10-Yr to Hit 3% if Inflation Surprises, says Bory

I used the benchmark, George, where do I sweat? Where do we really click in with some bond damage? What yield? Thank you? Good morning Tom. Uh. Well, I think three on the ten yere yield is it's a it's somewhat of a magic number. Um. If you look back over time, there's some critical support levels where bonds you know, should be trading within certain ranges, and once you breach uh kind of call it three to three point oh five per cent on the US tenure, you start sort of

entering into what I would call the danger zone. You lose a lot of technical support. You know, those folks that look at historical trends and trade based on momentum will start to lose faith uh in the ability of bond prices to go up. So you know, the expectation

would be that yields go higher. And then I think also importantly as you point as you point out, you know that would be about a sixty basis point increase in yields, and so mark to market negative returns across investor portfolios become a lot more real, uh and they certainly become a lot more meaningful. And so those bond investors who open up their statements at the end of the month are going to be in for a little bit of a surprise. Well, that classic looks league, so

I father this year, doesn't it. And I just wonder what that means for investor rebalancing in a common months Gewards. So I think there's a there's a major shift going on. You know, for the last ten years, the FED and other central banks have told you to effectively sell your cash and buy something else. And now, you know, a few a few years ago, but with increasing intensity, you know, the FED is starting to raise rates. And what I like to say is it's it's the long march back

to cash. They're starting to encourage people to pull money back into cash. And as you know, it takes a while for markets to pick up on a particular trend or a particular theme, and then there's this sort of one instantaneous moment where everyone has the ah ha moment and and money starts to rush in a particular direction.

And I think after literally ten years of of moving away from cash, you know, there's a little bit of money starting to move back, you know, towards towards cash, and and I think that is a is a very very significant shift. What's the dynamic right now of clipping a coupon versus total return? So what you know, the way I think about coupons, they do a couple of things. If you're if you're a retired investor, or if you're

living on your capital, that's your income stream. If you're a if you're a long term investor though, or or an investor that has is not using that money today, you know, it's your ability to compound. Uh, it's your ability to reinvest at whatever rate happens to be available at that particular time. And so you know, bonds that have been issued over the last couple of years have very very thin coupons, so you don't have the opportunity to reinvest all that much. It's not zero. Some instances

at zero, like in Europe, it's very very low. Here in the U S it's a little bit higher. But those coupons become very powerful to a portfolio. And so when you look across different parts of the market right now, that high income generation or that high coupon can be a very powerful tool to help you offset some of those capital losses, the mark to market capital losses and earn back some of that lost money due to interest

rate volatility. A month ago with Tom and asked that question, what was the prospect for total return saying high yield in ten, most investors would have said, it's not that great. It's a year for coupon clipping. You're not going to get the capital returns out of high yield this year. Spread to just two tight already. We've had some widening over the last couple of weeks. Has that changed your view on the trajectory of high yield this year? It

has not. Uh, you know, are when we started the year, we were expecting or we still are expecting about a five to maybe as high as six. But let's call it a five percent total return for the year. Uh, and we still feel pretty good about that. We had a very good start to the year and then obviously we've given a fair bit of that back. But what's redeeming about high yield is that it sort of throws

off a higher coupon. So you know, it currently has a coupon like level of of about x to six and a quarter, which it's still early in the year, so you can sort of reinvest that money as you move through time. So a five percent type return is we still think is is still pretty realistic for this year.

