Surveillance: Yield Values with Hornby

a brief down. It has been very visible. Lisa Hornby joins us out of the US multisector fixed income at Schroeder's and and Lisa, I really want to go to a general sentence buried in your note. The value was there for a decade in bills, notes and bonds. The values extraordinary discussed that why is price cheap in fixed income? Well, to be fair, we wrote that note about four or

five weeks ago. But you know, when we look at on yields today and the longer term, over the longer term, there is much better value than there has been certainly any time in the past decade. And in fact, if you look back even going back twenty years, where at the sort of top percentile or so, and so you know, in our view, the first six seven months of this year have been quite painful in return space, but when you look forward, we've now set the landscape for much

better returns. We actually have income in fixed income now for the first time in a while. We couldn't make that case a year ago. Lisa spreads of tit and aggressively. You've seen that we've gone from close to six hundred basis points on high yield to threatening to break four hundred. Lisa, can you help me understand just dissect that runny for us when that strength has come from? Is that an up and quality trade? Is everything? What's happened to here?

I think it's I think it's a few things. I think the main one for us actually is that people have a bit more certainty in the rates volatility scenario. And what I mean by that is, I think you went back through four months ago, people didn't know where

the terminal rate belonged. I mean you heard strategists talking three four or five six percent, to mean, there were there were lots of expectations out There are lots of various scenarios, and that led to extraordinary high rates volatility, and of course the the subsequent impact on credit spreads and and equity markets. Because if you can't price the

risk free rate, how can you price everything else? And I think what happened was not only did sentiment get so poor that positioning work perhaps a bit offside, but what happened was the FED was perceived to do a slight pivot and show that they are willing at some point to slow the pace down UM, and that they think that they're getting fairly close to you know, perhaps they've perhaps a neutral rate, you know, over long term.

But UM, I think people got comfort in the fact that the terminal rate is probably not five or six percent, it's probably three or four percent. But at Lisa, the FED is said, we haven't pivoted, no pivots going on here, and basically we're expecting that to hear that in the minutes. Is that going to reverse some of the spread tightening that we've seen. I think it will. UM. I think that the market narrative shifted a bit and that lower vowel regime is positive for risk assets, and especially it's

more positive when sentiment had gone so far offside. I mean, we looked at that, we look at that Credit Swiss panic Euphoria index. It was negative five panic for for you know, months, almost um. Now it's back actually in positive territory, So there was a massive swing in sentiment. I think that coupled with that perception that the FED became a bit more perhaps stablished, led to the rally that we've seen. To your point, Lisa, in our view,

this is a fade. I don't think that the I don't think the outcome that the market is painted, which is one if you know, you look at what's priced in the yield curve is invertus points to a recession. Um. You look at what's priced into FED funds rates, it's it's basically the FED stops in February or March hiking and they basically do an out about face and start cutting rights in in in the summertime. I think that's a that's a fairly unlikely scenario unless there's a really

big downturn, which there could be. But then should risk assets be priced the way that they are today, Lisa, Our bond markets as well as the FED all just trading and operating around an oil market that's influx um. I think oil is one part of it. Certainly, that's you know, that's going to lead to the headline inflation sort of gyrations, and you know, oil came off and and so we saw a big, big drop down and

in cp I headline CPI. But I think core inflation is more important, um and and that's really where the story is. And to us that's a bit more concerning. You know, yes, there was maybe a little bit of moderation, but the sticky components of core inflation are still running north of five five and so to us, that's the that's the real challenge. Yes, oil will will have puts and takes that will drive headline, but you gotta get core inflation down to more reasonable levels. And I think

that's what the FED is focused on. LESA. Just listening to that final common there, that just sounds like you think this debate over terminal rights own result that it's too ready to get ahead of the story. I think it's too early to be discounting FED cuts. Certainly, um, I think it's too early to be discounting the FED has has pivoted. I think that's that's not not done yet.

