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 rallied for a fifth straight week. yields drop to 2017 lows. the fixed income trading revival continues to drive earnings on wall street but muted loan growth raises concerns about the economy. we start with a big issue, why the left-wing candidate in france is spooking the bond market.

>> mr. melenchon. >> melenchon. >> melenchon. >> he could be dangerous because he is anti-europe, he is anti the euro, anti-austerity and he could enact that with the national assembly behind him. >> the concern right now, as much as anything else, is the fact that most of the landscapes or ideas we have for the future of french politics will be different from what we have seen in the past. >> the market was not thinking this would be a four-way race. it was le pen versus macron. now melenchon shakes that up. >> the most uncertain election in a very long time. jonathan: it seems we cannot concern a certain candidate called melenchon. capturing that story on the bloomberg is the amount of mentions of his name in news stories on the terminal so far. you see this spike, no mention, no mention, and then bang, out of nowhere, it is all about melenchon. joining us now from california is carl eichstaedt, who manages the $18 billion western asset corp.

here with me around the table in new york city is fran rodilloso, head of fixed income etf portfolio assets, and martin fridson, cio of lehmann livian fridson advisors. gents, great to have you with us. carl, i just want to begin with you very quickly. it is another candidate to get concerned about. give me a reason to actually purchase oat's, french bonds ahead of the first round. carl: the one thing we know is that we don't know and 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, pollsters are having a difficult time capturing these new populist movements, so we try to find some type of cheap insurance, u.s. treasuries probably being the easiest one, with the thought being if there is a bad outcome, u.s. treasuries are more than likely doing better. jonathan: we have had this big safety bid in support of u.s. treasuries. who is the most market friendly

candidate to come into the second round? would it be le pen or melenchon, to the likes of macron? >> what we saw from the market reaction is that le pen is the more market friendly potential second-round candidate, but interestingly we saw what happened in the u.s. when the news mentions go up. the candidate rises quickly so i think the market reaction, at least in terms of some volatility, was impressive. perhaps if you look at the french equity markets, volatility is not that high yet. jonathan: in the bond market we captured that story. you see the polls on the chances of a melechon or le pen win, and you see the spread. bunds, oat's, the spread just keeps blowing out, blowing out, blowing out on 10 years at about 70 basis points. that kind of political risk in a sovereign space, talk to me about what you are hearing in european high-yield in the credit space at the time of this political uncertainty that just dominates european markets, at least for the next several

months? martin: the good news is you are fairly valued by my analysis. you can look at the spread between the european high-yield index and u.s. high-yield index. i do some further massaging on that because you have to adjust for a very major difference in the ratings mix between the two markets, and even after adjusting for that, europe will tend to trade wider on average. current year would be much more worrisome if you were in a stage where europe was significantly overvalued. then you would be vulnerable to a shock. jonathan: where is the biggest risk at the moment in europe? is it 10-year oat's at about 92 basis points or in credit, the sovereign space and outside of sovereigns? carl: i would say european credit is a little overvalued versus u.s. the spreads are a little tighter, the risks are a little greater, and it is hard to find value in bunds in the 10-year area.

jonathan: what do you say to that, the idea that european credit is a little bit overvalued, a little bit more than the u.s.? martin: you are covering a wide range. my work really focuses on the high-yield sector. i think that right now, the u.s. is a little bit hard to gauge in itself so talking about relative value, you are talking about abnormally low interest rates and valuations on credit being a little bit hard to gauge. fran: i think when you talk about technicals and central-bank balance sheets, indirect or direct or impact on credit markets, the fomc has had an indirect impact on credit markets, bringing the whole curve down.

the ecb has purchased investment-grade corporate debt and as we talk about central banks unwinding policy down the road, that may be more impactful. jonathan: where is the biggest distortion in europe? in the credit space, given what the ecb has been doing, or in the sovereign space where you can see 10-year bunds at 20-something basis points, oat's 10-years at 90-something basis points? even the likes of btp's, 200 basis points over bunds, incredibly low nominally. where's the biggest distortion? carl: i think you can make an argument either way. both are overvalued due to ecb buying, in my opinion, but on the margin the sovereign base is just too low. jonathan: too low for stock in the sovereign space so 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 is time to be active. as a guy that sets up etf's, you

give me a reason to be passive as a fixed income investor. fran: 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 -- hit etf on the bloomberg -- and there are a wide variety of products in a wide variety of spaces so you can get longer or shorter duration vi' etf'just a passive portfolio. you can make asset allocation decisions using etf's and that is a big way fixed income etf's are being used, used actively to set up an income portfolio. jonathan: carl, what is your response? carl: i really believe in active management in the fixed income space, maybe less so in the equity space. we have too many built-in advantages. the bond index is about 75% government or government related, very low yielding

securities, so if i put together a portfolio that yields more than the benchmark, i win in three out of four cases. spreads are tighter, i win, spreads are unchanged, i win, and spreads widen a little bit, which doesn't compensate for the carry, i still win. moreover, when securities are taken out of the index, i do not have to sell at that price. a great example is november 2015, petrobras was removed from the investment-grade index and in the month of november the bonds were down 25 points. in december they were up 15 points, so it was never that bad and never that good, but the index had to sell down. jonathan: what do you say to that? fran: i think two things. one, index funds or etf's are not full replication strategies. they can't be, particularly in the credit space.

