jonathan: from new york city to our viewers worldwide, i am jonathan ferro. 30 minutes dedicated to fixed income, this is "bloomberg real yield." ♪ jonathan: coming up, a left-wing candidate you've probably never heard of spooks investors one week away from the french election. the president has a message for the bond bears. he likes low rates. treasuries rally for a fifth straight week. yields dropped to 2017 lows and a fixed income trading revival continues to drive earnings on wall street, but muted low growth rate raises concerns about the economy. we start with the big issue -- why a left wing candidate in

france is spooking the bond market. >> mr. melenchon could be very dangerous because he's anti-europe, anti-euro, anti-austerity, and he could enact that with the national a assembly behind him. >> the concern right now as much as anything else is the fact that most of the landscape is there, the ideas that we have for the future french politics is different from what we have seen in the past. >> the market was not thinking it was a four-way race. it was perhaps macron versus le pen and laplante would still lose. >> this is the most uncertain election in a very long time. jonathan: i candidate called melenchon capturing the story. the amount of mentions of his name in stories. no mention, no mention, and then bang out of nowhere is melanson. joining us now is the manager of an $18 billion core fun and joining us around the table is

the manager of panic associates and the cio of the libyan advisors. i want to begin with you very quickly. it's another candidate to get concerned about. give me a reason to purchase french bonds ahead of the first round. >> the one thing we know is that we don't know. for us to commit client assets based on our view of an election is imprudent. if we learned anything from brexit or the trump election is that pollsters are having a very difficult time capturing these new populist movements. we at western try to find some type of cheap insurance. coming u.s. treasuries being the easiest one, where the thought being that if there is a bad outcome, u.s. treasuries are more than likely doing better. jonathan: we have had this big safety bid to come and support u.s. treasuries. on the other side, who is the most market friendly candidate to come into the second round?

would it be le pen or melenchon? >> le pen is actually the more market friendly potential candidate, but interestingly we saw what happened in the u.s. when the news mansions goes up, the candidate rises quickly. the market reaction at least in terms of some volatility was impressive. if you look at french equity markets, volatility is not that high yet. jonathan: using the polls and the chances of melenchon and le pen winning, the spread keeps blowing out. the 10 is about 70 basis points. that kind of political risk and a sovereign space, you're talking about what you're seeing in european high-yield and a credit at the time of this political uncertainty that dominates european markets at least for the next several months.

>> the good news is that you are fairly valued by my analysis. you can look at the spread between the european high-yield index and the u.s. high-yield index and i would be further massaging on that because you have to adjust for a very major difference in the ratings index between the two markets. even after adjusted for that, europe tends to trade wider on average. it would be much more worrisome if you are in a stage where europe was significantly overvalued. you would be more vulnerable to a shock. jonathan: where is the biggest risk at the moment to europe? visit in the corporate bases outside of sovereigns? carl: i would say european credit is a little overvalued versus u.s. spreads are little tighter. risks are little greater. it's hard to find value at bund

at 20 basis points. jonathan: martin, what do you say to that to the idea that european credit is overvalued, maybe more than the u.s.? martin: you're covering a wide range. my work really focuses on the high-yield sector. i think right now u.s. is a little bit hard to gauge in itself. we talk about relative value and you're talking about an abnormally low interest rate share and credit valuations being a little bit hard to gauge. fran: when you talk about technicals and central-bank balance sheets and their indirect impact on markets, fomc has had an indirect impact on markets, bringing the whole curve down. the ecb has purchased investment grade corporate debt. when we talk about central banks unwinding policy down the road, that technical may be more impactful.

jonathan: carl, where is the biggest distortion in europe? visit the credit space or is it in the sovereign space where you can see 10-year buns at twentysomething basis points? even the likes of 20 basis points are credibly low nominally? where is the biggest distortion? carl: you can make an argument either way. both are overvalued due to ecb buying in my opinion, but probably on the margin sovereign space is just too low. jonathan: too low. the big question around this table is whether you want to be active or passive. last week we had a lot of active managers saying it's time to be active. as a guy who sets up etf's, you give me a reason to be passive

right now as a fixed income investor. fran: first of all, i think without hedging my response, using fixed income etf's, even passive ones, does not mean you are being a passive investor. you can look at the lineup on bloomberg and search for a fixed income and you can look at the lineup. there are a wide variety of products and a wide variety of spaces. you can get longer duration or shorter duration via etf's just in a diversified portfolio. you hit shorter duration yield, emerging markets, etc.. you can make asset allocation decisions using etf's. that's a big way that fixed income etf's are being used. they are being used actively to set up an income portfolio. jonathan: carl, what is your response? carl: i really believe an active management and fixed income space. we just have too many built-in advantages. the bond indexes about 75% government or government related low yielding securities.

