jonathan: from new york city for our viewers worldwide, i am jonathan ferro. this is 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, the federal reserve delivers a dovish hike in treasuries rallied. how chair yellen can pull off a beautiful normalization. on the auction block, what could be a record quarter for issuance takes on a crude reality. cracks begin to appear in junk bonds once again. and the uncertain world of politics collides with g-20. despite rejectionism and trade

-- concerns about protectionism and trade wars, e.m. comes out on top. we start with a big issue then, it is the federal reserve and a dovish hike. bill gross: when we learned that janet yellen is the perpetual dove. >> the fed has indicated that it will see something like three rate hikes again next year. there is some expectation they might accelerate that, but i do not think that is really likely at this point in time. >> i think we could see four hikes this year. it really depends on how strong the economy shows up. >> if the data continue to say the economy is coming back, they maintain their confidence, june is certainly on the table. jonathan: so the fed took the lead on rates and the markets rates and the markets followed. joining us from california is mohamed el-erian. he is the economic advisor at allianz. with me in new york is robert tipp, head of global bonds and i am very pleased to say this week, lisa abramovitz joining us, the gadfly columnist. mohamed, i want to start with you. are we witnessing a regime

change where the fed leading the market and out the market market and out the market leading the fed? mohamed: i think we are, and we saw it as early as two weeks ago when the fed implied the probability of a hike was only 30%. it was a very coordinated matter to triple net probability, so by the time it hiked two days ago, the market reaction was favorable. so yes, so i think we are seeing the fed's transition regimes, and it will be leading rather than following market. jonathan: robert, you are looking at what most people have characterized as a dovish hike you completely disagree. robert: i do. inghink the fed is rope a dop the market. when you look at the dots and how they have progressed, the participants of the meeting that wanted the under as of december 16, you had six of them that wanted the under and five that wanted the under.

when you come to this meeting, you have five that want the over and three that want the under. so in other words, the balance. the medians did not change but that participants shifted. i think janet yellen also hinted at this when she described gradual and what that means, i think they may be setting the market up to hike three times over the balance of the year, but do not want to over emphasize that and scare the market which might make it possible for the to be impossible tdo. jonathan: is there a hawkish tilt as far as you see things? mohamed: i think there is, but yellen went out of her way in the press conference to moderate it. i think what you are seeing is a more confident fed. a fed that sees the domestic economy improving, sees lower risks from the rest of the world, and is comfortable about three hikes this year, three hikes next year. what i think you will see next, jon, is a shift in the balance of risk, that they will hit to the extent that the change in the baseline is toward a fourth

hike rather than towards two hikes this year. and then i think down the road, if president trump and congress deliver on the pro-growth trifecta of tax reform, the regulation and infrastructure, you will get a fourth hike. lisa: i have to say, i am struck the fact that the market did not move all that much. maybe this is a short bet getting squeezed out of the market, but if you look at my terminal, you look at what happened to the yield curve, you can see down here was the all-time low. that was the lowest level since 2008 as far as the compressed five and 30-year yield curve. it blitzed up a bit, but this is not the entire market considering we are going to see some kind of major growth as a result of the fed holding off. jonathan: what do you make of the message that ces of the curve 530 spread which has been flat over theast cole of months? mohamed: i do not make much of

it. what i make a lot of honestly, and i would be interested to see what lisa thinks, the spread of the treasury and the bund. and that has narrowed, and it tells you there are two things going on. it is not just the u.s. i think there is a phenomenon going on where central banks are becoming less dovish around the world. lisa: well, yeah, and if you go into my terminal you can see the spread that mohamed is talking about. it is the two-year u.s. yield versus the german two-year yield, and it in its highest level since the 1990's. this basically leads to a question of, will this be borne out in the currency markets or is this where you are going to see the dollar strengthened potentially if people come to the u.s. to catch those yields? jonathan: we have to bring europe into the conversation. the front end has been anchored by the rate of 40 basis points and if you look at the situation in europe versus the united states, there is a clear divergence between japan kind of

