Corporate bonds on track for the best returns in a decade, but surprising rebound. How long can the rally continue . Taylor the dallas fed president Robert Kaplan weighed in on the credit market, telling bloomberg we begin with the big issue, tv those tighter spreads might markets betting low rates are be cause for concern. Here to stay in 2020. B and bb credit spreads are it is hard to see the yield so tight. Bbb spreads are very tight. Break out from here. If i see the market is bond yields moving sideways. Distinguishing between lower quality credits and better trapped in this range. We cant generate any inflation right now. Credits, i think that is an it should eventually be a encouraging sign. My bigger worry is you have got good year for bronz bonds. Increasing pe, historically low still attractive but cap rates, tight credit spreads, certainly not breaking out. 1. 20 by the end of the year. And im just keeping a close eye if we get to 1. 2 on the 10 year, we are looking at a global recession. We are going to test 1 . On excesses and imbalances. Taylor john, do you agree, a lot of things have to go incredibly wrong to get to 1 . Tight spreads a cause for concern . John one thing he has you have to have a recession to get there. Unless the market begins to price in additional cuts, the 10 highlighted that is true is that year, at most, will drop down to the 1. 60 range. There has been differentiation this year. Higherquality has outperformed, cccs have lagged, a recovery in december, but disappointing the fed will have to ease again. The fed will probably not cut again. The fed is going nowhere. Performance this year relative to the broader market. If there is any weakness in i think that is an important the data, you will see an outsized rally in bonds. The path to least resistance has been lower, and i see no point. In that environment, managers reason to think that will change that have the ability to do the in 2020. Fundamental credit work and differentiate between names and sectors are really best taylor can we break out of the positioned to outperform. Range set in 2019 . Our team has done a great job on that. Joining us from new york are i think that will be the key collin martin, peter tchir of going forward, to do that differentiation that president academy securities, and in kaplan is talking about. Pasadena, john bellows. Its not just buying the highest i want to get your 10year forecast from each of you for 2020. Yielding bonds and waiting for them to tighten. You have to do that collin we think it will rise modestly in 2020, somewhere in you have to the 2. 25 range. Maybe as high as 2. 5 . Do that differentiation and be a we think shortterm rates will fundamental manager in order to perform well. Stay anchored. We think the fed will stay on taylor what is the highyield hold. Market telling you with spreads at 3. 26, down from 5. 50 a year with signs of stabilization ago, collin . Collin investors are not being across the global economy, as compensated for taking on at well as here in the u. S. And maybe some pickup in inflation expectations, we can get close to 2. 25 for the 10 year highrisk bonds for what they treasury. Offer. You look at aaas down to b, if taylor peter . You look at the tiers of each your take on the 10 year in market, they are close to the postcrisis lows. The only types of bonds that 2020 . Peter i think we will see 2. 25 have spreads above that is ccc. As soon as january or february. I think we will start the year you are not being compensated. Off rough for treasuries. Higher yields, deeper curves as with high yield, it is not out the Global Growth gets priced of the ordinary to see spreads move sharply. In and a little bit of fiscal stimulus out of europe. Taylor john . John the better growth optimism the lower they are, there is is an argument for higher less of a buffer for investors yields, but i would highlight to offset some of that. Two other components. Taylor peter, we were looking first, inflation continues to be very subdued. At the chart. Is shocking to sed 2019 was supposed to be a year of higher inflation. Not only did that not happen but at 3. 26, and then Investment Grade at 97 basis points. Oks moo inflation moved lower across a whole set of measures. The second component is the fed. You . They have adopted an asymmetric peter im fairly comfortable with credit here. Reaction function, unlikely to we all talk about reversion to raise rates given the low the mean. Inflationary environment. I think there is a chance they if you go back to the early cut rates, whether in response 1990s, we spent all the 1990s at these credit levels, most of to a growth downturn, which the 2000s at these spread levels. I think it will turn out that would be a straightforward reason to cut, or even if investors were overcompensated inflation is too weak, chance to take Investment Grade credit that they cut. Risk the past seven years, and growth optimism a reason for we could normalize. I think we will see a world of higher yields. Against that, subdued inflation and asymmetric and accommodative bbb credits, where singlea fed. Our view is those things will matter more and keep yields low moves down to bbb, bbb holds at for the foreseeable future. Bbb, and maybe if we get a taylor i want to talk about the fed. Recovery in the economy, bb getting upgraded. I think we will look back and john brought it up. The wirp function on the say, what was the problem about bloomberg shows no movement in either direction in the first bbb spreads . Half of the year. I know it is far out, but what they are fine. You are probably being compensated. We saw this year, as companies is your take on fed