if i put together a portfolio that yields more than the benchmark, i win three out of the four cases. spreads widen a little bit, which is a compensate for the kerry, i still win. when securities are taken out of the index, i don't have to sell at that price. a great example is november 2015 a very large high-yield issuer was in the high-yield index. in the month of december, bonds were up 15 points. it was never that bad and never that good, but the index had to sell down 25 points. jonathan: fran, what you say back to that? fran: index funds or etf's are not full replication strategies. they cannot be in the credit space at least. and etf manager for a large issuer like that in the investment grade space is not going to hold on to petrobras. that's true.

we happen to have a fixed income strategy that is past and by bonds like that, u.s. fallen angel bonds, and petrobras was a fallen angel. the index has been around for 13 full calendar years and has outperformed merrill's high-yield index for 11 of those years. martin: i would just make a couple of points. i would differentiate between going outside the box and active management. i think those are two different concepts. the other point is the notion that has gone out there that this year will be a better time for active managers because correlations are down. i've done this work only in high-yield, but the bottom line in high-yield is that the active funds outperform when the market goes down and they underperform when the market goes up. that has nothing to do with correlations and that simply

because they are less volatile and somewhat more conservative in that sense than the indexes. fran: the growth of the fixed income etf's at van eck has largely been driven by institutional investors who are using etf's and a consummate to refashion, so these are tools as i mentioned. they can be used to make adjustments in an overall portfolio duration and obviously some of the efficient trading and cost efficiencies. jonathan: you will be sticking with us. coming up, the auction block. a big week for treasury issuance and another rough week for bond bears. from new york city, you're watching "bloomberg real yield." ♪

♪ jonathan: jonathan ferro from new york and this is bloomberg real yield. a light week for corporate issuance and we did see auction pick up on the sovereign side. the auction cycle here in the united states had $24 billion auctioned and $12 billion in 30 years. looking closer about 30 year bond sale with a yield at 2.23, the lowest since november. despite the supply, those governments all getting extra energy as the trump moves the bonds. the president says he likes low rates and the market responds with lower yields. we are back now with carl, fran, and martin. great to have you with us. carl, let's begin with you very quickly.

is that a fundamental change for the markets? should you get a re-price on treasuries just because the president says he likes low rates? carl: i mean, everyone wants low rates. rates are determined by the fundamentals, not someone's opinion. it's a level of inflation and economic growth and you have to be respectful of international sector. at 225 u.s. 10 year may not be interesting to someone in the united states, but to someone in frankfurt or tokyo, it's terribly interesting. jonathan: fran? fran: i agree with carl except in a way i would like higher rates. i would like a normal rate environment. in the u.s., as carl mentioned, we are luckless or to that then obviously japan or europe are. i like to see a set of conditions that encourages the fed to do most likely to more hikes this year. jonathan: carl, we have had this range a long time through 2017 and went through the low end of it yesterday. my question is as follows -- is this an inflection point where

we do start to grind materially lower from here on treasuries? carl: i think rates are pretty fair. i think the bond market has reacted very rationally. rates sold off a lot on trump optimism. we retreated in yield and we are dialing back that optimism. i think the 22510-year is pretty fair. jonathan: yet this big thesis right now that high-yield u.s. is incredibly overvalued. the 10-year at 220 -- does that, kick the thesis and somewhat -- complicate the thesis in someway? martin: it is built on a multiple regression model and taking into account credit availability, economic conditions, and interest rates. the question has been raised. historically low rates has met to the economy that the model would show the markets being

rich under these conditions because the interest rates are being held artificially low. i throughout the earlier period and looked only at the data of quantitative easing until now and the market has still been expensive through that since 2008 and not expensive if you look at it from a longer historical perspective, but still expensive. jonathan: the things look that extensive to you, carl, the united states? carl: we are not negative on corporate america. the balance sheets are still healthy, but you have to be respectful of the fact that spreads have come a long way. you have got spreads at very narrow levels. we have been taking some selective profits and our credit portfolio, but we are still positive on corporate amerco. jonathan: does it drop in quality, martin? martin: if you are concerned about credit in general, you are going to stick to the higher end because the downswing is going to be greater and the lower quality.

