♪ jonathan: from new york city for our viewers worldwide, this is 30 minutes dedicated to fixed income. this is bloomberg "real yield." ♪ jonathan: coming up, chair yellen has a plan to unwind a $4.5 trillion balance sheet. it makes it as boring as watching paint dry. the u.s. economy's first quarter was not so miserable after all but a big upward revision fails to shake treasuries. opec, whatever it takes falls on deaf ears. production cuts struggle to stay -- to stabilize oil. we start with a big issue, chair yellen's campaign to make the

fed boring again. >> predictable, slow, and as boring as possible. >> the fed noted that market participants had anticipated their expectation of balance their expectation of balance sheet reduction but that the market has been able to absorb that. there is a comfort that there won't be a reinvestment taper tantrum. >> everyone knows how to calibrate interest rate increases and their effects on the economy. no one knows how to calibrate a billion dollars of balance sheet reductions. what impact does that have on the economy? we don't know. >> is the fed back to trying to make markets feel comfortable again? were they shaken by last wednesday's selloff so much that we are back to the old fed, or is the fed going to try to lead markets? jonathan: joining me around the jonathan: joining me around the

table is greg peters, a senior investment officer, and bonnie wongtrakool, and in st. louis we have brian rehling. brian, i want to begin with you and talk about this issue around the balance sheet. is it going to be as boring as the federal reserve suggests and hopes? brian: absolutely. the whole point for the fed is to not use the balance sheet reduction as a policy tool, in my opinion. they used it once they wanted to drive rates lower and the point is to get out of this with no disruption. jonathan: greg, this will not be a policy tool for those hoping they would move on balance sheet and pause on rates. will they be disappointed? gregory: i'm not sure. i am not sure it will be as boring as the fed thinks. just because they say it will be boring, does not mean it will be boring. it introduces each fed meeting into play. they are talking about slow and steady but at the end of the day, they have to readjust, and what happens when the economy slows down and the signaling is,

we need to actually reduce the number, not increase the number? i am not as convinced. bonnie: i think the fed did a very good job in communicating a well thought out plan, and this increasing cap structure is one that gives a lot of uncertainty -- a lot of certainty to the market. target participants have been grappling with it and it puts it at ease. for example, treasury maturities being very lumpy in 2018. with this cap structure we know that will not be an issue. it also assures the market there will not be asset sales, so if there was a fixed amount they had to buy if there were not enough mortgages prepaying, with -- would they be selling mortgages into the market? they will not do that. if there will be some episode where we have a flight to quality treasury rally, we will see bit of a countercyclical balance under the structure. nathan: i sat down with mohamed el-erian a few years ago and he said this will be the

loosest tightening in history. i did not expect them to tighten. talk about balance sheet normalization, and yields still grind lower on ten-year treasuries. why? gregory: you look at the balance of data, it has been mixed. there has been an upward revision of the first quarter but it is still at the same kind of trajectory we have seen the past few years, 2%. i don't think that changes. i think the inflation number is key. in my mind, inflation peaked in february so the fed is doing anti-qe. we have had all of this stimulus thrown at the u.s. economy and we grew 2%. what happens in an anti-qe type of environment when inflation is subsiding and coming down and growth is not on the same track that many thought? i think that is your answer of why yields are where they are. jonathan: does that mean the treasury bears are going to have a tough time for the rest of 2017?

just like they did for the first quarter and coming into the second quarter as well? brian: i think so. i think we are range bound. the previous guest was spot on, it is the inflation story. while the survey-based measures are ticking up, you look at the long-term market-based measures of inflation and they are starting to trend a little bit lower, from a quite low level so i am not sure why the fed is in such a hurry to do three rate increases this year. jonathan: are we going to stay in this range of 220, 240? if you get to 240, you fade reflation and if you get to 220, you buy reflation. you'd jump up and down. is that what you expect? bonnie: we would expect volatility to remain low. you have got geopolitical risk and that will keep ceilings on yields as well as low global interest rates. we still have negative yielding debt. it is way down from the high, but you still have $9 trillion in debt. that is going to be a factor to prevent yields from rising