bouncing along the middle, europe in the negative, and treasuries way up there. is that spread going to reconcile anytime soon? robert: even at the ecb, i think they are beginning to become concerned about this. they have a very tricky job. on one hand they want to taper and get out of the bond buying business, and they want to reduce their risk, but i have not been able to avoid that. when you look at the bottom line on that graph, the two-year shaft, the two-year german bond, that is basically at -80, -90, -70 basis points. the bundesbank is buying those, and they will realize that loss and create a squeeze. they come in on the purchases. i think they are going to negative depot rate was not a positive. basically they have been taxing favors in a banking system that is not well-capitalized.

you want to encourage investment but it does not really pay to do that if you are not well and there are not opportunities. jonathan: there was a conversation started at the ecb where they might consider to raise the depot rate before they end qe. let's say we get a 20 basis point move from the ecb back to -20. what does that mean for the front end of the bund curve, and extrapolating out of that, what does that mean for the front end of treasuries and elsewhere as well? mohamed: that would be a remarkable changes they do that, and if they do that, you will see the curve shift in a major way. you will also see currency traders scrambling. i think the bet that a lot of people have on that has not worked so far is that this version will continue both in policies, in monetary policies with the u.s. more hawkish, and

in economic performance. if that does not play out, we will get major movements in currency and the fixed income segment. jonathan: i want to talk about credit just very quickly and bring up duration. you have the bloomberg index and cut it up by duration, if you cut it up with the conversation building in this program was that the longer dated stuff is where the outperformance is? wouldn't you have expected duration to underperform in this kind of environment? why is this happening in corporate credit in the united states? robert: yields are a lot higher than they were the middle of last year, so that brings and lots of long duration buyers and foreign buyers as well have been pushed to the back end of the curve.

in order to get an excess return after hedging, they need to go all the way out there. lisa: i have to wonder how much this is where the foreign bid is. i know there has been a lot of foreign investors coming into the u.s., pension funds and insurance companies trying to lock in this longer dated corporate yield. also you see there has been an incredible divergence between real money investors that are still plowing into these notes, and speculators betting against them and seeing if the prospect of inflation is not being priced in. i would love to get mohamed's opinion on whether or not the market is due for an unpleasant surprise with respect to how much inflation is going to pick up and basically are longer end rate, not pricing this in and all? mohamed: you are absolutely right about the liability driven investment that has led lots of institutional investors to reach for yield, and try and match long dated liabilities. and that has had a big influence. in terms of where the shock is going to come, i worry less about inflation and the credit curve, and i worry more about something you have written about, lisa, which is this combination of high leverage, lots of issuance, and credit quality that is not as good as spreads would suggest. so i think the major issue facing credit investors is to ask the question, do the fundamentals really warrant where spreads are? jonathan: i will get to credit in a moment. you have got to stop plugging

lisa's work. mohamed el-erian sticking with us, robert tipp sticking with us, and lisa abramovitz. next on this program, we take it to the auction block, putting us on course for a record issuance. in for viewers worldwide, this is "bloomberg real yield." ♪

jonathan: i am jonathan ferro. this is "bloomberg real yield." i want to go to the auction block where we are potentially seeing something that has not happened so far the century. investment-grade firms are on track to complete the busiest quarter for u.s. debt sales since at least 1999. appleton morgan stanley have pushed new issues to more than $17 billion. getting in on the action, siemens, offering $7.5 million in bonds, its largest in bonds sales. in europe, we have had 54 consecutive business days for issuance exceeding last year's longest run of 51. this month alone, we have seen over 50 billion euros of debt issued in that area. i want to bring back to the roundtable mohammed el-erian,