not to say that higher quality is cheap, but you will have less price exposure there. fran: you get greater interest rate sensitivity in all likelihood when you go up in quality, so it depends a little about your concerns, but there has been regression throughout the credit curve. so higher quality approach is i think rational at this stage. jonathan: in terms of taking risk, there's a decision on either long em or long yield. where do you stand on the argument currently? carl: we are very subsector specific. we like the banking sector. we don't like telecommunications. we don't like pharma. we don't like energy. our head of credit says lend someone who doesn't need it. jonathan: do you see the same fame at the moment? martin: we compare the spreads on emerging markets, high-yield, and u.s. high-yield and then do

some further processing on that to adjust for the difference in ratings makes and those two indexes -- ratings makes in those two indexes, and it's always whiter than the u.s., but the question is how much wider? right now, not enough and the emerging markets are relatively expensive. jonathan: do you agree with that, fran? fran: what proxy are using for emerging markets? are you looking at high-yield credits? martin: yes. fran: i wanted to highlight within emerging markets that people are talking about going to em debt and they should be talking about dollars sovereign's, dollar corporate's, or local currency sovereigns. within the credit sector alone, emerging market high-yield is "higher-quality" than the u.s. it's a low to mid double be on average and it's hard for many emerging market issuers to earn that rating, so the fact that

you get that, those are attractive features. the em to u.s. high-yield spread has narrowed over the last year, which does make it appear, like most high-yield markets, not perfectly cheap. jonathan: where you stand on energy right now and high-yield? martin: it rings vulnerable for a couple of years. high-yield was moving in lockstep with crude oil price and that has backed off. we are not seeing as closer correlation. if you are to see a drop off anything we had getting down to half of where oil is right now, high-yield would still be vulnerable. fran: flows were following crude oil market incredibly. if you look at inflows and outflows to high-yield etf's, they were following the oil market quite closely for some time and now a little decoupling.

you're not seeing the flows as energy prices rise. we are at a level getting toward the mid 50's where people were very happy when we got to the low 40's and energy prices for a large number of producers in the high end of the spectrum. jonathan: what is the bullish case for energy credit? what specifically for energy and emerging markets? carl: if you think about energy in terms of where it is on the credit and business cycle, energy just came out of recession. everything in energy company is doing today is to become more credit worthy and improve the balance sheet. we like energy both investment-grade and high-yield. jonathan: you're sticking with us. carl, fran, and martin. we want to get a check of where markets have been this week. yields grinding ever lower, down three basis points on the week so far. 10 year yields grinding down by

10. 30 year down three full percentage points. coming up, the final spread. president trump meets the italian prime minister and it's the first round of the french election on next week's calendar. we will look ahead to it. from new york, you're watching "bloomberg real yield." ♪

♪ jonathan: from new york city to our bureaus worldwide, this is "bloomberg real yield." time now for the final spread. you have got some imf meetings, the fed beige book, earnings from the likes of goldman sachs, and earnings continued here on wall street, and a week that concludes with a first round of the french election next sunday. we're back now with carl, fran, and martin. i want to begin with you and look ahead to next week. give me where you have got some conviction given the amount of uncertainty we do have on the horizon not just next week that beyond.

if you were to put one trade on the table, what would it be? carl: i think the long u.s. duration is an easy one because of the national insurance policy against the a lot of bad outcomes, whether it's coming out of france or the u.s.. i think the long u.s. -- i like the long u.s. duration and i like the long emerging markets. they had a good 2016, but remember they had an awful 2013, 2014, and 2015. i still think there are undervalued names like brazil, mexico, russia. martin: we focus on income investing and looking through a variety of specters. within the reads, some of the more specialized -- not the shopping mall types of reads -- but more specialized categories we would still see some value in. fran: i like emerging markets, but i like the local currency space. you talk about being beaten up over several years, the mexican peso sold off hard during the election, but many

emerging-market currencies had a brutal 2012-2013. countries like brazil, they lowered rates since the fall. they have a long way to go. jonathan: there are reasons for that, martin? martin: i would say there is uncertainty on the political front. you have a very dire situation in venezuela right now. there are always things to be worried about. jonathan: there always be something to worry about even after we get through this french election. i want to say thank you and rep things quickly with a quick fire around where ask you a series of question and you give one-word answers. carl, i'm going to begin with you. long oh 80's or bones? carl: both. fran: oats. martin: oats.

jonathan: fed reflation or long? fran: said. martin: fed. carl: long. jonathan: treasuries are credit? coral: both. martin: credit. fran: credit. jonathan: just to wrap things up, long high-yield or long em? carl: that's a tough one. i'm going to go em. martin: high-yield. fran: the em. jonathan: my special thanks to carl, fran, and martin. that does it for us. next week, we go back to friday 12:00 p.m. new york time and 5:00 p.m. in london. from new york city, you up and -- you have been watching "bloomberg real yield." ♪

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