Bloomberg: ‘Bloomberg Real Yield’ (03/31/2023)

Katie Greifeld highlights the market-moving news you need to know. Featuring a round-table including Charles Schwab’s Collin Martin, JPMorgan’s Kelsey Berro and Morgan Stanley’s Vishy Tirupattur.
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Transcript

From New York City for our viewers worldwide. I’m Katie Greifeld. Bloomberg Real Yield starts right now. Coming up, inflation continues to cool down, but Fed speakers say they’re staying the course as bond issuance comes back in a big way. We begin with the big issue. A bumpy landing ahead.

Personal consumption expenditures core today. We don’t have a clear vision of what’s going ahead of us. It all comes down to the labor market and the Fed’s ability to tolerate unemployment. The Fed is not thinking pause right now. Inflation is obviously well above the objective, their hawkish on inflation.

If they pause, what does the market do in response to that market’s pricing in give or take 100 basis points? Excuse me of rate cuts by the end of the year. This is a very sticky, tricky environment here. We’re about to get the full impact come out of recession. Recession is inevitable.

Joining us now, Colin Martin of Charles Schwab, Kelsey Berrill of J.P. Morgan, and vicious to repertoire of Morgan Stanley investing. I want to start with you. Is it that black and white, it’s a recession truly inevitable at this point?

I think it’s not as black and white. I think the probability of recession has certainly risen. But it is very difficult to say, pinpoint and say a decision is happening imminently. It might. We don’t have a good sense of how the tighter financial conditions and the tighter lending conditions that will

Come out of what we expect to come out, how quickly and how they would play out. I think I think it is safe to say that the the prospects for growth have certainly dimmed further. The the deceleration of growth that we have been seeing, it probably continue with the pace of that

Deceleration picks up. And the chances of a hard landing have certainly is the timing of which is yet unclear. Well, actually, on that point, we caught up with Matthew La, city of Deutsche Bank earlier today on Bloomberg Surveillance, and he said that tighter credit could lead to a landing that some won’t anticipate.

Let’s take a listen. We do think that credit conditions are going to tighten the way that we’ve tried to quantify it suggests it could be anywhere from half a percent on growth to just really more than 1 percent. But at this point, it’s difficult to

Gauge if that does tighten. I think it certainly means hard landing is more more likely than even we were in just a moment. And Colin, it’s a bit of an impossible question, but if you had to quantify it, how much is what we’re seeing in the banking sector worth in terms of Fed

Tightening? We weren’t. We think it’s worth something. So I don’t mean to give you an exact number, but we do think that it can replace part of the Fed rate hikes as Fed chair. Powerless, too. This is probably the number one thing we’re looking at. It’s something that everyone is talking about.

Obviously, you just showed that clip. But but tightening credit standards, tightening credit conditions. One thing we’ve been looking at a lot lately is, of course, that the senior loan officer survey, we saw tighter conditions pretty much across the board in terms of tighter standards lending to

Companies, higher spreads. And then we’ve also seen lower demand. So any way you slice it, I mean, that slows down or should slow down economic growth. But most importantly, those numbers were mostly from the fourth quarter of last year. So given everything that’s going on now, it’s tough to see banks really looking

To take too much risk. They have that whole unrealized loss situation that they have to take care of on their balance sheets. It doesn’t seem too likely that they’re looking to take much credit risk right now. So we expect this to really play an important role. And we talk often about long and

Variable lags with monetary policy. We think we’re at we’re starting to see them and we think we’ll continue to see them as credit standards continue to tighten. And Kelsey, when you were last on the show on March 3rd. You and I were debating whether or not

The Fed was going to go 50 basis points at this month’s meeting. And now the question has become whether they hike at all in May. And given the backdrop, given the conversation that we’re having, where do you think this Federal Reserve goes from here?

You’re right, Katie. It’s amazing how much a month changes things. And, you know, at the time we were arguing for 25. We were telling them or or our view was that those cumulative and lagged impacts of monetary policy, we’re going to start to bite. You know, and as the other guest

Mentions, the senior loan officer opinion survey was pointing to recession before the last theme, the dust up with SBB and Signature Bank and Credit Suisse and UBS. So from here, we really only expect further tightening of credit conditions. You know, one of the things that we’ve

Been digging into is looking at the loan growth in the post pandemic recovery. It’s been disproportionately driven by the small and regional banks. So if those small and regional banks start pulling back on their lending, we don’t expect the large banks to pick up that slack.