robert tipp, and lisa abramowicz. mohammed, to begin with you, what do you make of this surge in issuance we have had going into a rising rate environment? mohamed: historically rational corporate behavior. they are taking advantage of spreads and issuing ahead of what they think will be a rise in government interest rates. it is like the base of the borrowing cost. i think it is totally rational, and the question is, why haven't investors been more hesitant when it comes to buying all of this stuff? jonathan: lisa, why haven't they? lisa: you have the international investors in the u.s. and also the animal spirits. if things will get better and yields will go up, at least credit has a cushion of extra spread. of course that question of extra spread is shrinking dramatically and investors are not getting compensated as much as they should be. jonathan: robert? robert: i think in terms of the cycle, even though the fundamentals have peaked the liquidity is there, and the

default tends to stay very loud. performance tends to remain very good all the way through the fed rate hiking cycle until the fed actually creates a recession so i think it may be way too early for investors to be getting pessimistic. jonathan: there have been significant outflows reported this week, significant outflows in the high-yield space. do the cracks in credit show in a way you would expect them to? mohamed: i do not know if i would call them cracks. people are beginning to realize they are not being compensated enough for the risks they are taking, and that is particularly true in high-yield. there is tremendous dispersion in names. energy dominates. there is a lot of things that is wrong with that index. if you are buying the index, you are exposing yourself to a range of risks that go beyond simply the economy, so i think it is rational. i think investors are starting to realize that they are simply not being compensated enough. jonathan: the potential canary in the credit coal mine, energy. we are starting to see a couple

of cracks. this is the bloomberg index high-yield energy index versus crude. the last time the index for high energy yield companies were this low win crude was $80. robert, what does that chart tell you now that crude is nowhere near $80 but are we costs are what they are? robert: there has been a huge swing on investor psychology and energy, and it looks like it is overdone. i think that in energy, for investment grade firms that have a credit conscious mindset is one thing. they may make it through this cycle, but the high-yield energy companies really are on a nice edge. lisa: i have to be honest. i would normally go with the pessimistic view, but i have had so much pushback so i'm on the other side. the really bad companies are really on the downside, so what is left are creditworthy companies, some who have been downgraded from investment. there could be some of that dynamic as well, but it is not just energy companies because we are seeing retail companies as actually the worst performing slice of the debt market, and an increasing number going bankrupt. there are these sort of potholes out there, but it might be name specific rather than entire index.

jonathan: is there potential for them to bleed through to the rest of the market or does this stay isolated? mohamed: it is absolutely correct to say this should be a very selective investment. you want to be in divine active investor, not passive, has when you are passive you are buying the whole thing and not differentiating enough. what we have typically seen is investors overreact when certain companies go under pressure, so yes, it can leak, and that is investor behavior. we have seen it over and over again. a few names have problems, the whole index gets contaminated, you get contagion, and then you get an overreaction.

the right thing to do is have dry powder and wait, because i think certain segments of high-yield and corporate emerging markets will come under stress. jonathan: is that the trade, go to cash and get ready to pick up the pieces? robert: i agree you have to be selective in this environment, but i think it is too early to be cautious. we have had a backup of spreads and there is a lot of anxiety coming into the fed meeting. i think that is why we rallied on the heels of that. i think you will probably see a recovery from the intermediate long-term here up to performance levels. lisa: yes, there is some cautiousness when you look at yields, but there is not cautiousness when you look at debt issuance. we talked about his earlier, mohamed was talking about the leveraging of these companies, i will go into my terminal and look at league go. this is the total amount of high-yield bond issuance in the u.s. in march. the first line is so far this march, and then going back to

previous years. we are on pace for a record march issuance of high-yield bonds even as we see more than $4 billion withdrawn over the past week. you have to wonder, are investors not taking into consideration these risks? jonathan: mohamed, why aren't they? you said it was rational from the investor side, but why aren't investors lapping it up so much? mohamed: because goldilocks dominates mindsets. people think we will sustain a low volatility environment that they can capture low yields. i would also point to something else. those who have lived ith hi-yield a emerging-market world have seen it over and over again. we get populated by crossover investors. the crossover investors are not specialized in these asset classes. they come in typically through indices. they come in, they are two risk investors. the minute something goes wrong, because they are not anchored by

