Surveillance: We Must Take The Yield Curve Seriously, Fels Says

Did you make it? I did not make it over, but we watched every moment. Did you did you enjoy every moment? Say? Mr Sun came down and put the ball on that and it was very exciting. You want be coming back, will you know? I was here with our editor in chief John Michael Thwaite, and he made clear that you know the idea of going from Liverpool and down to see the Todds play, it's a good thing.

You could just do a football tool for the reason while there's Brexit and it's sort of it's a numbing day, John, that quiet day, but everybody's done. Roger Boodle was wonderful of brexiteer A leave guy writing for the Telegraph once a week of capital economics, and Roger was really ferocious about the crisis. This is so, where are we now and what is the next spring till I think the mystery is the support that Mr Corbin will have. I

think there was pleasantries yesterday. Uh, clearly the Tories the Conservatives are very upset. But the next step is really to see what actually happens in discussions today. It looks like Parliament moving towards blocking a no deal Brexit. I imagine everybody else would come along with that, and then it's the one next. One of the solutions will be to have James Diamond come over and solve Brexit. Do

you want Jamie Dimond to self Brexit? It was page twenty eight of his I think he's busy over at JP Morgan for the next five years. He's busy over

at PEN Morgan. And of course, folks, Mr Diamond out where I'm going to guess twenty three pages of detail on the financial performance of JP Morgan, but also, as usual James Diamond on the American experiment political and economic experiment, and also on the view forward we have with us this morning, Yacum Fells of PIMCO just thrilled to have him for this extended time in our London studios today. And Yakom, I want to go to one clear financial

headline punditry headline from Mr. Diamond. Yield curve in version not giving same signal as in past. You've addressed this. What do we do with yield curves UH day in and day out of this pending recession? Well, Tom, I think we have to take the yield curve very seriously. Right, there were a lot of voices around UH in the last time the yield curve inverted in the previous cycle that things were different than it was foreign buying that

was depressing the long end. That's certainly true. But the issue is if the yield curve stay is inverted for longer, and you know, to be a reliable recession signal, that has to stay inverted for at least three months. But if that happens, then it becomes less and less attractive for banks to lend. Right, they borrow short, they lend long. So that's the reason why the yield curve not only

predicts recessions but also causes recessions. One of the hallmarks of yaka Field's work is the acts as the timeline of all these things we speak about every day. And as you mentioned, the idea of a chronic inverted yield curve, the overlap now versus two thousand sixteen or other periods is we've also had chronic negative interest rates. How chronic are chronic negative interest rates? Well, they seem to be chronic.

You know. We've got a huge part of the global bond universe trading at negative yields, and there are really two factors behind that. One is a fundamental factor, which is the global saving blot, and the demand for safe assets, which is partly caused by demographics, partly caused by the fact that more and more of the savers in this world sit in emerging market countries where people have rising

incomes and they're looking for a safe asset. The other explanation for the negative interest is obviously what central banks are doing. So if you put the two things together, I think we better get used to an environment where we were looking at negative yields for a long time. Com Fels it's important we bring in John Ferroll because he's in tight preparation for the real yield Yakum you can see it Fridays. I'm Bloomberg is aware of what on what time it is, and privileged to speak to him.

Let's talk about the distortions work him in fixed income globally right now, euro investment grade yields I think are about zero point eight percent at the moment. I think sixtent of the euro credit universe right now carries a negative yield. Yes, that's corporate debt with a negative yield. What does pimcotew clients about where you should tilt your portfolio in that environment? Well, look, in this environment is really really difficult to a find yield at a reasonable price.

I think that's that's what we're trying to do for our clients. So we think the US fixed income universe is still attractive. The problem is for European and also for Japanese investors, the currency hedging costs are excessive um and this is because the short rate differential is so wide. So if you want as a European investor, if you invest in US fixed income and you want to hedge your currency exposure, then you're actually getting a very you know,

after hedging, you're still getting a very low yield. So there's almost no escape from the low yields, and our focus is really on the safer parts of the credit spectrum. We do worry about the fact that leverage in large parts of the corporate universe, including investment grade, has gone up so much and the quality of the investment grade universe has deteriorated. So that's why we actually recommend to be underweight corporate credit in this environment. So just on

