Bloomberg: ‘Bloomberg Real Yield’ (04/28/2023)

Katie Greifeld highlights the market-moving news you need to know. Featuring a round-table including Goldman Sachs’ Alexandra Wilson-Elizondo, Morgan Stanley’s Sri Sankaran and Creditsights’ Zach Griffiths.
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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 sticky inflation and slowing growth has stagflation in Focus I have what Traders say will be the fed’s final height while the riskiest corners of the credit Market continue to Rally we begin with the big issue all eyes on pal it’s not done I would be shocked if the

FED didn’t hike interest rates by 25 basis points Jay Powell cannot pivot to a dovish stance 100 May will see another high I had a spinning it’s a it’s a tough environment inflation data we got core PC suggests that it’s hotter than what the where the FED would like it

Core inflation is not really coming down inflation is still well above Target the data are going to have the FED hiking further economic momentum is going to be downshifting things are definitely appear to be slowing out there every traditional leading indicator of recessions is flashing red we’ve been

Talking about recession for ages and ages the full picture suggests that we will have pressure on the economy the underlying uncertainty is now structural joining us now we have Alexandra Wilson Elizondo of gold golden Grand of more G and Zach Griffiths of credit sites and Alexandra I want to start with you

Because we have high inflation slow and growth and of course still unresolved issues when it comes to the financial sector what does the FED do with all of this Katie we really think we’re in that bend not break stage of the cycle and what that means is we’re going to get some

Really conflicting data right now but the most important thing one of the data points that the FED is very focused on is on ECI and we got that point today and what that showed is on an annualized basis you’re seeing figures close to five percent that’s very far from the

Fed’s target of you know ultimately three and a half in terms of what they’re looking to see there and if you look at what’s happening next week we get a lot of data we get payrolls and we get an unemployment rate and the expectations there are for 180k and a

Three and a half percent unemployment rate these are frankly just figures that don’t align with ultimately getting to that two percent Target and we think that the economy is slowing but it’s just not slowing enough and so they’re going to be very focused on inflation still so Shri of course the FED zero

Focused on inflation that continues to be an issue and at the same time it’s become clear in the last week that there’s still issues to be resolved when it comes to the financial sector of course we’re talking about First Republic still looking for that rescue plan when you think about the state of

What we’re seeing in the banking sector and you weigh that against what’s going on in the economy how do you think the FED is factoring all that into their monetary policy plans I think over time the the damage caused by the the pullback or the potential pullback from the the banks or the

Changes in the regulatory framework Etc will become clear right but I mean for the fed’s decision it’s the the data that’s here and now that really will matter and I do agree with the the previous speaker right now it’s almost as if it is the inflation part of the

Mandate that they are likely to prioritize the hope would be that to some extent the titling of lending conditions which is coming through from the banking side gives them some more kind of rationale for holding on to a pause but they’re probably going to parse that pause as a as a dual-sided

Boss I.E a hawkish boss in the sense that they don’t want to buy the optionality of potentially hiking later on rather than allowing the market to interpret this pause as a Prelude to a pivot or rate cutting just yet and Zach let’s talk about some of the economic

Data because again it seems that pce and the employment cost index again really driving home the narrative that inflation is still very sticky here of course we’ve got GG EP earlier this week growth is slowing you still have the labor market hanging in there but a lot

Of people are adding that all together and they’re talking about stagflation has that entered the conversations that you’re having now yeah Katie stagflation has been a part of our conversations for a while now and something that we outlined as a possibility coming into 2023 we think it’s the least likely outcome at least

From the fed’s preference standpoint and that’s why we think they will go 25 basis points next week they’ve shown a clear preference toward hiking too much now as opposed to not hiking enough and finding out in 12 months they didn’t do enough and having a stagflation-like scenario and that’s important for the

Credit markets we see a true stagflation scenario as the worst possible outcome both for investment grade and high yield we currently assign the lowest probability outcome to that situation and that really comes from the FED being very serious about fighting inflation now and addressing perhaps some tightening of financial conditions from

The banks in the future well Zach we heard a similar point from SEMA Shaw of principal asset let’s take a listen stagflation by far that is the worst case scenario you know one of the things that has been the underpinning markets to this point is this idea that at some