And so ultimately, it is going to result in slower growth and lower inflation. And it is going to allow the Fed to pause. So if I look at the core P.C. data today. This, in fact, is the first month of the tightening cycle where the Fed funds

Rate is above the rate of core PCI e inflation. So, you know, everyone is focused on core inflation being sticky high right now. But we’re seeing both our bottom up and our top down indicators really pointing to a deceleration in inflation coming

Over the next few months. Kelsey, it’s a good point that the Fed did get at least one win this morning when we got those P.C. numbers coming in a little bit softer than expected. But of course, we know that the consistent message from the Fed, Ben,

Has been that they need to do more work. And we heard from Boss Foote, Boston Fed president rather, Susan Collins. She caught up with Michael McKee this morning, saying that the recent data has not swayed her outlook. My assessment at the last meeting just last week with the summary of economic

Projections did suggest an additional rate hike and then pausing and holding over the year. But I need to assess all of the data that’s going to come in between now and when our next meeting is in early May.

The new data that I’ve seen just in the past week has not materially changed how I’m thinking about things. So this definitely sticking to the script there. But what does more work to do mean for this Fed? Does that mean simply hiking rates more

Or just not cut it? I think that I think she herself said that there is data to be coming and they’ll be watching the data we have in front of April veto to be to come in. And I think our own expectation is that

They will hike under the 25 basis points, that solid base case expectation. But then pause at that level. That’s what of what economists are saying at this point. But we are keenly aware of the how they if we have depending on how the data

Pans out between now and May could. We are keeping our minds open. All right. An open mind. I’d like to hear it. But if we look at what the bond market is pricing in, Colin, I see more than 50 basis points of cuts priced in at this

Moment again. The Fed has made very clear from the top down that cuts are not in their base case. But what would need to happen in the economy for those cuts that are priced in to actually become a reality? Well, I think we’d need to see the

Banking concerns likely not necessarily spread, but just stay out there for a bit. They’ve kind of taken a backseat, given all the Fed speak lately, given this morning’s, you know, slightly better than expected inflation report. We’d likely need to see them remain a concern. We’d likely need to see inflation

Continue to slow and then probably more economic data just tilting towards the negative side. Right now, the markets still aren’t buying what the Fed is selling, like you alluded to before. Most officials are kind of telling the same line and saying we expect more work

To be done. But the markets are only pricing in a 50 percent chance of a of a of a hike at the next meeting. A lot can change in the next four to five weeks. So we’re going to be looking at that a lot.

As the other panel said, there’s a lot of data that’s going to continue to come out for those cuts to to be a reality, to become a reality. We’ll need to see a significant turn for the worse in an economic data and a continue in the disinflationary trend. Colin, what’s your base case?

For the Fed, coming up, what we do expect them to hike at the May meeting. We don’t necessarily agree with that because we think the cumulative impact of all the Fed tightening as well as the tighter bank credit standards. We think that is enough. But we are listening to officials there

Telling us what they intend to do. They’re telling us that the banking system seems sound right now and that they are committed to fighting inflation. So they didn’t ask for our opinion. We do think they’ll hike in May, but we think it’ll be a debt hike and then hold

To kind of see how it plays out after that. And Kelsey, it’s the last trading day of the month, finally, and it’s worth reflecting on what an insane month of volatility it’s been. If you look at two year Treasury yields. We were above 5 percent at one point.

Now we’re hovering around 4 percent or so. You go out the curve, you look at 10 year yields. We were above 4 percent earlier this month. Now we’re hovering around 350. When you think about the charts, the dramatic moves that we’ve seen, have we overshot to the downside when it comes

To yields? So maybe in the short term we may have overshot. I mean, there’s been a lot of rate volatility, as you mentioned, but we do think in the longer term, the direction for yields is going to be to continue to move lower from here.

So we actually view a two year yield above 4 percent ultimately to be probably a pretty good buy. Well, yields move up maybe another 25 basis points on a retracement. Yes, that’s absolutely possible. But the way that we’re thinking about investing right now is to be extending

Duration of our portfolios. We get this comment a lot that cash at 5 percent is really attractive. Well, if you think cash at 5 percent is attractive, you should also think that the two year yields above 4 percent is attractive because 5 percent annualized rate, you only get that if cash rates

Stay at 5 percent for 12 months. In our view, we expect the Fed to cut in the fourth quarter of this year. And so you’re better off locking in those yields, but also being able to extend duration and take advantage of that potential capital gains as yields move lower.

