to do with inflation, which of course, is China central pivot away from Covid 0, a potential reopening of one of the world's biggest. Economies, what would that mean for U.S. inflation? What would that mean for the Federal Reserve? Yes, I think China's reopening is faster than anyone expected. I think the decision to 40 reopen is almost a force for one because the local government cannot afford to continue that this route of the PCR test and all these knockdown down anymore and they can't afford their economy to have a hard landing. So. So this quickened pace of reopening, well, create the chaos in the near-term. So I think in the near term, we'll see the growth and activity continue to to worsen before they get better. So the timeline is really hard to estimate right now. When are we going to see the pickup in activity and the recovery in its economy? So I think right now it's partially dependent on the the mutations of the various, whether we are going to see some some more detrimental, that variant of the virus. But at the same time, I think we are closer to the end of the tunnel. So I see it's a double edged sword. On one hand, you will see a pickup in recovery and then potential to increase demand for global commodity and that will actually increase the risk of inflation. And I think that's definitely a wildcard. But at the same time that the growth will be hard to to estimate at this point in terms of timing, the timing of the recovery. So in the near term, we'll see more of inflation or deflation from China, a double edged sword. One of many crosscurrents hitting fixed income of all stripes. We're going to keep talking about it next. I'm thrilled to say George BOERI, Tracy Chen and Matt D, OK. Everyone is sticking with us. Up next, it's the auction block. J.P. Morgan makes a move to top the tables. That's next. This is real yield on Bloomberg's. I'm Katie Greifeld. This is Bloomberg Real Yield. Time now for the auction block, where the global debt markets solve roughly 140 fundraising transactions, including bonds, loans and asset backed securities worth at least 75 billion dollars pulled in 20 22 over in the U.S., bond offerings of just about dried up in December. Volume is set to finish down by about 16 percent from twenty twenty one. J.P. Morgan, though, did sell three billion dollars early this week to narrowly take the lead in the Bloomberg league tables for high grade sales in 2022. We did catch up with notable investor Bruce Bruce Richards from Marathon, who calls for a recession in the second half of next year. Now, that slowdown, coupled with an earnings recession, will start downgrades and a default cycle. We think we'll have a cumulative default rate of 10 percent. That's enormous. The reason why it's enormous is because the high yield market used to be a one point seven trillion dollar market. Today it's a five trillion dollar market. And so 10 percent of that is a whopping large number. The good news is 90 percent of the credits won't default. And for us to pick a quality pitfall of double B credits, double B long structure credit that yields 8, 9, 10 percent, that won't default. At the same time, you have this big default cycle picking up and now allows you to play it in multiple different ways. Still with us, George BOERI, Tracy Chen and Matt DAX and Tracy. Bruce picks up on an interesting thing about this cycle. This potential downturn is that we haven't really seen a pickup in defaults. And obviously he thinks that's going to change. But where do you fall on that? Do we see more defaults in 2023? Yeah, I think this psycho is not a normal psycho, right? So I think if you use the old playbook, it might not work this time. I think in terms of default, I think it will go higher definitely next year. But how high it can go. It really depends on the interest rates as the credit assets. I think in this cycle, the interest sensitivity is a little bit lower than before. For example, the mortgage, the mortgage owners, their existing mortgage, the average existing mortgage coupon that they locked in use about three point five percent. So they're very sensitive to rate to rate increase is a little lower. And this applies to corporate bond market as well. So and the balance sheet of both consumer and corporations are much better than that than than the ones they have in the global financial crisis. So with that being said, I think the default cycle might be a little benign. This time around. But I'm more worried about the financial stability because the pace of hiking in this cycle is unprecedented. We haven't seen that in the past 40 years. So I think something is going to break. We have already seen housing that has been slowing down quite drastically and that the bitcoin market has some ma some some turmoil as well. So what will be the next shoe to drop? I think the financial market. What? Well, we'll see some on some some fireworks there next year. While some turmoil in the bitcoin market might be an understatement. But as we look ahead to next year, we had J.P. Morgan's Bob Michael looking for opportunities, saying that our best idea is to use every backup in yields to add high quality duration to portfolios, investment grade corporate bonds, top our list, while government bonds now offer the highest real yield since the financial crisis. And George, I want to know, is that your best idea as well, high grade bonds. So the notion of positive real yield is really our best our best idea. And you can scale positive, real yield to different points along the rating spectrum as well as the yield curve. And just going back to what you just mentioned around to the corporate and corporate risk, there is there is a fair bit of kind of risk embedded in the corporate system, but it really comes down to sort of balance sheet structure more than anything else. And so that whole notion that maybe you get 10 percent cumulative default rates, that does grab a lot of attention. That's probably a pretty good messaging and a starting point. But really, where do those defaults ultimately manifest themselves? It's going to come down to who is not able to either absorb or hedge out the sudden sharp increase in interest rates, as Tracy mentioned. If you've financed yourself with low cost debt that doesn't mature for a long period of time, you're in a very good position right now. If you bought, if you bought, if you borrowed a