Point in the next six months eight months is that the FED is going to start cutting rates there is a lot of assumption out there that inflation is going to keep coming down inflation if it were to reignite and start moving up that takes away everything which is underpinning the market today

And sure I mean worst case scenario or not how do you invest what’s the stagflation Playbook so to speak I mean the circulation the risk of stagflation obviously is cannot be ignored but I think the positioning wise it is very much where consensus already lies which is more of an up in quality

Bias holding on to the the pockets of the credit Market where you can whether a meaningful slowdown with respect to the earnings attitude or the growth narrative and companies which are unlikely to lose access to markets even if rates are held higher for longer I think the pocket that really becomes or

Comes to the the four in terms of risk is where you have the layering of over leveraged ballot sheets and also rate sensitive balance sheets and for them the higher for longer scenario that is so typically associated with a stagflationary setup that is going to eventually start mattering a lot more

When the maturity walls are coming up by the end of this year or early next year and the greater risk there is for those balance sheets for those companies is it basically that leverage that you spoke of or that interest rate risk still yeah I mean ultimately it’s a

Combination of the two right eventually in a typical hiking cycle the earning side of that equation eventually helps kind of limit the damage from higher interest rates that’s both true on the coverage side that’s also true on The Leverage side I think here you’re going to have this layering of risk that

Eventually matters but if you were to put me on the spot and talk about which of the risk matters more I would actually argue that it’s the the coverage side of that equation I.E the ability of companies to pay double digit yields even if it were a relatively okay

Balance sheet that is going to be quickly challenged I mean they can’t pay it for a short period of time potentially refinance with very short non-call structures and so on but these are temporary or stop Gap Arrangements a persistent double digit yield environment is going to be bad

Regardless of the quality of the balance sheet well Alexandra of course as we discuss all these risks we should note that it’s the final trading day of April and if you look at what the treasury markets done in April it’s not a lot you’re looking at 10-year yields right

Now they’re just two basis points lower on the month that is the smallest Range in quite a while at least a few years what breaks us out of this range we think it’s very difficult to break out of the range in fact the the concept of non-linearity as you think about the

Long and variable lags with fed policy ultimately Keeps Us range bound and if we do get to the point where you get a breakout in yields we do think that there will be a bid to the market because people are really interested in adding that traditional ballast back

Into portfolios in particular as you’re coming into the summer months and you could see some of the you know negative news cycle as it relates to the debt ceiling really start to pick up well let’s talk a little bit about the debt ceiling because whenever I bring it

Up people tell me you don’t have to worry about it until it starts to show up in markets and if we look at the t-bill market right now you see a big discount priced into three month T Bills versus one month T bills Alexandra when you think about that when you think

About what’s being priced in is it time to start caring so there’s actually a meaningful bifurcation between the equity market and the bond market which we’ve seen on multiple different layers throughout this year but as to your point we’ve seen you know 150 basis point inversion between four-week bills

Um and three months reflecting some of those stress concerns as it relates to the debt ceiling um and you’ve seen Sovereign spreads really start to wind out but you know credit has been relatively resilient and the equity Market is more focused on some of this localized earnings data

Which has proven to be actually much better than expected um so ultimately you know the tail could be quite large if you saw something akin to 2011 but in that instance you’re also dealing with the European sovereign debt crisis and so we just we think that you

Could see risk off credit spreads wide in equities down but not to the same extent will that come in on that because to Alexandra’s point of course you’re starting to see dislocations when it comes to the treasury bill Market but when you look cross asset it’s really

Hard to find those types of concerns do you see any meaningful spillover in the months ahead we think spillover is a very distinct possibility as negotiations have really been non-existent up until very recently and when looking at the Tebow curve I’d even focus on just four weeks to eight

Weeks so the one month to two months and you can see that there’s an intense focus on that early June period And if you look at income tax receipts that have come out over the past week they’ve been a little bit weaker than expected we do think that brings early June into

Play and so when we think about how that spills over into markets broadly we think that takes place over the next month or so maybe we need to get through earnings first you’re starting to see a little bit of upward pressure on credit spreads and we think that could

Intensify if it looks like we are looking at more of a 2011-esque scenario although we went back and looked at past that selling episodes The Market has gotten a little bit more resolved and pays a little bit less attention each year to the debt ceiling in terms of