the wholly, coming increasingly defensive, Yes, that's true. We've been going increasingly defensive. We are looking for other areas to pick up yields, so we're not sitting on hordes of cash. We think that, for example, agency and non agency mbs are attractive. We think there are some opportunities in emerging markets where the outlook has improved. We're just cautious on the on on corporate credit per se, which is a very crowded trait and where liquidity can ease up, where

a couidity can tighten, excuse me, can tighten very strongly. Um, if you get a sell off, John, can I rip up the script? Of course you can. This is really important. I'm gonna make a joke, but it's deadly serious. Yet last night johnnah Tottenham Stadium, the Todd Stadium, it's a cashless stadium. I mean they've overtly said we're a cash

less stadium. And Yakham Fell's this goes to Ken Rogo's magnificent book The Curse of Cash in the experiment in Sweden led by Sweden, I should say, of essentially cashless society, is that where we're heading? Are we all going to be like they are at the Tottenham Stadium. Well, I don't think cash will go away, Tom. Yes, Sweden has made big strides in that direction. But I think if you were to get in a situation where you know, interest rates would go even more negative, people would want

to go back into cash. So rates are probably not negative enough yet to induce people to use more cash or to hold more cash. But I think that's the situation we would get back get get back into. It's an interesting experiment. Thank you so much, Jack and Fells with us with him, Cooin, just thank you so much for being with us today. I was wonderful John Farrell to see Roger Brute, Jakom Fells and sat in the key of this Brexit debate. Let's bring in Derek Halpenny.

Shall we m U s G European head of Global Markets Research, Derek, let's talk about how price is responding to information. The euro is barely moving on week data coming out of the euro Zone. What's the signal you take from that? Well, I think definitely one of the signals is that technicals can be important, and that's one twelve level has been pretty important and has been indicated

in the past as as showing good support. What's behind us It's difficult to kind of pinpoint, although I have just written a piece covering the i m F FX reserved data through to the end of last year, and what that shows you, once again for the third consecutive quarter, is that center banks appetite for euro is very, very significant. And there's only been one period of time going back covering the i m F data to when appetite for buying the euro has been this strong. Well, what's the why,

what's the lot of support? Is? Is Santra banks and sorry, why why why is this there? Well? Well, you know his historically they've tended to purchase euros when they see long term value. So whenever you see these periods of heavy buying, it has tended to coincide with a period that has been where you've seen a fairly notable drop. Unusually, Santra banks have been very good at picking bottoms because what has transpired after these periods of strong buying is

nearly always a period of euro appreciation. So Darry, let's talk about that. Because we had two guests on the program yesterday who were looking to break out of this training range on euro dollar very tight, very narrow after over the last few months. But they expect to break out of that training range to the downside. Why do you think we can break out bit to the outside Well, you know, well, first of all, I should mention I mentioned as the time earlier, I have cut my euro forecasts.

We were expecting when we were forecasting one twenty for the end of this year, and I've had to acknowledge that the macro situation in Europe has been far weaker than I had anticipated, so I've cut I've cut our year end target to one sixteen. So I'm still expecting the euro to move a bit higher, but nothing like what I was anticipating before. And that is down to simply having to acknowledge that the macro situation is is

is a lot weaker. But you know, I think we're in a situation now where when we talk about relative cyclical support, not just cyclical supports. From a cyclical support perspective, the dollar isn't a worse position than it was last year,

because clearly we're seeing slower macroeconomic data. But when you say relative macro cyclical support, well, you know, nothing really has changed, because obviously the slowdown that we're getting is not just the United States, it's global, and it's I think in part related to Chin that now we're beginning to see some tensative evidence of at least demand stabilizing

in China. And if we get this trade deal, if we move towards a softer Brexit, which I think is clearly the direction of travel, there's a couple of big picture assumptions that fit with some modest recovery and euro from from current levels. So, Derek, if the upside on euro dollar is somewhat limited because of what is happening in the United States, just in terms of the relative change for the US economy, where do I get upside

in European markets right now? We talked a little bit earlier on the program about where investment grade euro credit was trading. It's actually pretty tight about any basis points on on eurodebt right now, that's the yield. I'm just wondering where I get my upside of. It's not through credit, if it's limited through the Euro, if it's not through equities,

because we've already had a decent run. Where is it? Derek, Well, again, I'm not, I'm not an equities analyst or expert, but you know, I at track relative valuation and all I would say is that you know the period of out performance of US equity is relative to Europe. And further, afield tells me that the asset pricing is is priced for a kind of a doom gloom scenario across the world outside of the US. And I'm not, I'm not

convinced i'd be that pessimistic. Now again, I go back to the data has been more disappointed than than than I anticipated. But if if China and we've had a lot of stimulus coming through, and if that starts to roll out in the economic data, I think the pessimism that's there at the moment should should receive somewhat I can't afford the next time Arsenal plays at the Tottenham's new stadium, the new Stadium. But dear company, um, you know I need to make a train in em where