This should weigh in here. Where do you fall on the duration debate? I think at the moment at the moment, we are still neutral on duration. I think you will need to see some some range of this. We went through a period, as you noted earlier, Kitty.

We have seen a enormous wanted to the end. The front end began to be a part of the curve. We need to see some stability before we feel comfortable enough recommending duration. We are not quite there yet. And the thing that I always get tripped up on in this conversation, basically,

Whether or not it makes sense to go out the curve here to extend duration is why would I like we’ve just been talking about you can get very, very high yields at the front end of the curve. Collin, when you’re talking to clients

About the case for duration or where along the curve you want to be, where do you fall? I echo most of the points that Kelsey made is the number one question we get. And what we focus on the most is reinvestment risk. And most of our clients don’t want to

Hear that. It’s something we’ve been talking about for a while now. And I think it’s an even more difficult pill to swallow when you see the 10 year yield that just three and a half percent. Knowing that you could have got 4

Percent or more just a few months ago. But we think the risk is that at some point the Fed will cut rates. We don’t think it’s going to happen necessarily soon. The Fed has told us that they want to hike and hold. But at some point that rate is likely to

Come down. So considering a five year, seven year, a 10 year, whatever makes the most sense for you as an investor, we’d move a little bit further out and invest and lock in that yield with certainty rather than being at the whim of what the Federal Reserve needs to do down the

Road. That’s been that’s not a case for a while. Again, it’s a difficult pill to swallow, but we’d rather lock in a three and a half to 4 percent yield for the next five to 10 years rather than risk being at, say, 2 percent or maybe even lower

At some point the next year or so when the Fed does need to cut. Colin Martin, Kelsey Barrow and vicious repertoire. Everyone is sticking with us. And up next, it’s the auction block as bank uncertainty settles down just a little bit.

Firms drive back to the bond market to sell debt before earnings season. This is real yield on Bloomberg. I’m Katie Greifeld, this is Bloomberg Real Yield. Time now for the auction block where we finally saw a ramp up in bond sales after they stalled amid the banking uncertainty.

Europe saw thirty three billion euros worth of issuance this week. The U.S. also had a rush of borrowers to end the quarter. But both regions still fell well short of projections for March. Looking at the quarter overall, that stall in mid-month put a damper on global corporate and financial sales,

Sending them both to the lowest levels since 2019. Meanwhile, the freeze in the U.S. junk bond market is showing signs of falling. With a packaging company marking the first deal since early March. Meanwhile, Amanda Lyneham of BlackRock says the sharks are circling in the credit market.

We’re already seeing some signs under the surface of levels of distress picking up in the credit market. So if you leave the default rate aside, which is fairly backward looking, but instead look at real time valuations, what we’re seeing is that the share of bonds in both the U.S.

And European high yield fixed income markets trading at distressed levels or above 1000 basis points has picked up to to levels that we haven’t seen in the U.S. since the summer of 2020. So the market is signaling that there is some concern.

Still with us, we have Colin Martin of Charles Schwab, Kelsey Barrow of J.P. Morgan and Bishop to repertory of Morgan Stanley and Kelsey. Sure. If you look under the surface, there are signs of stress in the corporate bond market.

But if you look at overall investment grade and blue chip spreads, I don’t see anything close to panic levels. ISE currently around 140. You look at high yield, it’s 470 basis points. Does that make sense? Well, it may make sense for the short

Term the Fed and the FDIC have taken bold steps to provide liquidity to the financial market, to the banking system, and that has allowed investors to be able to pause and take a breath. And actually, this is a great opportunity for us in our portfolios for what we call spring cleaning.

So essentially, we are stress testing all of our portfolios, all of our securities, all of our corporates, all of our securitized credit against adverse scenarios. And we’re cleansing the ones that don’t stand up to the test. And this relative period of strength is

Going to give us the opportunity to do that spring cleaning. It’s a useful exercise in really all areas of life. And when you’re, you know, dusting off the portfolio, when you’re taking out some of those less good looking credits, do they tend to fall in any specific sector? How are you evaluating these?

So we do think that there are a variety of areas that we’re focused on right now. We are focused on core high quality fixed income within the investment grade. The stress has been very concentrated in the regional banking sector. But there are a variety of high quality industrial and non cyclical names that

Have prepared their balance sheets appropriately for upcoming strengths, you know, outside of the investment grade market. Another bucket within our core high quality fixed income portfolio alongside treasuries and investment grade would be agency mortgage backed securities. So these are fully guaranteed by the government.