action, at were going through the debt least in the first half of 2020 . Quickly companies collin we think they will be on could turn themselves around and hold the first half. We like to say for the maintain their credit rating. Foreseeable future. I think we will probably not see that is what the markets are pricing in, and thats what fed officials are telling us. A ton of spread tightening from here, but i dont think we will go back to widening. With the three cuts they did people will have to find the this year, they have opportunities in those beaten up successfully uninverted the cyclicals, those names that were undervalued. I think people will be searching yield curve. And now, things are ok. For yield and that is where they financial conditions remain will find it. Easy. Barring a major change in the the names left for dead that economic outlook, maybe a risk come back. Taylor john, i want to read off environment where we see stocks fall, we think they will something from pimco who thinks be on hold. The strength in highgrade taylor peter, i want to get credit might be here to stay. Your take now that phase one of he says there is not enough the trade deal has been sort of highquality income producing assets to meet the demand. Resolved, what do you need to that is the reason credit did so see in the Economic Data to get the fed to move in either well this year. It was not just the fact that direction . The fed and other Central Banks cut rates. Peter i dont think the fed will do anything in rates unless the fact is there is just that there is a big change in sentiment, very positive or negative. Much demand. Does demand continue in 2020 . John i think the fed is a big i think we may see as early as component of this. Generally them starting to contain how big the Balance Sheet will be. A lot of this rally started in obviously, there accommodative october when they started policy moves this year will regrowing the Balance Sheet. Looks like we will make it lengthen the cycle which is through the year end without any problems in the shortterm funding market. Reducing one of the major risks in credit, reducing the recession risk. Another thing the fed has done i think in january, they may by bringing down rates is reducing the hedging costs for Foreign Investors who want to start to set expectations that we cannot keep growing at this buy credits. Pace. I think both of those are that will be a headwind on positive. Stocks, ok for the rates market. The fed is definitely a part of the procredit story. Taylor i want to go back to the i want to come back to the idea steepening yield curve. That there is differentiation that is bringing some optimism to a lot of the markets here. Within the credit market, and managers can take advantage of that. Listen to what Morgan Stanley is let me give you an example. We have noted that Energy Credit has really lagged. Saying that it is a step in the right direction. Energy credit has lagged even though management teams are being very prudent with their Balance Sheets. I take big confidence from you see asset sales in order to the steepening of the yield curve. Manage their maturity schedules, that is a measure of success, of confidence about the future. Bring down leverage in some cases. Now we are talking about an endogenous rise in longterm rates. And yet, spreads are still quite wide to the markets. It is not the fed pushing them higher. Energy would be a case where the market is pushing them prudent Balance Sheet management higher because it is more from the leadership and those companies is a positive. Optimistic about the future. Spreads are not reflecting that. Taylor james athey of aberdeen giving a little bit of a that is where you could take some risk. Different take. This is what he had to say. You dont get a recession when the curve inverts. Taylor everyone will be sticking with me. You get it when it reed still ahead, it is the final spread. Again when stephens this week features manufacturing data out of the u. S. And china before we close out the year. This is bloomberg real yield. The fed has 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 prerecessionary yield curve behavior. Taylor john, your take on a steep yield curve, the steepest since 2018 . John i think the resteepening of the yield curve, the fed deserves credit. At the beginning of 2019, the yield curve was inverted, sending a clear signal that short rates were too high, monetary conditions too tight, and the feds cuts have addressed that to some degree. However, i think it is premature to signal an allclear here, to declare success. If you think about the level of yields, inflation breakevens on the 10year are 1. 75, well below the feds 2 mandate, below where we were six months ago. And a lot below where we were 18 months ago. The yield curve is not inverted, and the fed deserves some credit, but we are a long ways from an allclear. I think the level of inflation breakevens is still worrisome and demands attention from the fed. Taylor we are showing a chart of the feds Balance Sheet, you were highlighting this, the togetherness of the feds actions and the Balance Sheet, and how we see a steepening yield curve. Is the steepening yield curve different this time around . Its a good sign given rates are rising on the long end versus the last time we saw a steepening of the yield curve. Eventually leads to recession because it bets on the short end of the curve. Peter i want to take one step back. August is when we got the inversion. I think there were a lot of technical factors at play. A bunch of inflows into long dated treasuries, a shortage of sellers. 