I actually makes some money. Is Brazil the mother of all opportunities right now? Well, again, there's there's doubts there in terms of the elocy to get reformed through. Before Baltion Arrow came to power, there was optimism that he would be able to implement pension reform and and there's some question marks over whether or not that can be achieved.

So again, you look at where dollar Brazil is traded and if you have a correct view in terms of political progress, well down, Yeah, there's a there's a good trade there potentially, but it's still high risk. I mean, John, do you remember the romantic days where you'd like you actually trade for in exchange to buy the ferrari? Good times? Tim, I mean, it's just someone somewhere still doing that. Well I don't know, are they? And there's a lot of

money can be made trade in the range, Derek. I mean the range has been narrow, tight and sending predictable over the last six months, hasn't it. Yes, And again if you look at if you look at volatility. We still have relatively high vault in in the pound. So if you track volatility for for euro pounds any of the other major currencies, pounds stands out. But I don't know. I'm beginning to come to the idea that I don't think we're going to get this kind of knee jerk

jump in the pound. I just don't see a moment arriving where suddenly people go, ah, Brexit uncertainty, It's gone, let's buy the pound. We're just not going to get into that situation. So that the level, the elevated level of volatility, which I can understand at the moment, if we don't get that kind of big move, then you know, you could see evolves come back and move back towards the other major currencies. Derek, how do you fold the

dollar analysis into an equity bull market? I mean, are they two separate worlds or could you actually take a dollar analysis and look at October in December of last year and this mother of all recoveries we've had. One of the reasons why I have a parish view for the U s dollar is I you know, generally I think US assets are expensive and the dollar is strong

and going forward. If, as I mentioned earlier, we see some relative change in the extremes about outlooks for for US versus the rest of the world, I think that could readjust. But if you look at the monthly Treasury capital flow data into the US, it's not particularly positive and there's clearly evidence there foreign investors reluctance to go into the US. Again, an email from a US viewer and listener who's Derek like me? Clueless culturally, how is

Arsenal different from Pattenham in London? Um? Well, the kind of the motto is victory through harmony. That's the Arsenal long term motto and I think that shows you know, we play attractive football. That's our in our genes and it's it's it's not to and one more sensible. Our our stadium cost three hundred and seventy million pounds, spurs cost a billion. There you go, careful analysis from from from from Derek Harputny. Thank you so much. I like that.

What was that victory in the harmony? The North North London rivalry? You know there's a day called St. Totter Ringham's Day and it's the day when Arsenal fans celebrate the the idea, the fact that Spurs can't catch them in the league anymore, because typically in recent history at least Arsenal used to finish above Spurs. But Spurs have a better side now, So those two sides to sort of fighting for a for a different trophy at the end of the season. That's amazing how they have the same,

nearlyly the same slogan as Bloomberg Surveillance. Our slogan, Folks is surviving through harmony. I'm surviving until eight thirty five Eastern when I leave this radio studio and go over to day begins right, quieter tape today. We'll see where we go tomorrow with jobs reports. Stay with us tomorrow for all of our coverage of the American labor economy. We're really beginning to focus on this given all the news slow as well. John farre will be in New York and I will be north of Milan, Italy at

the meetings in Chernobio. Really looking forward to attend. I've literally spent Folks a decade finding excuses to not go in this year. Franci Laquise dragged me north of Milan. I need a preview, right now, so we do go to Milan and Christina Hooper of INDUSCO joining us from Northern Italy as well. Christina, what is your observation of the Italian economy parachuting into Milan? What do you see

there as an economist? Well, certainly there is a slowdown underway, and we just saw forecast cut to just zero point one. But there's also good news coming from Italy, and that is that there is no longer talk about an ITHEL exit. Um. There is much more consensus around staying within the European Union. So that excludes one very big geopolitical risk and UH, and it's more now about growing the Italian economy going forward. As a market strategist, you've got a dovetail in all

of this economics. Is there a Christina Hooper optimism about participating in markets given some of these real economic growth challenges? Well, there's certainly caution there, and caution just suggests selectivity and discernment. But there are opportunities, certainly valuation opportunities that are presented.