You know, I do think that they probably moderate their pace in September to fifty probably, you know, they could do a couple of fifties, They could do a couple of I don't think the five or six percent story is the one that you know, people were fearful of at the very front of the year. I don't think we're getting there, But I think the market is pricing in this very uh specific outcome where we head into

a very moderate or mild recession. The FED is able to stop hiking and then start cutting, and that just seems unlikely. Historically, they don't cut when inflation is at elevated levels unless growth is really really bad. Employment is much higher, unemployment excuse me, it's much higher than where we are today. So you know, I think the markets is getting a little too excited right now to be to be you know, I've always called that Lisa a

bedtime story. To have equity market balls sleep well at night, and that's what that is. Right now, Lisa won't be there. Shoulders Kitchen ex joined us now chief ex Strategistics Sock gen K. The first line in your note this morning the markets listening to the Fed and ignoring them or just not listening, which one is it? I think that

I think they're choosing not to listen. I'm sure markets are listening to the Fed, but they're not really hearing the message, or you know, there's a there's a disconnect between some of the kind of optimism that a little bit less inflation means we'll get less from the Fed and a fad that's looking at high inflation anyway, I mean, way, way, way too high and a labor market which you know is just incredibly tight now, and so they really have

nowhere to go. And I will be surprised if we don't end up pricing a four percent FED funds peak into this market before we've done over the next few weeks, because it seems to me that the message from the Fed is it cannot soften at all at this point. Kid, what is the message of strong Swiss Frank and particularly Euroswissy breaking through point nine seven to point nine six? What is the signal of that sticking out like a sore thumb on a Monday morning. Um, it tells you

a little bit about risk conversion. I mean, it tells you something about the fight. But the Swiss decided that they wanted to get rates backed in depositive territory if they've ever got a chance, and that they've got some intuation that they need to fight. Uh, and if they have to sacrifice all attempts to keep the currency down in the process. It's fine because dollar Swiss isn't the problem,

so so domestically you can see what they're doing. But yeah, I mean, it's an extension of the China story from this morning that says the US economy might still be doing well so long as we don't look at the yield curve and don't worry about the the things that don't don't jell well with yours economy. But if we look at the rest of the world, there's just a

world of trouble out there. Kid. You're talking about how perhaps this market is not listening to the federals or and I wonder in this quiet summer week, whether Wednesday will be a pivotal day in terms of FED meeting minutes, whether they try to signal, hey, wake up, four percent

FED funds rate is actually a reality. Do you believe that this will be a catalyst for some sort of dollar strength, for more market disruption As people kind of start to hear whij Powell was saying, hard to know for sure, because I think I think what the you know, I think I think the last FMC meeting was about stepping away from excessive forward guidance. So I don't know if they want to come back and steer us too hot.

I think Jackson holl is a different story. But but I think they have a they have a problem with with with the degree of over precise forward guidance we've had from central banks in a very complicated and chaotic global economy, it just doesn't make sense. They should take the fact, you know, the facts as they are when they get them and moved. They should have hiked in June last year. You know, they then so on and

so forth. So I would I would be a little bit depressed if I thought that they were still using

FMC minutes to mike a manager expectations. UM, I would be more encouraged if they came out having seen that, having seen the peril data, and having seen everything that we've seen since this month, if they came in and Jackson hole and they don't say, look, you know, we have to get inflation back in its box, and we could only do that by putting some slack into the opor market and find out contradictions just keep on easing.

And that's been problematic. Lisa. I was reading through the notes last week and pretty much every single note, so the same thing. It looked like to me at least, that we were equating peak inflation, Lisa, with peak FED hawkishness. I'm not sure whether you can do that. And a lot of people came out and basically said the FED put is still a FED call, and that the more that starts rally, the more that the FED is going to have to step in and do something to to

cause this to reverse. And how much is this going to become the reality and the talking point of the next few weeks a kid, would you summarize it as follows as Lisa just called it, Is this a FED call now? And does this FED have to respond to this aggressive rally we've seen in this equity market, this aggressive tightening we've seen in credit spreads. I don't think that.

I don't think that the market helps the FED. But the reality is that inflation that with the labor market where it is and wage growth where it is, as a result of that, inflation may drift lower over the course of the next six nine months, but they'll still have a problem because it's not going back under five percent easily from here. So you know, there's a two stage. So I think I think the Fed's messaging in sense of the fleas problem is the third's problem is they

don't have a choice. The inflation mandate requires action, more action. The market does what it does. The concern is that as soon as the market things, they might have done enough. Um that that that that sort of look at it and you think, no, they just haven't, not until the data improved. A kid, just quickly, as an arsenal fan, did you enjoy two other London clubs just beating each other up for ninety minutes yesterday? It was good entertainment?