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 Departments job. I think the fed has done a lot for that. What im looking for now is the Treasury Department to issue more duration. This treasury is focused on issuing a lot of tbills and frontend bonds. Balance sheet is skewed a little to the front end. I would like to see them come taylor im tayler riggs. This is bloomberg real yield. Out and issue more 10year, 30, maybe introducing a 20year. Time for the final spread. Coming up over the next week, monday, chinese pmi and u. S. Flooding the market with wholesale inventories. Duration to keep the steepening. I think the steepening yield curves gives comfort. Tuesday, the bond market closes early ahead of new years day on wednesday. You can help the economy. It is really the yield curve that leads the discussion, rather than the discussion thursday, china manufacturing leading the yield curve. Pmi data. Friday, minutes of the feds taylor collin, do you agree, are you comforted by the latest meeting. Steepening of this yield curve . Still with us around the table are collin martin, peter tchir, this time is different with the and john bellows. Resteepening after the initial peter, Tony Crescenzi told us inversion. That 2020 will be a year of collin i agree with john, this coupon clipping. Is a success by the fed. They lowered rates and got the if you look at returns, is it price or coupon in 2020 . Yield curve out of negative tory. I do think its important to put peter for the total return it in perspective. Investors, youll have to be it is still relatively flat if careful. You look at the threemonth, 10 year, you are still in the 25, it may be a coupon clipping. 30 basis point range. For spread investors, you can do when you look at the broad yield well. You will have to be aggressive, curve, it is still a relatively as john talked about. Flat trend. Energy could outperform. If you look at the past mid you have to be overweight. Cycle adjustments of the 1990s, that was also followed by a steepening of the yield curve. You have to be overweight some of those sectors that still have we saw a recession push back and juice in them. You have to time the market. There will be opportunities to buy and sell, rebalance your recession expectations push back portfolio. I think that will drive returns a little bit. We do think it is a success, but much better. We need to see more before we taylor it is time for the see an all clear sign. Taylor john, as you look at rapidfire round. 2020, is the pain trade higher how many fed cuts in 2020 . Collin. Yields or lower yield . Collin zero. John if i could respond to peter zero. Something that collin said about the midcycle adjustments. I think its important for john i will be a little more bullish and say one. Investors to understand this is not the 1990s anymore. Taylor what is the upper bound the fed is doing something for the 10year in 2020 . Very different than what theyve collin we think 2. 25. Done in the past. They are not responding to upper bound, 2. 5. Something global. They are responding to low peter 2. 75. Inflation here in the u. S. They have made that clear. John for the 10year treasury . Powell has tied future rate hikes to inflation explicitly. This is not something that we taylor upper bound. Think will be reversed in the next two years. John 2. Taylor what part of highyield outperforms . Instead, as long as inflation you know what, i will just get remains low, the fed will be on one answer there. Hold. Its important to emphasize, this is not 1990, this is about inflation. Collin martin, peter tchir, john bellows, thank you. This is bloomberg real yield. 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. That could very well happen if you see some kind of reignition of Global Growth and optimism, and yields move higher on the backend. But if inflation did not move higher and we didnt 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 the 1990s. Important for investors to understand that. The second point is i think 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, it is the Auction Block. The 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. En taylor im tayler riggs. This is bloomberg real yield. I want to go to the Auction Block and begin with asia. Japan sold just under two trillion yen of negative yielding twoyear bonds. Scarlet im scarlet fu. The bid to cover ratio was 7. 4 this is etf iq, where we focus on the assets, risks and rewards 4. 7 times close to the offered by Exchange Traded funds. Sixmonth moving average. Italy sold 2 billion euros of zero bonds due in 23 months. Investors offered to buy 1. 48 times the amount sold. The bonds were sold at a slight premium with a yield of. 005 . Scarlet tale of two years. Here in the u. S. , the Treasury Department holding three etf flows show caution reigned auctions this week for 2, 5, and for most of the year until risk 7year notes. Took over in november. How does that set us up for 2020 . Demand of 32 billion for sevenyear notes rose from the we get passive aggressive with the big three. Last auction. Blackrock, vanguard, and state demand for two and fiveyear street sound off on what is notes was lower than average. Fueling the fire of etf adoption. Elsewhere, Corporate Credit is and the Holiday Season calls for an etf whose motto may as we looking to finish the year on a high note with highyield rallying for 16 consecutive sessions. Wells fargo weighing in on the recent outperformance in the junk space. Across highyield, you are pulling in 2020 returns into 2019. I think there is a yearend 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 highyield. We have gotten to a point where spreads are low, prices are high, and the returns we saw