Market reactions so we think that the the move could be widening in spreads and down in equities but perhaps not to that same magnitude to Alexandra’s point yeah sure is that your expectation as well that ultimately we could see these debt ceiling discussions actually impact the credit Market

Yeah I think that’s the fair formulation of the previous two speakers right but the the one point that I would add there is that the transmission is not just through the market side I mean it’s not really about Gamma the US government default thing on its uh debt but it’s

Actually the delays in payment of other obligations be it like fed salary be it federal employee salaries or social securities Etc which also adds to this concern that you may have more of this slower growth impetus coming out of the the debt ceiling side of that equation

As well guys great discussion so far we’re going to dig much more into the credit Market next Alexandra Wilson Elizondo SRI sankarin and Zach Griffiths everyone is sticking with us and up next it’s The Auction Block Six Flags makes its return to the junk bond market as junk bonds broadly outperform investment

Grade that’s next this is real yield on Bloomberg thank you I’m Katie greisel this is Bloomberg real yield time now for the auction block as we wrap up the week the month and the rather just the month for issuance we start in Europe where the UK received a

Record level of demand for its inflation link notes as investors seek some shelter from persistent prices and over here in the U.S April volume for high grade sales Miss estimates by a wide margin expectations were for a hundred billion dollars instead we’re landing near 65 million dollars and in U.S high

Yield this week’s Six Flags sold 800 million dollars and a slight discount total yearly Supply now stands over 56 billion dollars with a 4.4 percent year-over-year gain meanwhile Amanda lynam of BlackRock says that despite growth concerns there are some bright spots even a period of just below Trend growth

And a higher cost of capital environment should warrant a rebuild of risk premium in corporate credit ironically as as least I’m sure you well know high yield is actually outperformed IG so far year to date so for all of the concern about downside risks to growth we actually

Haven’t seen that manifest in the lower quality parts of the market still with us we have Alexandra Wilson Elizondo SRI sankaran and Zach Griffiths and Alexandra it’s really striking when it comes to high yield this is one of the least loved rallies that I can remember is that warranted should it be

In terms of you know when you’re looking from a multi-acid framework and you’re thinking about getting Equity like returns without taking on the equity risk high yield credit actually doesn’t look so bad I mean you’re talking about loans at nine and a half percent yield traditional high-yield at nine default

Rates are somewhat low and if you have the view that default rates will be low and maybe the default site is somewhat longer in terms of this cycle then it does represent some opportunity to really have some carry in the portfolio while we’re you know navigating this cycle ultimately maybe going over your

End let’s talk about that a little bit more Equity like returns are you talking about high yield credit broadly or specific type of structures um well this is more just talking about the owl and yield of the market but if you’re looking at some places even like private credit you’re you’re talking

About you know mid-teens low teams type returns uh you know these are you know in the recent history these are like once in a lifetime opportunities to get into some of these deals so we think that there’s a lot of opportunity but the index level on top is tight

Um it’s hiding some of the sins that are under the hood and we have seen some bigger you know cap structures and names default recently But ultimately it this could carry on for some time and to your point yes it’s it’s unloved but um you know it’s been sort of consensus to fade

You know the negative convexity of high yield but it’s really it’s going to take some time here and Zach I’m curious at what point fomo starts to kick in because we talk about the concept of the fear of missing out all the time when it comes to equity

Markets but just watching junk continue to rally and when I say junk it’s also the riskiest types of junks I’m talking Triple C really lead this rally at what point do investors who had maybe been been going up the quality curve say all right I can’t ignore this anymore

I think that’s a great Point Katie and it kind of gets back to what we saw at the start of the year a really big rally across credit really across the different ratings levels and so when we think about going forward when does it

Get to be that point if we have a little bit more clarity on the monetary policy front let’s say we hear from the FED next week they go 25 and they’re on pause we still have economic growth remaining positive we have many companies that have been able to term

Out debt over the past couple of years we don’t have a maturity wall concern over the next couple of years still and so we think that that kind of backdrop where some of this macro volatility that we’ve had over the past month or so with the regional Bank situation if that

Starts to come off we think it creates a situation where you can see spreads tighten even further back toward our year-end Target of 400 basis points on high yields so we do think there could be more of that fear of missing out aspect but we’re going to need to see