The prospects for this asset class determined by what's gonna happen with CREWED still just on an index level, because at the back end of last week, CREWD really broke down w t I back south of a sixty dollars, and I think that's when we really started to see how your credits start to bleed, George. So I'm just wondering to those two things start to move in tandem again and whether they haven't in previous months. So UM high yield is an asset class does have relatively high

UM contribution from from energy related companies. So I think it's roughly about twelve percent of the high old market is somehow is basically energy links. So we do have a fair bit of sensitivity to oil prices um and and with oil prices coming down, that did put a little bit of pressure. But I think the important thing is keep in mind a lot of those companies that had meaningful problems, they sort of restructured a couple of

years ago. Today's sort of stock of companies, if you will, are in pretty good shape and uh AND should be able to weather the recent volatility and oil prices from the Lehman Low's I'm looking at the Bloomberg Barkley's uh US Total Aggregate Index. I'm gonna get it out on Twitter for all of Bloomberg Radio and maybe the worst since two thousand and eight is two thousand and twelve thirteen, where we went down four point six percent on the

index roughly seven point three percent and them. So that's roughly one third of a bear market. That's a pullback. And the way I look at that, George, is that's a year and a half for two years of coupon. I mean, that's really in terms of risk taken. Your risk is to give up two years of coupon and a pullback, right, you know, I think that's exactly right.

And I think as you talk, you know, sort of the aggregate bond market has you know, a relatively long duration, and and just simply thinking about duration is kind of that you know, that break even if you will, relative to um uh to sensitivity to changes in interest rates. So as prices go down, a small coupon, you know, requires a lot longer period of time to earn back that kind of that kind of loss. And and so one of the strategies we've been advocating is is actually

staying closer to higher coupon UH like entities. And and we just kind of remind people the economy is doing pretty well. Companies are actually earning a tremendous amount of money and that's going up, so their ability to pay is getting better and should enable those high coupon companies to continue paying you those coupons. I mean, I mean,

johnn I just think it's fabist. Doug cass uh sends in a nice messagers just saying, look good hot heels versus treasures and historically tight they are your folts on that, Joch Well, I mean, spreads are still you know, they're relatively tight um. But but as as yields go up in in an expanding economy or you know, we we will tend to see credit spreads actually tightened. Default rates are coming down at a very sharp rate. Uh, and we expect them to continue to come down over the

course of the year. So you can look back and say, historically credit spreads are tight, that's true. But when you have corporate profitability expanding by let's call it ten twelve percent paranum, you know, not a lot of companies are going to be defaulting in that kind of environment. George Bori final word on treasuries big CPI print on Wednesday, is this a market that's primed a whole lot better

for an inflation surprise? This weakening United States? I do not think we're primed for an inflation surprise if we break to the upside, if inflation comes out above consensus. So anything above one point seven percent, I think you get to three percent of the treasury and a hurry and probably a bit more. George boris quite a catch to get your thoughts on the fixed income universe from self rings all the way through the credit George Bori.

The Wilds Fani Securities, head of Credit Strategy. I would suggest this is the interview of the day. Mr Bernstein was an advisor for Vice President Biden. He is someone with a tilt to the Democrats or left that all conservatives read. Senior fellow the Center on Budget and Policy Priorities, and of course for years of the Economic Policy Institute. Jared honored to have you on after the beginning weekend

of literature. I want to cut to the chase, which is, how do you define and what does it mean if we have chronic one trillion dollar deficits. First of all, it's always the best way to start today talking to you too, so thank you. Uh well uh. I like to put these things in the context of g d P uh and we're looking at a deficit to GDP that's between four or five over the next couple of years. That's extremely unusual to have deficits of that magnitude with

an unemployment rate this low. In fact, we've almost never done it before. So it means we're stimulating an economy that's closing in on full employment. I totally agree with the point that was just made that the Ken indicator to watch will be inflation, but since we don't really know where we are relative to full employment, it's not necessarily uh an inflationary move. But it's a lot more

