taylor: from san francisco for our viewers worldwide, i'm taylor riggs. bloomberg "real yield" starts now. ♪ taylor: coming up, yields on the u.s. 10 years slipping back below 1.90 heading into the final week of the year as investors place their bets on rates in 2020. signs of optimism. it may not signal the all clear just yet. what it means for inflation and growth expectations in the new year. and wrapping up a year of outperformance in credit. corporate bonds on track for the best returns in a decade, but

how long can the rally continue? we begin with the big issue, markets betting low rates are here to stay in 2020. >> it is hard to see the yield breakout from here. >> rates will probably drift lower. >> bond yields moving sideways. >> we can't generate any inflation right now. >> it should eventually be a good year for bonds. >> still attractive but certainly not breaking out. >> 1.20 by the end of the year. >> if we get to 1.2% on the 10 year, we are looking at a global recession. >> we are going to test 1%. >> a lot of things have to be going incredibly wrong to get to 1%. >> i think we are going lower. >> the u.s. economy could go into recession. >> unless the market begins to price in additional cuts, the 10 year, at most, will drop down to the 1.60 range. >> the fed will probably not cut again. >> if there is any weakness in the data, you will see an outsized rally in bonds. >> the path to least resistance

has been lower, and i see no reason to think that will change in 2020. taylor: can we break out of the range set in 2019? joining us from new york are collin martin, peter tchir of academy securities, and in pasadena, john bellows. i want to get your 10-year forecast from each of you for 2020. collin: we think the 10 year treasury range we think it will rise modestly in 2020, somewhere in the 2.25 range. we think short-term rates will stay anchored. the fed will stay on hold. with signs of stabilization across the global economy, as well as in the u.s., pickup in inflation expectations, we can get close to 2.25 for the 10 year treasury. taylor: peter? your take on the 10 year in 2020? peter: i think we will see 2.25 as soon as january and february. i think we will start the year

rough for treasuries. higher yields, deeper curves as the global growth curve gets priced in. a little fiscal stimulus out of europe. taylor: john? john: the better growth optimism is an argument for higher yields, but i would highlight two other components. inflation continues to be very subdued. 2019 was supposed to be a year of higher inflation. not only did that not happen but inflation moved lower across a set of measures. the second component is the fed. the fed has adopted an asymmetric reaction function, and i think they are unlikely to raise rates given the low inflationary environment. there is a chance they cut rates, whether in response to a growth downturn, which would be a straightforward reason to cut, or even if inflation is too weak, chance that they cut. growth optimism is a reason for higher yields, but against that, subdued inflation and asymmetric and accommodative fed. our view is those things will matter more and keep yields low for the foreseeable future.

taylor: i wanted to talk about the fed. the wirp function on the bloomberg shows no movement in either direction in the first half of the year. i know it is far out, but what is your take on fed action, at least in the first half of 2020? collin: we think they will be on hold. we like to say for the foreseeable future. that is what the markets are pricing in, what fed officials are telling us. with the three cuts they did this year, they have successfully un-inverted the yield curv and n financial conditions remain easy. barring a major change in the economic outlook, there may be a risk off environment where we see stocks fall. we think they will be on hold. taylor: peter, i want to get your take now that phase one of the trade deal has been sort of resolved. what do you need to see in the economic data in the trade

tensions to get the fed to move in either direction? peter: i don't think the fed will do anything in rates unless there is a big change in sentiment, very positive or negative. we may see as early as january, them containing how big the balance sheet will be. a lot of the current rally in equities started in october when they started regrowing the balance sheet. looks like we will make it through the year end without any problems in that short-term refunding market. they may start to set expectations that we cannot keep growing at this pace. that will be a headwind on stocks, ok for the rates market. taylor: i want to go back to the steepening yield curve. it is bringing some optimism to a lot of the markets here. listen to what morgan stanley is saying, that it is a step in the right direction. >> i take confidence from the steepening of the yield curve. that is a measure of success, confidence in the future. we are talking about an endogenous rise in long-term rates.

it's not the fed pushing it higher. the market is more optimistic about the future. taylor: james athey giving a little bit of a different take. this is what he had to say. >> you don't get a recession when the curve inverts, you get it when the curve reese deepens -- curve re-steepens. you have to deal with the problems that have built up in the expansion phase of the cycle. essentially, if i were to look at the curve today, i would say this is classic pre-recessionary behavior. taylor: your take on a steep yield curve, the steepest since 2018? john: i think the re-steepening of the yield curve, the fed deserves credit. beginning of 2019, the yield curve was inverted, sending a clear signal that short rates were too high, monetary conditions too tight, and the fed's cuts have addressed that. however, it is premature to signal an all clear here,

declare success. if you think about the level of yields, inflation breakevens on the 10-year are 1.75, well below the 2% mandate, below where we were six months ago. a lot below where we were 18 months ago. the yield curve is not inverted, and that deserves credit. but we are a long ways from an all clear. the level of inflation breakevens is still worrisome and demands attention from the fed. taylor: we are showing a chart of the fed's balance sheet, you were highlighting this, the togetherness of the fed's actions and the balance sheet, and how we see a steepening yield curve. is the steepening yield curve different this time around? it is a good sign given rates are rising on the long end versus the last time we saw a steepening of the yield curve. then it eventually leads to recession, it is really because