Whatever else it? Kid? Juicus? So kid, thank you. Right now we're gonna rip up the script. We can do this with William Lee, his chief economist at Milk And Institute. We're going to talk to him about the Empire statistics, but said, let's take advantage of his encyclopedic knowledge of the Pacific rim and the dynamics of China. Of course, Dr Lee has all of the efforts he's done at the International Monetary Fund over the years and City Group, and of course has a shingle out at the Milk

And Institute. Right now, Billy, I want to go to the Party Congress. Right now, Elizabeth Economy of the Council on Foreign Relations, in her beautiful book The World according to China has the view of China looking out. How does Beijing and their leader in Beijing, how does he look within? Giving the grim data of the day, Actually, President she has made a major campaign of his to

start looking inward. It's called the deal circulation strategy, where he wants to have the domestic economy become the primary focus for China and the source of growth going forward. Unfortunately, so much as collapsed within China that the domestic economy is nowhere to be found, especially in the private sector, where the only store of wealth the middle class had. The property sector has completely collapsed, had about a year

of declining real estate crisis. So so so right now the rest of the world is the only hope for China, and even that's collapsed because the latest data show the export numbers are are are are nowhere to be found. So China really has nothing to hang on too. Going into the Party commos, how does she Billy prosecute decisions, logistics, the process of it to Shanghai or to cheng Do.

How does Beijing actually get the message out. You know, right now there's a tension between the center of the central government and the municipal governments because right now the only place for revival is to have the municipal governments go in there and do infrastructure building and just start pumping out fiscal policy. Unfortunately, every municipality out there is

so indebted they can't do it. Uh. And so so the only thing that j Pick has to to have to save face going into the Party Congress in October is to have some prayer of saying we will have a revival in the second half of the year. These numbers today have put that to rest, and there's no chance for that. On top of that, uh, Speaker Pelosi has slapped him in the face, and the loss of face going into the Party Congress is gonna be something that's gonna be very hard for him to recover from.

But we get to timeline in the moment. Just on the economy, are you describing a balance sheet recession in China? Balance sheet recession for short in the private sector because the only source of saving for the households has been real estate and the very volatile stock market. And so with the collapse of the real estate market and the

health the huge youth unemployment. It's very hard for households to have a positive outlook for the future and start buying things like consumer durables, and and and and other other items. So so the balance sheet recession notion is very much in play at China. Now leaves money to your policy impotent, doesn't it. And I feel if that's the case, I'm just trying to work out where that leaves the global economy off the fact of this dynamic stating to bubble to the service just a little bit more.

The only place monitored policy can have a play here would the regulatory policy to somehow ignore all of the holes that are in the real estate sector and say, okay, guys, go on and Bill, we're gonna backstop all of your your your bad debt and all of those empty apartments of yours. That's the only place Montory policy brow. It's the regulatory side, and China's doctor to be able to do that because the regulatory sector, the real estate sector

is in such bad shape. So what are we looking at, Bill, in terms of GDP growth for China? I hear two handles going into the rest of the year. Uh, and so in order for China to get to his five and a half percent target has to have seven and eight percent for the rest of the year, and right now is exactly going to the opposite direction as the rest of the world economy. Factored that in the likelihood in your idea that you can see a two hand

all for Chinese GDP growth. I I think that notion has gotten out, especially among my my friends who are China chief economists out there. They can't publish it because they may be banned from China, but I think the notion is among the among the investors of the world. Well, this may be temporary and the China will somehow recovered because it always has, but the structural problems I just pointed out are just so severe. I think there's gonna be a lot more work to be done for China

to regain anywhere nearest investor status. What about the asset pricing though globally and we're just talking about the Empire Manufacturing survey severely disappointed. Biggest, second biggest job in this history of this index, The second biggest just all in level that we have ever seen in this index is history. How much how are we looking at a global recession really pitting off the slowtown in China. Well, manufacturing is

really at the core of the globalization. That's the one sect that's most affected by globalization, and China in particular because it's been the next is the manufacturing So we would expect any kind of slowdown in China that affects the global supply chain to kill the manufacturing sector before anything else. And we have seen that in the data now, so that's not so surprising. What is going to be difficult with the how the rest of the economy work.