I also think it's important to point out that typically, UH, the Eurozone's fortunes are correlated with a lag to China's fortunes, and one could argue that a lot of the disappointing data we've seen recently, certainly um, the German data that just came out today, can be at least partially attributed to the slowdown in China. Now that we're seeing economic data pick up in China could ultimately funnel through to

the Eurozone. And as usual, its super totally nails the debate right now, folks, which is truly a debate of gloom versus your way wrong. We're out front of an economic recovery. Certainly. We saw that from James Diamond today Christina Hooper over at a large bank in New York. Mr Diamond with his annual note JP Morgan, he really pushed against the recession, Uh certitude that's out there? Help Mr Diamond with that? Why can we be more optimistic than a pending recession? Well, I think what he was

was just very realistic. Um. You know, he was talking about certainly some challenges set on certainty German economic slowdown, Brexit, US China trade war, but there are opportunities in all those and quite frankly, Um, what we've seen from the

set is not so much uncertainty. I would say, as just an about phase, and that's creating a much more accommodative environment, particularly since other central banks are coming along, including the Bank of Canada and the e c B. So this should create an environment that's much more supportive of risk assets going forward, and of course supportive of the economy as well. Why are equities going up? I mean, we do this macrobabble every day, but the fact is

there's revenue dynamics, operating income dynamics. I guess there's an earnings gloom out there, but I'm not going to get elevated equities with earnings gloom. Is that the great miscall that we're actually going to generate profits? Well, certainly we're going to see something of an earning slowdown, but I think it's really very premature and completely um hyperbole to

say we're going into an earnings recession. Um, there are challenges, but there are also profits still being created and so um with you know, with a different rerating, right, We've experienced reratings with yields going off that have caused us to scrutinize valuations, but the current rerating, which is lower rates, has actually made equities look more attractive she's just joining us Christina Hooper with Investco. She joins us in Milan, Italy.

Uh this day, what are correlations in the market right now? I love to go equities, bonds, currencies, commodities, and they bounce around. How tightly are they coordinated now? Correlated? Well, it really depends on the day, UM, But certainly over the last few weeks what we've seen is really an interesting dichotomy in that equities went up UM, but also there was a flight to two treasuries government bonds and so yields came down UM. And I think that really

suggests a lot of the confusion in markets right now. UM. There are reasons to be optimistic to me about risk assets, and we see that UM evidenced in the stock market. But then there's an underlying fear, especially about a potential global slow news and that's what we're seeing in Yale. This has been wonderful, Christina Hooper. Maybe I'll see in the airport here in the next twelve hours Christina Hooper. Of course, within Vasco, we hope to see her in hold as Tom Keane jets off to the Alps. I'm

joined in our New York studio by Michael McKee. Michael, of course, covers all things economics for Bloomberg Television and Radio, and Michael, it's interesting. Asset manager giant black Rock recently published a report detailing the physical risk associated with climate change on municipal bonds, commercial real estate, and US utilities. To help us walk us through that story, we welcome Brian de se Bright as black Global Head of Sustainable Investing.

He's also a former Obama Senior advisor on climate and energy policy. He joins us on our Bloomberg Interactive Broker studio. Brian, Welcome to Bloomberg. What are the key findings of this report that you guys recently published. Well, there's a couple of them. The first is that investors are under appreciating the physical risks in these three asset classes that are in the market today and we believe are not appropriately priced.

So if we look at US utilities, for example, you see a pervasive impact um in the wake of these extreme weather events. That signals that investors are not fully understanding or fully appreciating these risks, and so that that that's that's point one. The second point is that it matters there's differences across these different, uh, these different asset classes. So with respect to municipalities, we want to look a lot at what's the local GDP impact in the municipality

that affects their resilience to these types of risks. In commercial real estate, we want to look at the actual impact of inundation and wind share of extreme weather events on individual properties and that those those very a lot depending property by properties. So the second, the second implication is investors need to really drill down to the individual asset class level to really understand these risks in a

more granular way. The two questions two part question here, One is, uh, is there something worse now about individual weather events winds or forest fires or something like that, because we've always had those and they have to be priced.