bets on the short end of the curve. peter: i want to take one step back. august is when we got the inversion. there were a lot of technical factors in play. a bunch of inflows into long dated treasuries, a shortage of sellers. people were getting stopped out. some of that flattening was purely technical. we reversed that. we wrote back in august, steepening the yield curve should be the fed and treasury department's job. the fed has done a lot for that. what i'm for now is the treasury department to issue more duration. this treasury for some reason is focused on issuing a lot of t-bills and front-end bonds. they haven't issued as many tens and 30's so the value is skewed a little to the front end. i would like to see them come out and issue more 10-year, 30, maybe introducing a 20-year. flooding the market with duration. i think the steepening yield curves gives comfort. it is really the yield curve that leads the discussion, rather than the discussion leading the yield curve. taylor: collin, do you agree,

are you comforted by the steepening of this yield curve? this time is different with re-steepening after the initial inversion. collin: i agree with john, this is a success by the fed. they got the yield curve out of negative territory. i do think it's important to put this in perspective. it is still relatively flat if you look at the three-month, 10 year, you are still in the 25, 30 basis point range. when you look at the broad yield curve, still a relatively flat trend. if you look at the past mid cycle adjustments of the 1990's, that was also followed by a steepening of the yield curve. we saw recession pushback. we do think it is a success, but we need to see more before we see an all clear sign. taylor: john, as you look at 2020, is the pain trade higher or lower yield? john: if i could respond to something that collin said about

the midcycle adjustments. it's important for investors to understand this is not the 1990's anymore, the fed is doing something different than what they've done in the past, not responding to something global. they are responding to low inflation here in the u.s. they have made that clear. powell has tied future rate hikes to inflation specifically. this is not something that we think will be reversed in the next few years. as long as inflation remains low, the fed will be on hold. it's important to emphasize, this is not the 1990's, this is not about inflation. in terms of the pain trade one , thing that strikes me about the pain trade, what is the consensus? one consensus trade that we hear over and over again is the steepening of the yield curve. for reasons that have been discussed. that could happen if you see some kind of readmission of global growth and optimism, yields move higher on the backend. but if inflation did not move higher and we didn't see an

increase in global optimism, then i think steepening the yield curve would be a pain trade in the sense that consensus is there already. you could see a flattening as a result of that. first point, this is not 1990. important for investors to understand that. secondly, the steepening yield curve is a consensus trade. that means the risks are flatter from here. taylor: everyone is sticking with me. coming up next is the auction block. the u.s. treasury department selling $113 billion of longer dated notes in the final full week of 2019. plus, a strong finish for the corporate credit markets. that is all coming up next. this is bloomberg "real yield." ♪

♪ taylor: i'm tayler riggs.

this is bloomberg "real yield." i want to head to the auction block and begin with asia. japan saw just under two trillion yen of negative yielding two-year bonds. the bid to cover ratio was 7.4 -- was 4.7 times close to the six months average. italy sold 2 billion euros of zero bonds due in 23 months. investors offered to buy 1.8 times the amount sold. the bonds were sold at a slight premium with a yield of -.005%. here in the u.s., the treasury department holding three auctions this week for 2, 5, and 7-year notes. demand for $32 billion for seven-year notes rose from the last option of securities with the same maturity. demand for two and five-year notes was lower than average. elsewhere, corporate credit is looking to finish the year on a high note with high-yield rallying for 16 consecutive sessions. wells fargo weighing in on the

recent performance in the junk space. >> across high-yield, you are pulling in 2020 returns into 2019. there is a year-end squeeze going on as people scramble, looking for that recovery trade, where can i get the incremental yield, incremental return, how can i set myself up for next year? we have seen a meaningful squeeze in the market. taylor: still with me are collin martin, peter tchir, and john bellows. collin, i want your take on some of his comments, that we have pulled a lot of those returns in the ccc space specifically back into 2019. do you see that as being the case? collin: we do, we think it will be difficult to mimic the returns we saw this year in the credit markets, especially high-yield. we have gotten to a point where spreads are low, prices are very high, and the returns we saw this year, frankly, will be

difficult to follow, unless we see spreads go to all-time low levels. our outlook for next year and our guidance for investors is to be very defensive, suggest underweight in high-yield bonds, especially the junkiest part, like ccc's. the outlook is to earn your coupon. coupon payments will make up most of the return in 2020. taylor: peter, your take on credit in 2020? peter: we came into december looking for this squeeze across the board. the first step is figuring out which credits benefited unfairly by the squeeze, start selling those. there will be a return to weakness for those weaker credits. having said that, we like cyclicals, autos, commodities. certain names were beat up that are starting to come back. i think those can continue. it will be difficult for managers to figure that out, but that is what you're supposed to be doing with your portfolio now. figure out which of those weaker names are underpriced and have upside, adding to them, and then taking profits or cutting losses on those that have a surprising

rebound. taylor: the dallas fed president robert kaplan weighed in on the credit market, saying those tighter spreads might be cause for concern. >> b and bb credit spreads are so tight. bbb spreads are very tight. if i see the market is distinguishing between lower quality credits and better credit, i think that is an encouraging sign. my bigger worry is, you have got increasing pe, historically low cap rates, tight credit spreads, and i'm just keeping a close eye on excesses and imbalances. taylor: john, do you agree, tight spreads, a cause for concern? highlighteding he that is a concern, there has been differentiation. higher-quality has outperformed, ccc's have lagged, a recovery in december, but disappointing performance this year relative to the broader market.

