Pros and Cons of Negative Interest Rates (January 24, 2020)

Lisa Abramowicz: Joining me around the table here in New York, Maggie Labi of Janney Montgomery Scott. Mark Lindblom of Western Asset Management. And Sam Dunlop of Angel Oak Capital Advisors. Mark, negative rates, they're going away anytime soon.

Mark Lindbloom: Probably not. However, a lot of the the press that we're seeing here and talking about negative rates and what a bad thing they are, it's not as if the central banks around the world, particularly ECB, asked for that. Their mandate is inflation and economic growth. And they're responding to that. Secondly, I think that there's a lot of optimism around the world right now, a bit of a Goldilocks situation. We've seen a bit of a change in that recently. So there's there's room for downside there. That growth is yet to come. So we think the prudent measures that the ECB and others are going about are justified. And then finally, a third point I would make is that the folks arguing that this is a bad thing, you have to look at the opposite and say, what if this hadn't happened? Would the world and Europe in particular be a better place? So while we don't like it as much as others, and we do think that it's not a place to be invested, we do think that they are sticking with their mandates and watching right now the gap between us and German two-year bond yields.

Lisa Abramowicz: It has shrunk to the narrowest since 2017. And I wonder how much this is evidence of just European investors flooding into the US to take advantage of that extra yield and pushing yields down here. What do you think?

Mark Lindbloom: There's no doubt that there was a tremendous amount of savings around the globe. And we've seen at Western from all of our offices around the globe, inflows from Asia, from Europe and a lot of parts around the world into the US as the high-yielding country of the world. So that has certainly been a key factor with recent inflows and the support of bond markets. The other side of that, though, is we get back to this idea of growth and inflation. And are the central banks--that would be the Fed, the ECB--doing the right thing? Growth is OK. It's not great. There's a lot of optimism. There could be softness. But we do know and our guiding light has been this low inflation with inflation where it is, it seems wise to us that people buy bonds either because inflation is low or as a diversifier to their global portfolios.

Lisa Abramowicz: You know, given the fact that you're pointing to this shift from foreign demand to domestic demand, I do wonder how much the Fed is kind of fueling this with their repo facilities. I mean, they say, yes, it's bills. This doesn't count as quantitative easing. But how much is really that? What's going on, Mark?

Mark Lindbloom: We don't think a lot of the Federal Reserve has been quite concerned about the level of reserves in the system that we think have done a very good job of maintaining the Fed funds level between one and a half for one to three quarters, which is our stated target, obviously, and we're not so concerned about about them accomplishing that or continuing to accomplish that. So there was a big scare, as you know, at the end of the year about the level of reserves and what we might see rates do over over the turn. And we thought they did a very good job of getting in front of that. We see them continuing to provide reserves, whether that is through a continuation of buying bills or repos or some combination. We're just not particularly concerned. We don't think it's been driving a lot of the inflows into the Treasury market. It is supportive, though, of the Treasury market.

Lisa Abramowicz: This is sort of been the theme that I've been hearing. It's not a great risk reward proposition. Doesn't look like it's imminently going to collapse. We talk about high-yield bonds, right. Are you just avoiding it? Are you being selective? How do you approach it to agree with that sort of thesis?

Mark Lindbloom: You know, for bond guys, we're pretty optimistic. We think the economy in 2020 is going to be OK. We hope pray around two quarters. Fundamentals are all right.

Lisa Abramowicz: That's a bond person being optimistic.

Lisa Abramowicz: We think it's going to be OK. A bit gloomy maybe. We're OK. Carry on.

Mark Lindbloom: Earnings coming in ok, so given all that, however, we don't think it's going to be to Sam's point another 2019, which was spectacular no matter how you look at, hard to find things that went down in 2019. So we think this year we'll be much more. We'd be much more selective. Sort of a bond picker's market, if you will. And what we've been doing based upon that is reducing below investment grade quite significantly given the risk reward that he talks about. We just don't think it's there at 5 percent-ish and 330 basis points over similar in European. However, where we do find value with the help of our credit analysis of things like bank loans, which have been not doing as well, see yellows which have been bloodied over the last couple of months. So when did the shift in the fourth quarter, particularly in November, when they were having a hard period of time. I have to be very careful in picking those names, both in the primary market as well as the secondary market, but we see much better value there. And the other area, too, that we haven't talked about, we feel is a lot of value. The name of the show is real yields. So all related to real yield is on emerging markets. So those are the three that we're being very selective, unlike last year where we felt. You know, a lot of sectors were doing quite well.

Lisa Abramowicz: How much is the emerging markets back contingent on the dollar weakening?

Mark Lindbloom: Well, obviously, it depends upon his dollar issuance or if that's local bonds. And we're approximately half and half an hour broad market portfolios. But we do think to your point, that this year will be better for the local bonds as well as those currencies. If those fundamentals hold up the way we think they will in 20.