But the other is I read that interesting story yet just last night about real estate in Miami and the people who buy the condos on the beaches that are going to be underwater, but they say they're gonna be underwater in thirty or fifty years now by and hold investing. It's one thing, but fifty years, Um, do I really need to be concerned right now? Yeah? Absolutely? So the first thing is what has changed? Uh? The the issue really is the frequency and the severity of these events.

So we've always had extreme weather events, but what we've seen over the past several years is ah increase in both of the frequency of for example, Atlantic based hurricanes and the severity. Importantly that the share of hurricanes that are Category five, category four or five. We see the same with extreme rainfall events um and we've seen some recent instances of that, including in the in the Midwest.

So from an investment standpoint, the challenges if you're using backward looking models that look back and say, what's the probability of this type of event happening over the last hundred years, you're missing this the recent increase in the in the frequency and severity of these events. The second point is really important one, which is what's the time

frame of these impacts? And part of the what we found in this research is that, for example, while something like sea level rise is slow moving and really manifests itself over the next thirty to fifty years, if you own that commercial property on uh in South Florida, for example, the biggest risk in the over the next five to fifteen years is not c level rise, It is the inundation in the flooding that comes from one of these

extreme weather events. So when a hurricane hits, the flooding that can occur um or the wind shear that could occur is a larger and more immediate risk to your investment than the longer tailed risks associated for example, with CELW rice. So, Brian, when you say that maybe the market is not properly pricing in these things, how do

you measure that? How do you define that? Yeah? Well, this was one of the key parts of our research was to try to say, first can we actually look geo locate this physical risk data down to the asset level, and then two can we ask the question of is this are those risk priced or not? We do that

differently for different asset classes. For example, with municipal bonds, we do We've done a like for like comparison, So looking at for example, at a place like Jupiter, Florida that UH and a place like Neptune, New Jersey, similar

bond issuances, but very different physic core risks. And if you if they if these were priced, these risks were price into the market, you would expect to see that in terms of pricing differentials and yields on these bonds on a like for like comparison across municipalities, you really

don't see a pricing differential in utilities. We look at we do an event study and we look at the the what happens to utility stocks in the wake of these extreme weather events, and we try to say, if these if these risks were fully priced into the market, then you would not necessarily see any pricing reaction in

the wake of these events. What we see, in fact, is that you see a persistent pricing reaction and a sell off in the wake of these events, which then boomerangs after about forty days, which indicates that investors are selling off on the headline in part because they aren't fully understanding or able to price these risks uh into

the market. Or could it be that they have priced the risks to a certain extent, a certain extent they figure they're not price able, and then after the hurricane is over, the hurricane is over, and they're not thinking it's going to happen to that asset immediately again, and their turnover is going to be such that why bother taking less because the odds are so small that your

individual assets going to be hurt. Well, So one of the things that we're excited about about UM being able to use more granular downscale data to actually measure the physical risk at the asset level is that element that UM seems to the market hard to price or impossible the price is something that we believe better data can

actually get us to a better place on. So to the degree that utilities investors are looking and saying there's an element to this risk that we just think we can't quantify, we think that bringing this type of geolocated downscale data at the asset level and then aggregating it up to the security level built creates an additional tool to try to differentiate and say, what is the exposure of uh, you know, a particular utility operating in the

southwest of the United States, first utility in California. So, Brian, what's been about thirty seconds, what's been a response to your report? Have you been any pushback from say, I don't know, climate change deniers or whatever, because there is obviously questions in the marketplace. Sure, well it's UM, it's out today, and so so that the well, a lot of the well, we'll see a lot of the feedback

coming in. I think one key thing for us though, is this is really about our investment process and about price and market pricing and risk. And so we use what we believe is the best data on weather patterns and frequency and severity of extreme weather events. But our focus is on trying to understand whether and how these issues are priced and how we can build that into

our investment models. Bright these thank you so much. Bran is black Rock Global Head of Sustainable Investing and former Obama Senior Advisor of Climate and Energy Policy, joining us here in our New York studio. 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