that is an important point. in that environment, managers that have the ability to do the fundamental credit work and differentiate between names and sectors, are really best positioned to outperform. our team has done a great job on that. i think that will be the key going forward, to do that differentiation that president kaplan is talking about. it is not just buying the highest yielding bonds. you have to do that differentiation, have to be a fundamental manager in order to perform well in that environment. taylor: what is the high-yield market telling you with spreads at 3.26, down from 5.50 a year ago, collin? collin: investors are not being compensated much for taking on at high risk that they offer. going back to the broad credit spectrum, whether you look at aaa's down to b, if you look at the tiers of each market, they are close to the post crisis lows. the only types of bonds that

have spreads above that is ccc. you are not being compensated. with high yield, it is not out of the ordinary to see spreads move sharply. whether it is 100 basis points, 150 basis points. the lower they are, there is less of a buffer for investors to offset some of that. taylor: peter, we were looking at the chart. it is shocking to see high-yield at 3.26, and then investment grade at 97 basis points. what looks more overvalued to you? peter: i am fairly comfortable with credit here. we all talk about reversion to the mean. you go back to the early 1990's, we spent all the 1990's at these credit spread levels, most of the 2000's at these spread levels. i think it will turn out that investors were overcompensated to take credit risk the past six or seven years, and we could normalize. i think we will see a world of

bbb credits, where single-a moves down to bbb, bbb holds at bbb, and maybe if we get a recovery in the economy, bb getting upgraded. i think we will look back and say, what was the problem about bbb spreads? you are probably being compensated, very few names get in trouble. we saw this year, as companies were going through the debt diet, those companies that got in trouble at the investment grade level could turn themselves around. i think we will probably not see a ton of spread type thing from here, but i don't think we will go back to widening. which is what i keep coming back, people will have to find the opportunities in those beaten up cyclicals, those names that fell behind and were undervalued. people will be searching for yield, and that is where they will find it. taylor: john, i want to read pimco, that thinks the strength in high credit is here to stay. he says there is not enough high-quality in assets to meet the demand. that is the reason credit did so well this year, not just the fact that the fed and other

central banks cut rates. it is just that there is that much demand. does demand continue in 2020? john: i think the fed is a big component of this. the accommodative policy moves this year will lengthen the cycle, that is reducing one of the major risks in credit, reducing the recession risk. another thing the fed has done by bringing down rates is reducing the hedging costs for foreign investors who want to buy credit. you've seen big foreign participation. i think both of those are positive. the fed is definitely a part of the pro-credit story. again, i want to come back to the idea that there is differentiation within the credit market, and managers can take advantage of that. let me give you an example. we have noted that energy credit has really lagged. one thing that is striking is that energy credit has lagged even though management teams are being very prudent with their balance sheets. you see asset sales in order to

manage their maturity schedules, bring down leverage in some cases. and yet, spreads are still quite wide to the markets. energy would be a case where prudent balance sheet management from the leadership and those companies is a positive. spreads are not reflecting that. that is where you could take some risk. taylor: everyone will be sticking with me. coming up and still ahead, it is the final spread. this week features manufacturing data out of the u.s. and china before closing out the year. this is bloomberg "real yield." ♪

taylor: i'm tayler riggs. this is bloomberg "real yield." time for the final spread. coming up over the next week, monday, chinese pmi and u.s. wholesale inventories. tuesday, the bond market closes early ahead of new year's day on wednesday.

most global markets will be closed. thursday, china manufacturing pmi data. friday, minutes of the fed's latest meeting. still with us around the table are collin martin, peter tchir, and john bellows. peter, tony crescenzi told us that 2020 will be a year of coupon clipping. if you look at returns, is it price or coupon in 2020? peter: i think it will be different -- for the total return investors, you'll have to be careful. it may be a coupon clipping. for spread investors, you can do well. you will have to be aggressive, as john talked about. energy could outperform. you have to be overweight. those sectors still have juice in them. you have to time the market. there will be opportunities to buy and sell, rebalance your portfolio. i think that will drive returns that are than just getting the coupon back. taylor: it is time for the rapidfire around. how many fed cuts in 2020? collin.

collin: zero. peter: zero. john: i will be a little more bullish and say one. taylor: what is the upper bound for the 10-year in 2020? collin: we think 2.25. upper bound, 2.5. peter: 2.75. john: for the 10-year treasury? taylor: upper bound. john: 2. taylor: what part of high-yield outperforms? you know what, i will just get one answer there. collin martin, peter tchir, john bellows, thank you. this is bloomberg "real yield." ♪

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