Kinzie than Kines himself would engage in. Andrew Vandam, among other sources in the Washington Post this weekend did Jared Bernstein treatment on charts ratios of deficit. What is the ratio besides deficit to GDP that Jared Bernstein is watching as we begin our analysis of two thousand twenty. Well, I think I'm I'm looking interestingly. It's called the unemployment rate, the ratio of the unemployed to the labor force, and I think that could get down to three and a

half percent by the end really year. That's a number we haven't seen since the nineteen sixties. The question is, will that unweash pressures and inflation and interest rates that will cause to move from tapping the brakes to hitting

them much harder. Let's go a little won because here, Jared Bernstein, some would suggest we may get stimulus, tax cut stimulus, budgets, silliness stimulus, two bouts of stimulus, and we get domestic stimulus, but we give it all back over at minus n x where the trade deficit expands, et cetera. Off dollar dynamics. Could we have a two part economy, a boom domestic America and the controrational component it's weak. I'm really glad you brought that up, because

I haven't heard it enough. But you guys look at so much data that you're always looking under under rocks that others miss. I've been writing about this myself. I see it differently, though. I do think that the magnitude of the trade deficit is going to be a drag on growth this year, and those who are looking at this stimulus, which by the way, it's not a chance of whether we're going to get it. We are going

to get it. We're gonna get more physical stimulus than we've probably ever had at an unemployment rate this low. That will help to offset the drag on GDP growth from the growing trade deficits. So I don't know that that's such a downside Jared. Typically it's emerging markets, the fear twin deficits. Why should the United States for America fear twin deficits. I don't think they should, for precisely

the reason I just said. I mean, if you have the h If you have the trade deficit as a drag on GDP road, which is definitional, then having the government step in and offset that, you know you you either have to offset your trade deficit with consumption investment or government spending. Again, a lot of this depends on whether we're closing it on full employment, because then the extra spending just shows up as inflation and higher interest rates.

But if there's still some room to run, and I think there's there is uh, then that offset is actually a useful one. So jared market participants won't fear twin deficits. They probably won't fear one trillion dollar budget deficit either. Five percent of GDP, well, they will be concerned about is the trajectory where we're going the destinations. Just several years ago, the UK had a budget deficit of five percent of GDP, but it was closing and that was

the important factor. This one's getting wider and wider. How much Why do you think that can get? Could we approach say almost ten percent of GDP before the next down term, which would be absolutely no, we can And that that's exactly the way to look at this. I I distinguished between the near term and the long term. In the near term, I hear a lot of people, UH, creating a lot of anxiety that I don't share. In

the long term, I'm right with them. And it's precisely for the reason you suggest, at some point after a few years, you have to start squaring your outlays with your receipts. That's not a sustainable pattern. And and there's no way, uh, And I should say there's no way. I would be very surprised if larger budget deficits are the ones we currently have a few years from now are not problematic, in no small part from the reason you suggested, we're going to lack fiscal space or at

least when we hit the next down front. I've never asked this question. Are Patrick Ley of Vermont in Richard Shelby of the South? Are they on the same page on this budget? Between them, they have seventy five years of senatorial experience. Are Lady and Shelby on the same

page on this booming budget deficit? I don't think that they've been I think that the politicians just haven't been able to resist the spending, and at least for Democrats, so I can speak to most authoritatively they'd actually have a have a good rationale. I mean, the share of the budget that we're devoting to domestic priorities is it an all time low. Let's come back Jared Burnstein with

a smart discussion on the deficit, whatever your politics. We like that of course with the Center on Budget and Policy Priorities. And you know they and many other think tanks are going to provide wisdom in the coming weeks. He is uh laurea from Yale on economics. And there are always too many things to talk about with Robert Schiller, so let us focus in on one of the things he's been focusing on, which is the simplicity and failure of the price earnings relationship. And maybe there's a better

way to do this, Professor Schiller. Wonderful to have you with us. How do you teach extrapolation at Yale University? The dangers of extrapolation? Uh, the suspect nature of the value of extrapolation. When you got a chalk piece in your hand and a chalkboard, what do you actually say to the cherubs at Yale? Well, I don't think extrapolation is mostly mechanical. It's not like people are charting the

data and drawing lines. It's more intuitive. People like to think about investments in satisfying way that sounds common sensical, And they just remember recent years and they don't study history, right, And if the last ten years has been up, then they kind of think that's the way the world works, and if it's been down, they think that the world is a dangerous place. And if Robert Fogel was so good at in Angus Madison of looking back and how we try to guess forward, are we any good at