Global economy will adapt its global supply chains in a way that it takes China out of the picture, or at least become less important part of the picture. But you said something moments ago i'll paraphrase that certain people can't publish things because they'll be thrown out the country now built. There's an element of truth in that in the minds of a lot of people. And I wonder if these things start to deteriate just a little bit more, Bill where I look for reliable data on what's actually

happening in that economy. Well, I hate to say this, but my supply, my cell side colleagues are are kind of constrained. I'm lucky to be at Milton where I'm not constrained to say what I think. And I think it's going to be very difficult to find hard intelligence about China outside of private sources. That's tough. Bill. Thank you, bo Lee at the Milk and Institute on Oil. Ellen Wall joins senior fellow at the Atlantic Council and really quite good on particularly the mix of what's going on

in Saudi Arabia. Ellen, thank you so much for joining us today. Should we get used to oil at eighty or ninety or are you with a school of thought that normal is much higher and we're just on borrowed time down here n suns and borrowed time. But I do think that for the current the current picture that yes,

higher is definitely a new normal. And when you look at the changes that are going on in the US in terms of oil production and new regulations and different corporate outlooks towards increasing production, there's definitely a trend towards less dynamic responses to the market, um, higher costs in terms of production, uh, slower increases in production, and so I think we definitely could be looking at a somewhat higher basis in terms of oil, and as you've been mentioning,

inflation also does play a role in that. And it can't just pick up on some of this and ask you how durable this decline is going to be. With south of four dollars a gallon for gas in this country right now, on average, we've seen numbers declined, decline, decline every single day going back to the middle of June. It's pretty impressive. STUF. Secondly, grand home over the weekend to see an and hoping it continues. Do you have

that same feeling that it will continue? Well? I think that you also have to remember that seasonality is still a very important component in gasoline demand and gasoline prices, and generally around this time we do see a slight dip in demand. School is starting for large portions of the country, and um this summer driving season is coming

to an end. But I think that um what will really give us a good sense of where things are headed in terms of gasoling prices and demand is as we hit the fall, as we hit September, when refineries have to go into their maintenance season, I think we'll get a good picture of whether demand is still strong, whether it's going to drop off because typically prices decline.

But will refineries feel secure enough to even go offline to do maintenance or will they feel pressure to keep churning out more and more barrels and kind of put off needed maintenance, And that could be a significant factor for gasoline prices for the rest of the year. Hepic of a swing factor Ellen is COVID zero and China

ending that after the National People's Congress later this year. Uh, that would be a huge deal if if China ended its COVID zero policy, because essentially the market is always kind of on edge. Is China going to shut down? Uh? Is this major city gonna shut down? What's demand going to look like out of China? And to some extent, you get a little bit of a sense when they issue their import quotas, especially for the independent refined reason,

but how much oil they're going to be importing. But at the you know, at the stroke of a pen, they could basically crush domestic demand. And so I think that if they do get rid of this zero COVID policy, I think that that will be quite telling for the market, especially for the next year. Well, but how tight is production right now? How tight are supplies? And that's I guess the question that I have is how resilient is the market to a potential shock and demand one way

or another. Right now we're seeing cooling demand. How low would those prices be if it weren't for that tightness. Yeah, I don't think. I think we We could definitely potentially see prices, you know, down in the sixties if it weren't for that tightness. But on the other hand, part of the tightness is what is causing prices to to cool down, the fact that they were so high because things were tight and then we did see some demand destruction.

We are seeing continued fears of global recession. You know, even if we do get more data out of Europe and Europe does plunge into recession, which I think most people think is going to happen. Um, that doesn't necessarily mean that they're still not gonna need oil because prices electricity crisis there are still so high and that could cause them to switch to UH to some oil. And the distinction to me and say ave given one hundred page research report is the potential demand of the Pacific

RIM and even the Pacific rim ex China. Do you believe in that that they're going to have the buoyant boom over one year, two years, three years, it's gonna pop oil to a permanence above a hundred dollars of barrel. I don't believe that that's necessarily going to be the case.

I definitely think that there's room for an economic boom there um, but I wouldn't say that that's definitely gonna cause oil to to stay above a hundred, especially if you're looking at say a major decline in in European demand, if you're looking at economic weakness in America, those could all be significant factors. And also remember that, um, when the middle of December comes at early December, that's when these sanctions on Russian oil are supposed to take effect.

And I think that that will be very telling for where oil is going in the next year in and how well these sanctions are actually enforced or adhered to the coast isn't clear. We've heard that a lot, haven't we. All'm walta the Atlanta Castle, the Britiant Allam walt on the Lightest and I thank you. This is the Bloomberg

Surveillance Podcast. Thanks for listening, Join us live weekdays from seven to ten am Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment, and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course, on the terminal. I'm Tom keene In. This is Bloomberg people,