an etf manager in the investment grade space like that will not hold on to petrobras, that's true. we have a fixed income strategy that is passive that actually buys bonds like at, u.s. fallen angel bonds which petrobras was a fallen angel. that is a passive strategyhat you could look at historically. the index is a merrill lynch index that is been around for 13 full calendar years and has outperformed merrill's broad high yield market index for 11 years. jonathan: marty? martin: just to make a couple of points, one is i would differentiate between going outside the box and active management. i think those are two different concepts. the notion that this year will be a better time for active managers because correlations are down. i have done this work only in high-yield, but the bottom line is that the active funds outperform when the market goes

down and underperform when the market goes up. it has nothing to do with correlations, and that is simply because they are less volatile. in some are more conservative in that sense than the indexes. >> i am going to point out that the growth of the fixed income etf's at van eck, has largely been driven by institutional investors who are mainly using etf's in a complementary fashion with their active managers as well. these are tools, as i mentioned. they can be used to make adjustments to an overall portfolio duration, and obviously some of the efficient trading and cost efficiencies are attractive. jonathan: gents, you will be sticking with us. coming up, the auction block, a big week for treasury issuance but another rough week for the bond bears. from new york city, you are watching "bloomberg real yield." ♪

♪ jonathan: i am jonathan ferro. from new york, this is "bloomberg real yield." i want to head to the auction block now. while it was a light week for corporate issuance, we did see auction pick up on the sovereign side. the auction cycle in the united states has $24 billion auctioned in three-year notes and $20 billion for 10-year and 12 billion in 30 year. looking at the 30 year bond sale, it had a yield of 2.94% with a bid to cover a ratio of 2.23, the lowest since november. but despite the supply, they are all getting some extra energy as the trump bump moves some bonds. the president says he likes low rates. the market responds with lower yields. we are back with western asset management's carl eichstaedt, van eck associate, fran

rodilloso, and cio of lehmann livian fridson advisors, martin fridson. gents, great to have you with us. carl, let's begin with you. is that a fundamental change for the market, should you get a reprice on treasuries because the president says he likes low rates? carl: everyone wants low rates. i think rates are determined by the fundamentals, not someone's opinion. it is the level of inflation, it is economic growth. you also have be respectful of the international effect where 2.25 u.s. 10 year may not be teresting to someone in the u.s., but in frankfurt or tokyo it is 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. we are a lot closer to that than japan or europe, but, and i would like to see a set of conditions that encourages the fed to do most likely, two more hikes this year. jonathan: we have had this range for a long time through 2017 and we broke through the lower end of it yesterday. my question is as follows -- are

we clearning the decks? is this technical of the shorts rolling off? or is this an inflection point where we start to grind materially lower on treasuries? carl: i think rates are pretty fair. i think the bond market has reacted rationally. rates sold off a lot on trump optimism. we retreated in yield, we are dialing back that optimism. i think a 2.25 10-year is pretty fair. jonathan: you have this thesis that high-yield u.s. is incredibly overvalued. the 10-year at 2.20, does that complicate the thesis? martin: not really. the judgment that the high-yield market is expensive is based on multiple regression models, econometric model taking into account credit availability, economic conditions, interest rates. the question has been raised, historically low rates have meant the economy is weak so

your model would show the market as being rich under these conditions because the interest rates are being held artificially low. i throughout the earlier period, and i looked only at the data from the beginning of quantitative easing through now and the market is still expensive, not as expensive if you look at it in a longer historical perspective, but still expensive. jonathan: do things look that expensive to you in the united states? carl: i would say the credit market is fairly valued. we are not negative on corporate america. balance sheets are still healthy, but you have to be respectful of the fact that spreads have come a long way. you have spreads at very narrow levels, so we have been taking some selective profits in our credit portfolio, but we are still positive on corporate america. jonathan: is it time to go up in quality, marty? martin: going up in quality, if you are concerned about credit in general, you will stick to