guessing forward in the markets? Well? And you know, I always say that efficient markets is a half truth. To some extent. We do, especially individual stocks you know, that have promising story. The market gets that somewhat that maybe they overreact to the story. But it's you know, we do have I am pro market some sense. It's just

not perfect. Professor Schiller, I wonder if you could speak a little bit about the word itself, the word finance, and how it is misunderstood and misapplied to the idea of wanting to make money. Well, okay, I teach a finance course here at Yale and online. By the way, it's for free, of course, Sarah, But I emphasize that finance isn't really about making money in the sense that

many people think it's about. It's a technology for allocating resources, for incentivizing people to do something for other people according to someone that someone else's desires. Uh. And it's a it has powerful implications. Risk management is a powerful tool to improve human welfare. Having said that, I'm wondering if you could then apply that attitude towards the prices that are paid for stocks and why you describe some markets as so pricey that really the way we mentioned them

is not really accurate. Well, I don't you know, take my course, You don't. You don't need to, Oh, yes, I do. Uh. I think that Uh. Finance went through a phase. Uh. Theoretical finance went through a phase uh, which was you might say a turning point was Eugene Fama's Efficient Market series around seventy and then the Random Walk down Wall Street with Malkiel. Uh. It was a model that it was a little bit too self satisfied, uh, too mechanical. And now there's been a behavioral finance revolution,

which is still going on. Professor Schiller. Everybody's equity focused on the exuberance of Robert Schiller, when you see high yield bonds b double a industrials, to go back to my grandfather, other priced this narrow in tight to full faith and credit ten years. Does that Does that define for you a bond bubble, that bonds are priced to perfection? Is? Maybe, Sir John Templeton would mention it. Well, the bond market

has had a peculiar tendency to track lagged inflation. So there's a I think it's a sevent correlation between bond yields and the last ten years of inflation, but not much correlation with the next ten years inflation. So the bond market is is backward looking, just like the stock market is I I look, professor, showed all this. Just what were your comments? Quickly here and once again the certain thing, the short fixed trade, and then down we

go with sevent losses. How what was your response when you saw those charts eight days ago? Uh, it was not surprising to me that volatility would suddenly shoot up after a period of historic low volatility. Uh. This is Uh, it's kind of what happens in about the same thing happened in ninety nine, although volatility wasn't really low in the late nineteen twenties. It was not high uh and so uh and earnings were growing. I hate to bring nine. I love that story. So does everyone else. Took a

dramatic story. Everything looked fine, volatility was low, and then suddenly the market dropped. The one thing that was wrong was that people thought the market was overpriced. The same thing happened recently here just now, very good, Robert Shorey, thank you so much, greatly appreciate with Yale University. Just some perspective there from the academic end. And now, really, folks, what we love to do, which give you an important conversation across these markets for a judicious length of time.

Yakum fills with this. Pimco. Yakum, you're claimed for the synthesis of the three bees, the three cs. Are you under the three d s? I mean we're going through the alphabet here. How do you write an essay about what we've witnessed in the last ten days? Well, Tom, I think what we're seeing here is that markets have to come to grips with the very tricky transition from the world where monetary policy was the only game in town. Um lifted all asset prices in order to support the

real economy. And now we're transitioning from monetary policy to fiscal policy. And you know, ironically, this is what economists and central bankers had been calling for for a long time, that fiscal policy steps into support economy, so monetary policy can step back. But I think what we're learning is and what markets are learning that this is a very tricky transition. The reason is fiscal policy supports the economy directly.