What the FED does next week what the ECB does and get a little bit more clarity on the monetary policy front first so case can be made there but to your point it comes with a ton of nuances shree it’s notable that despite that this rally that we’ve seen both in investment

Grade and in high yield financials have definitely lagged is that for good reason or do you see some opportunity when it comes to the banks I think the lag there that you talk about is probably more confined to the the smaller Regional backspace when we look at the financials and depending on

Whether you include reads into the the financials overall cohort or not but I think the Nuance there is that for the banking system overall it’s not just around kind of the the In-Place fundamentals or concerns around some of the the risks which have emanated in March it’s also that investors are

Already kind of positioned I would say that that’s been one of the consensus overweights within the investor portfolios particularly on the investment grade side globally and that’s also a sector where we do see a clear path for Supply continuing to remain high as Regional Banks shift out of deposit funding into potentially

Tapping into wholesale markets so it’s this combination of existing positioning and the fact that there is a reason to think about continued Supply that’s what’s driving some of this underperformance within financials and true I want to get your thoughts on this idea that a credit crunch could be

Looming for the economy there is no doubt from UBS earlier this week and they noted that if you look at bank commercial and Industrial loan growth it looks on track to drop about five percent in the last three months of the year and then about 10 percent in the

First first quarter of 2024. those are near levels that are typically associated with a recession and when you think about the possibility that credit could become less available how big of a risk is that in your eyes I think we definitely have to solve for Bank lending being more expensive and

Potentially two shorter Tenors so the term structure of funding and the cost of funding associated with banks is probably going to be different but part of the reason why we’re not seeing that escalate into something of a bigger concern looking at the the market so the high yield Market specifically is that

Companies still have some time to put into place refinancing plans I think if you look at the overall refinancing needs it’s pretty much negligible through the remainder of the year it starts to build more gradually in 2024 but that’s still around six to seven percent of the outstanding debt that

Matures next year it’s only in 2025 that you see that real pick up and if you’re looking at this set of financial conditions both in the context of Banks and in the context of market cost of funding being this High by the time you get to the end of this year or early

Next year that’s when I think the credit Market starts to really worry about access to financing and what that means for the lower Quality Companies and Alexandra we only have about a minute left but talk about what this moment means for active managers with all these dislocations that are popping up in

Corners of the market yeah we really like active management right now in fact when you take a look at what’s happening from the earnings perspective you’ve seen 60 of the S P 500 ish you know come out with their earnings and 70 of them have beat expectations but there’s so much Nuance

Under the hood and we think that the ability for active managers to really come in and provide liquidity when we see large air pockets um you know when when that starts to happen when you start to get to the late stages of the cycle we want them to be

Able to you know put dry powder to work so we think this is going to be a really great market for active managers Alexandra Wilson Elizondo SRI sankarin and Zach Griffiths everyone is sticking with us and still ahead it’s the final spread the week ahead all eyes on the

FED ahead of its rate decision plus it’s jobs day in America that’s next this is real yield on Bloomberg foreign this is Bloomberg real yield time now for the final spread the week ahead coming up Euro area CPI out on Tuesday along with earnings from Uber Ford and

VP Wednesday it’s the main event we’re talking about the feds rate decision and then Thursday brings more earnings in the form of apple and Peloton plus we have the ecd’s rate decision and another round of jobless claims then we’ll round out the week on Friday with another big

Data point we’re talking about the U.S April jobs report but first it’s time now for the rapid fire round three questions three quick answers shree I want to start with you does the FED cut rates this year oh Zach oh Alexandra now Shri does investment grade or junk outperform in 2023

Investment grade Zach I yield Alexandra IG all right guys it’s the final question Shri does the twos tens yield curve uninvert this year no Zach no Alexandra no all right guys great discussion really appreciate it on this Friday my big thanks to Alexandra Wilson Elizondo SRI sankaran and Zach Griffiths and of

Course we’re counting down to the feds May rate decision many saying that this will be the last hike from the FED let’s take a quick look at the bond market you’re looking at the 10-year treasury yield sitting at 344 a two-year yield at just above four percent we’re gonna see

How that changes in the week ahead and what it means for that dynamic between the front end and the long end of course that’s been in Focus all year that yield curve deeply inverted but for us that does it for now same time same place next week this was Bloomberg real yield

And this is Bloomberg thank you foreign

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