fundamental understanding of the asset class, they tend to abandon the asset class quickly, and that is why the asset class tends to overreact on the way up and overreact on the way down. be careful also of the dominance of crossover investors because they are much bigger in volume than the dedicated investors. jonathan: i think mohamed is being polite. i think they are also known as tourists. mohamed el-erian sticking with us, robert tipp, and lisa abramowicz. in the markets this week, what a week it has been for sovereign debt. they will build through the week. negative five basis points, 1.3% on the two-year. the 10 year rallying by nine basis points. it will be 30 year coming in by six. coming up on this program, the final stretch. g-20 finance ministers meet in germany, and janet yellen taking the stage once again. this is bloomberg "real yield." ♪

♪ jonathan: from new york city,

i'm jonathan ferro. time for the final spread a -- where we take a quick look at what is coming up ov nexer the week. it will include another speech by the fed chair, and shinzo abe will be in germany as well g-20 finance ministers, where e.m. will likely be discussed. if you look at the bloomberg e.m. index, it shows the group has mostly performed better than expected with donald trump and the white house. i want to bring back our roundtable. mohamed, beginning with you, you talked about the experienced with the emerging markets. it was so easy to paint a pessimistic and negative picture for the emerging markets, but it has ripped. why? mohamed: because they lagged for such a long time, and they were simply too attractive for crossover investors. jonathan: robert? robert: yeah, i would agree, the positioning was really wrongfooted. there has been a lot of rotation

among the different spread sectors. they are out of favor, now they are coming back. jonathan: lisa? lisa: i think that right now emerging markets seem to be following the price of oil and the global backdrop for growth. if you take a look into my terminal, this is a chart of the breakdown of emerging-market, u.s. dollar, quasi-corporate debt, brought to us by bloomberg intelligence, damien in particular. more than 25% of the debt included in this index are tied to oil and gas companies. in other words, where oil goes, so too does the fate of this particular emerging-market debt. jonathan: is that the story in your experience as well, mohamed, for em debt? mohamed: i think oil has a big impact, commodities have a big impact so yes, that certainly is part of the story. i think another part is simply that the asset class was not as

bad as people made it out. remember, this is an asset class that almost by definition goes through potholes, etc. and people underestimate the amount of resilience that there is in that sovereign and quasi-sovereign segment of the asset class. lisa: mohamed, you were talking earlier about tourist investors and high-yield -- what about tourists in the emerging-market? are you concerned the money will come flowing out? mohamed: it is the same phenomenon exactly and if you are a dedicated investor you tend to fade the effect of tourists and you want to have dry powder. at some point it will be shaking out.

and if a tourist gets attracted by the pamphlet, the beach, but the minute there is some crisis, they go to the airport, and they forget that part of being in and emerging-market is you tend to have weaker institutions and things happen. so yes, you want to fade on the way up and fade on the way down. jonathan: let's get to the quick fire round. one word answers, mohamed, i want to begin with you. do you want to be long high-yield or long e.m.? mohamed: e.m. jonathan: robert. robert: i would take e.m. jonathan: lisa? lisa: e.m. jonathan: tighter or wider? mohamed: wider. lisa: wider. jonathan: this time next year will janet yellen be the fed chair? mohamed: no. robert: should be a good pick, but i don't think so. lisa: no way. jonathan: thank you very much for joining us this week right here on bloomberg "the real yield." a programming reminder, the lone dissenter, minneapolis fed president neel kashkari will be on "bloomberg daybreak: americas" beginning at 9:00 a.m. wall street time on thison from new york city for our viewers wodwide, that does it for us. we will see you next friday at 11:30 new york time, 3:30 p.m. in london. you have been watching bloomberg "the real yield." ♪

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