It does not work through uh financial markets. It does not work through asset prices, and more fiscal stimulus can actually be bad for asset prices. The reason is that, well, we're seeing rising budget deficits, the treasury has to issue

more debt into the market. This could push up the term premium and bond yields, and it could lead to what I would call a reverse portfolio rebalancing effect where markets have to absorb the additional bond supply um and that means investors could move out of risk assets, and you know, this could backfire on the real economy. And I think this is what markets are currently trying to

come to grips with. These are the set of expected, unexpected and even true unexpected unexpected it could be out there. So much of this has a background of gurus and pundits yakham fells suggesting that we can do all this smoothly, and that the glide pass of adjustment from QUEI to QT or whatever the theory may be, or the theme may be, that we can all do this smoothly. I see no evidence of that in history. Where did we get this belief in splooth, smooth glide pass to a

new regime? Well, I think we've seen it working in Japan, um, So it is possible to do it smoothly. But what it requires is that the central bank, you know, has to get in bed with the government, so there has to be monetary and fiscal coordination. The Bank of Japan did this beautifully by just pegging the ten year BONDI it and inviting the government to do more fiscal expansion. Um. But this is not what we're doing in the US, at least not. But we can't make the comparison to Japan,

where they've got such an absolutely original savings culture, can we? Culturally? They're different? Right? Yeah, that's right. And you know they've gone through two decades to lost decades with deflation, so that's also what's different. So I think the transition from monetary to fiscal policy is inevitably more bumpy here in the US, and I think this is what we've been

seeing over the last two weeks. Is there anything that you would like to edit or change based on what's happened over the last week or so to your asset allocation outlook for No, not not really so. Um if if we look at the situation, we I mean, we've been gradually becoming more cautious in our in our investments. Um. We At the same time, you know, we do not see a recession around the corner. That so that hasn't changed. Yes, we've had a market correction ten percent or so, but

this is not enough to derail this economy. So we think at least over the next six or twelve month the recession risk is very low. Um Uh. What I would emphasize though, is that I think we are close to peak growth for the global economy. That doesn't mean a recession is around the corner, but you know, it will be difficult for the global economy to continue to grow at the same pace it has been growing in two thousand and seventeen and in the early part of

this year. The simple reason is that you know, we're running out of slack in the US labor market. China's credit impulse has turned negative, so the Chinese economy is decelerating. UM. And the euro appreciation and the yend appreciation that you know is the flip side of the coin of the week dollar will also take its tall on on growth. So peak growth UM, No recession around the corner, a more cautious stance in our st allocation, UM, but not

outright barrish. So more money devoted to commodities, yes, um. And the reason is that we think inflation will probably surprise on the upside over the cyclical horizon. We're now getting the fiscal boost in the US. We are seeing uh, seeing a week dollar, so that spells higher inflation UM. And we think commodities will also benefit from that. Does that include also things like master limited partnerships for those that are not satisfied with a two point eight or

two point nine percent ten your treasury. Yes, that's right, UM. So the energy sector, we are quite upbeat on the energy sector here in the US. You know, the pipeline's shale production is being rammed up given what's happened to the oil price, so that also should support MLPs in the energy sect. But your compim nails something there which is still we need to find enhanced yield. How do we find an enhanced yield? You know, I hate to use this word, but the word of the vogue and

of the moment. How do we find enhanced yield? And what is the risk in searching for that? Given regime change? And the answers is no free lunch, is there? Yeah, there's there's never a free lunch tom um. But how do you find enhanced yield? Well, first of all, it requires hard work. It requires a lot of you know, bottom up work to look at individual companies, to look at sectors um so a lot of bottom up analysis from a top down perspective, from a macro perspective, it

is difficult, you know, to find yield. You have to go global. We think there are still opportunities in emerging markets. We still like a basket of high yielding currencies um in emerging markets. So it is possible to find the enhanced field. But um, you know, you have to look very very hard. I just think it seems to be too good to be true. Yea. Can we have to leave it there? Ya can fails. Thank you so much, just never enough time. He is with PIMCO. Thanks for

listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at Tom Keane before the podcast. You can always catch us worldwide. I'm Bloomberg Radio