whole load of bank debt, that is sort of rapidly repricing and you haven't hedged it and you can't pass through those interest costs. Well, now we've got a meaningful problem. So we've taken a very narrow approach as to where these made manifest themselves in the loan market for us is kind of is definitely sort of the spot where we see the most amount of pressure and we're most cautious. We've been reducing our allocation. Their investment grade looks pretty good. Most of high yield looks pretty good. To go back to Tracy's point, asset back in securitization arguably looks the best. Well, Matt, what you expect out of defaults largely expects whether you have a view for a recession and like you touched on before the break. If you look at what stocks are pricing, if you look at what treasuries are pricing, it looks pretty close to a recession. But then you look at spreads, investment grade and high yield, no such concern. What changes at twenty twenty three or spreads writer? Are all the other asset classes going to win out here? Yes, this is a very interesting conundrum. And I think what explains it is the fact that the labor market is still quite strong for now. So it's more of a recession delayed but not denied. So the recession, which people were expecting sooner, is probably later 2024 or even early 2024. So you actually start to see job losses and you start to see the unemployment rate tick up. Do you really see that the consumer side be squeezed? Maybe you don't need to see those recessionary levels yet. But from our view, the more complex the macro picture, the more disconnected the yield curve and leading economic indicators are from investment grade ie your credit spreads makes your portfolio decisions somewhat easier. You just don't want to stick your neck out too much on a number of asset classes. You want to be broadly diversified. You want to make sure that treasuries agency backed mortgage backs do not be too overweight spread products. But we do agree there were longer periods of time investment grade corporates, high quality fixed incomes who do quite well. Picking up on a point, George made me agree 100 percent. These are some of the best real yields we have seen since the financial crisis. This was an opportune time to grow overweight fixed income. We were overweight fixed income three or four months ago. We want to make sure our clients, they fully investment fixed income and not put all their money in t bills are seeing a lot of activity in the short end. But be out the curve close just as you do duration, target fixed income and be overweight fixed income. Well, it's funny that you mentioned t bills because one of the only things that really worked this year is cash and actually Romaine Bostick. And I caught up with Stephen Byrd. He's the Aberdeen CEO earlier this week on that topic. Cash has been a very good diversify. It's been doing the asset class where you've been getting a share return in 2022. So you've got to any diversified investor. Has got to have a portion in cash because nobody knows what's going to happen. So when you don't know what's going to happen, you need to look at balance in your portfolio. So cash, there is a short term benefit because you're getting a risk free rate today, which which is very, very attractive. But we also think that you've got to be positioning for not just today, but tomorrow. And that's where our investors are seeing what's going to happen next. Now, Stephen Byrd also said that his position in cash has been increasing as rates have risen and charge. Do you agree with that, that you should be in cash at this moment, at least at some level? Yeah. Liquidity is really important in this market and we've seen that it has sort of become more of a factor is the yield as the year has unfolded. You know, the sort of the hurdle rates four and a half percent off. I know I can buy, you know, sort of frightening yields and roughly right around that level, four and a half to five. Everything else has to beat that. So third, there's a good argument for maintaining a certain amount of cash. We have had relatively high cash positions in our portfolio, both from a liquidity management perspective, but also from a tactical positioning perspective. We're not giving up on that just yet. But when we look at the shape of the curve and we look at sort of, you know, kind of optimal risk return targets, the two and three year part of the curve looked very attractive across a variety of of segments of the market. That includes, you know, as I mentioned, some corporate, some structured products and mortgages, you know, that sort of position from both kind of a yield and a curve positioning standpoint to us looks very, very attractive. The combination of those two gives you quite a bit of income. A lot of carry and really tries to sort of position that that yield, that very generous yield relative to sort of where volatility is today. Charge for a Tracy Chen and Matt D, OK. Everyone is sticking with us. And still ahead, it's the final spread, the week ahead. Major central bank decisions continue. Plus, a host of U.S. data. That's next. This is real yield on Bloomberg. On Katie Greifeld, this is Bloomberg real yield, and it's time now for the final spread the week ahead. Coming up, we have the BFG rate decision on Tuesday, plus a slew of U.S. economic data that includes GDP, housing, spending, durable goods and jobs. It's time now for the Rapid Fire round. Three questions. Three quick answers. Tracy, I'm coming straight to you. Does the Fed cut rates next year? I don't think so, George. No, Matt, no. Tracy, have we seen the peak in 10 year Treasury yields? I think so, yes. George? Yes, definitely. Matt? Yes, we have 10 seconds left. Do we see 100 or 200 basis points first on ISE spreads, Tracy? 200. Matt. What aren't you. But I'll be close. George, you know, we may touch two hundred. George, Tracy and Matt, thank you both so much from New York. This is Bloomberg.

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'Bloomberg Real Yield' (12/16/2022)

Katie Greifeld highlights the market-moving news you need to know with 30 minutes dedicated to fixed-income. Featuring a round-table including Allspring Global Investments' George Bory, Brandywine's Tracy Chen and Merrill and Bank of America Private Bank's Matthew Diczok. (Source: Bloomberg)

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