They tend to trade with a little bit more volatility when there is excess rate volatility. But at the same time, they give you an extra 70 to 100 to 150 basis points of yield pickup depending on where on the coupon stack. And that’s another area that we’re

Adding to the portfolios to build that high quality core portfolio to weather potential storms. And this should come on into the conversation. When you’re looking across the corporate credit market at this moment, where are you seeing opportunity and what areas are you avoiding? Actually, I quite agree with what Kelsey

Said. I love, you know, the combination. That means looking for a high quality, fixed income, high quality investment lead, perhaps away from some of the regional financials, regional banking sector, where there’s probably going to be more supply to come. I mean, we have our own expectation is that banks, particularly regional banks,

Will well would play defense in defense of the new form of orphans to these banks. And I mean, as part of that defense would be shored up more liquidity. No more. These you don’t have the wholesale funding markets. So perhaps more supply to come. We’ve seen that.

So there’s potentially in some of those boxes we’ll see more supply pressures. Maybe that’s the we will move. What we were suggesting is looking at away from them, you know, in high quality industrials or all investment grade market. I’m very much supportive of the agency,

UBS. We think the agency will be a monkey to one market where it’s significant, be additive to the attract to the whole. It all depends. And that’s something we have very constructive on. Well, guys, to this point on what we’re

Talking about when it comes to banks and regional banks, I mean, never let a good crisis go to waste. That is a true statement in journalism and in portfolio management. You do have some investors trying to sort through the rubble here. And we have a quote from Sam Wilson.

He is a portfolio manager at Voice. He said to Bloomberg News that if you are willing to buy into the fear, there is definitely an opportunity. There is still room for spreads to heal when it comes to some of this bank debt.

And Collin, when you’re evaluating the risk return of some of these bank bonds, what do you see as the reward greater than the risk? I don’t think so. Right now, though, I’ll head that a little bit. If we look at the financial markets specifically, we think most large financial institutions with investment

Grade ratings are in okay shape. And and the Fed facilities that are in place now should help shore up liquidity concerns. And when you get when you take all that into consideration, we’re generally OK with him. We tend to take kind of a big picture

Look at the corporate bond market. We allow our clients then decide what’s what’s in their best interest to invest. My comments are going to echo the other the other two guests don’t have too much in terms of an alternative view here. But but we’re really excited about investment grade corporate bonds right

Now. We were talking earlier before the break about extending duration and maybe some clients and investors pushing back on, moving further out in the curve or being disappointed with the drop in yields. If you look at investment grade rated corporate bonds, on average, you can get

5 percent or 5 percent or more. Almost all across the curve, we think that’s really attractive depending on. At risk and without taking too much credit risk. So we think if you if you’re an investor looking for higher year yields, they’re still here. All right, Colin, Kelsey, Vichy, everyone is sticking with us.

This is Bloomberg Real Yield. I’m Katie Greifeld. This is Bloomberg Real Yield. Time now for the final spread the week ahead. Coming up, St. Louis Fed President Jim Bullard sits down with Bloomberg’s Michael McKee on Monday and then Tuesday brings even more Fed speak. Plus, Credit Suisse’s annual general

Meeting post UBS takeover Thursday brings another round of U.S. jobless claims before the main event on Friday, of course. That’s the March jobs report. Before we get there, though, it’s time now for the Rapid Fire round three questions. Three quick answers. Fishy, I want to start with you.

Do 10 year Treasury yields touch 3 percent or 4 percent first? 3 percent. Kelsey, 3 percent. Colin. 3 percent this year does the Fed hike in May? Yes, Kelsey, no. Colin. Yes. All right, guys, final question this she does quantitative tightening last through the end of 2023. I’m clear, Kelsey. OK. Probably not.

Kelsey, your view now? Colin. No. All right. Let’s leave it there. My many thanks to Colin Martin of Charles Schwab. Kelsey Barrow of J.P. Morgan and vitiate to repertoire of Morgan Stanley. Great discussion, guys. Really appreciate it. And as we close out the final trading day of the week, the final trading day

Of the quarter, you look at where two year Treasury yields are right now, four point oh, 9 percent the high for this month. As you know, it was above 5 percent. And that feels a long time ago. You look at benchmark 10 year Treasury yields currently there at three fifty.

That number is like a magnet. But again, remember earlier this month, we were above 4 percent again, feels like a long time ago. We know that that banking crisis left a mark. Quick check on the S&P 500 right now, up nine tenths of a percent.

Stocks continue to rally from New York. That does it from us. We will see you in two weeks after a break. This was Bloomberg Real Yield and this is Bloomberg.

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