the higher end, because the downswing will be greater in the lower quality, not to say that higher-quality is cheap. you will just have less price exposure. jonathan: fran? fran: you get greater interest rate sensitivity in all likelihood when you go up in quality, so it depends a little bit about your concerns but there has been compression throughout the credit curve, so a higher quality approach is i think rational at this stage. jonathan: in terms of taking risks, it seems you have a decision about either being long em or long high-yield. where do you stand currently? carl: we are very subsector specific. we like the banking sector, don't like telecommunications, don't like pharma, we like energy. our head of investment grade credits likes to say, lend money to someone who doesn't need it, don't lend money to someone who needs it. jonathan: do you see the same sector breakdown at the moment? martin: looking at the overall picture, 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 mix in those two indexes. and emerging-marke, even after that adjustment, is always wider than the u.s. the question is how much wider? right now, not enough and emerging markets are very expensive relative to u.s. high-yield. jonathan: do you agree, fran? fran: i want to ask marty, what proxy are you using for emerging markets? high-yield credit within emerging market or? martin: yes. fran: i wanted to highlight within emerging markets, people talk about going to em debt. they could be talking about dollar sovereigns, dollar corporates, or local currency sovereigns. within the credit sector, emerging-market high-yield is "higher-quality" than the u.s., sort of a mid to lower bb.

and it is harder for many emerging market issuers to earn that rating. the fact that you get that in a spread over u.s. high-yield over a shorter duration, those are attractive features, but the e.m. to u.s. high-yield spread has narrowed over the last year, which makes it appear like most high-yield markets, not particularly cheap. jonathan: where do you stand on energy in high yield? martin: it remains vulnerable. for a couple of years high yield was moving pretty much in lockstep with the crude oil price and that has backed off. we are not seeing as close a correlation. but if you were to see a drop off anything like we had getting down to half of where oil is now, high-yield would still be vulnerable. jonathan: fran? fran: flows are following the crude oil market incredibly. inflows and outflows to high-yield etf's, they are following the oil market quite closely for some time and now a litt bit of decoupling, no

seeing the inflows as energy prices rise. now we are at a level getting toward the mid 50's where people were very happy when we got to the low 40's in energy prices, for a large number of producers, particularly in the higher end of the spectrum. jonathan: what is the bullish case for energy credits, more specifically energy in emerging markets? carl: if you think about energy in terms of where it is on the credit cycle, on business cycle, energy just came out of recession and everything they are doing is becoming more credit worthy, improving the balance sheet. we like energy, both investment-grade and high-yield. jonathan: gents, you're sticking with us. carl eichstaedt, fran rodilloso, and martin fridson. want to get a check on where the markets have been this week. bonds, twos, 10's, yields grinding ever lower. down three basis points on the week so far. 10 year yields down by 10.

a 30-year, sub-three full percentage points. still ahead on this program, it is the final spread. u.s. bank earnings, president trump meets the italian prime minister, and it is the first round of the french election on next week's calendar. from new york, you're watching "bloomberg real yield." ♪

♪ jonathan: from new york city for our viewers worldwide, i am jonathan ferro. this is "bloomberg real yield." it is time now for the final spread. over the next week, you have some imf meetings, the fed beige book. you have earnings from the likes of goldman sachs and earnings continue on wall street. the week that concludes the first round of the french election next sunday. carl, i want to begin with a look ahead to next week. give me where you have some conviction, given the amount of uncertainty we have on the horizon, not just week but beyond. if you were to put one trade on the table, what would it be? carl: i think being long u.s.

duration is an easy one because it is the natural insurance policy against many bad outcomes, whether it is coming out of france or the u.s. i like being long u.s. duration and long emerging markets. they had a good 2016, but remember, they had an awful 2013, 2014, 2015, so i think there are still some undervalued names, brazil, mexico, russia. jonathan: martin? martin: we focus on income investing and looking through a variety of sectors, preferreds the biggest component of it, the reit's. within the reit's, some of the more specialized. not the shopping mall type of reit's, but more specialized categories. we still would see some value in. jonathan: fran? fran: i like emerging markets, but i like the local currency space. when you talk about being beaten up over several years, mexican

peso sold off hard during the election and they had a brutal 2012 through 2015. yields in that asset class averaged 6.5%. countries like brazil, they have lowered rates 300 basis points since the fall. they have a long way to go. jonathan: they yield that for a reason, don't they, marty? martin: there's uncertainty on the geopolitical front. you have got a very dire situation in venezuela. there are always things to be worried about. jonathan: even after we get through this french election. gents, i want to say thank you and wrap things up with a quick fire around where i ask a series of questions and you give one word answers. carl, i am going to begin with you. long oat's or long bunds? carl: oat's. martin: oat's. fran: oat's. jonathan: fade reflation or long inflation?

carl: fade. martin: fade. fran: long. jonathan: long treasuries or long credit, treasuries or credit? carl: both. jonathan: marty? martin: credit. jonathan: fran? fran: credit. jonathan: long high-yield or long e.m.? carl: that's a tough one. i'm going to go e.m. martin: high-yield. fran: e.m. jonathan: my special thanks to western asset management's carl eichstaedt, van eck's associate fran rodilloso, and lehmann livian fridson investors marty fridson. that does it for us. next week, we go back to fridays, 12:00 p.m. new york time, 5:00 p.m. london. from new york city, you have been watching "bloomberg real yield." ♪ so you're having a party?

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