materially. on the other hand, growth has not been great but it is ok. the idea that we should be a lot lower in treasury yields, it is a challenging one to put forth. jonathan: at the start of the year, we had an aggressive short in treasuries and i want to pick out the speculative positioning on the 10 years because it has anged. we came into the year with a big record short. we snapped back aggressively. jeff gundlach asking the question, when this chart zigs, should you zag? because when this was aggressively short treasuries, the positioning has changed. do you have to go the other way to think about where the positioning is? >> you need to think about positioning, but it does not change the fundamentals of the trade. so you are talking about 10 to 20 basis points. that is real money, don't get me

wrong. but at the end of the day, the longer-term trends are in place that i think serve as a range bound type of existence for 10 year yields. jonathan: what do you make of that, the consensus reflected has often been wrong in the treasury market over the last couple of years. will it continue to be so? brian: probably. right now, i think the market will be relatively calm for the balance of the year. the market has a funny way of surprising us. jonathan: i ask this question on almost every show over the last couple of months. have we seen the low? the 10 year yield low? have we seen that yet? i am going to ask you the other way, have we seen the high on the 10 year yield this year? bonnie: with respect to the low, that is not something we can answer. there are still a lot of geopolitical risks that could push us below 2.16 so i think that is something as asset managers, we should not try to predict. whether yields could rise higher, i would put the chances

on meaningful fiscal reform this year. i think they have diminished and the market is coming to grips with that. to think that yields could go a lot higher than 275, i would definitely take the under. jonathan: greg? gregory: let's just talk about election night. during election night, the 10 year -- when it looked like the trump administration was on its way to winning, the 10-year hit 170. in a month's time, it was 270. i think that helps define the range. i am not saying 170 is the right number, but sometimes that snap reaction and directionality is more proper than a month later. jonathan: you think we could get back to 170? gregory: not necessarily, but i think there is a gravitational pull down to those levels. not a lot has changed since then from an economic standpoint, and inflation readings were more positive at that point, from a

trajectory standpoint. jonathan: bonnie? bonnie: going back to the positioning and futures, the -- in futures, the fact that is cleaner makes these moves less so we may not see as much volatility because the positioning is cleaner. jonathan: do you agree with that, brian? and another question i will throw into the mix as well, we talk about the treasuries and the domestic u.s. economy but we have not talked about what the ecb might do on the back half of the year. how critical will that be to the treasury market and the anchor that it has had in the last year? brian: in an average year, the 10 year treasury trades at about 120 basis point range. either the high or low are getting taken out some point this year. we will see which way it moves, but i do not think we will trade in between those two levels for the rest of the year. in terms of your other question, yes, absolutely, international yields have been an anchor. no question about it.

the ecb, i think they have learned a lesson from the taper tantrum here in the u.s., so look for them to be very cautious and measured as they slowly roll back their language, and eventually taper into next year. so, i do not look for quite the market reaction we saw in the u.s. because i think they have learned some of the lessons. bonnie: we would agree with that at western asset. we have seen growth improve in the eurozone. we had then long that the euro and european credit, especially with respect to the banking sector but with respect to ecb action, they will be very cautious. they have a single mandate, and that is medium-term stability at or below 2%. the rise in inflation they have seen in the eurozone, they view that as transitory and they know a lot of that has been driven by energy and do not expect that to continue. if you look at wage inflation, in the peripheral countries the wage inflation is zero. the real wage growth is

negative. the only places you have decent wage growth is germany and the netherlands. you're getting your 3%, 3.5% wage growth. so for them, they will remain on the current path. we do not see them reducing their purchases for quite some time. jonathan: for 2017, if you had to hold 10 year bunds or 10 year treasuries, which would you hold? bonnie: we think treasuries hold bonnie: we think treasuries hold more value. the bunds are more distorted. jonathan: greg? gregory: same answer. jonathan: brian? brian: no question. jonathan: everyone will be sticking with us. gregory peters, bonnie wongtrakool, and brian rehling. coming up, it is the auction block. a big week for high yields. the market sucked it all up. this is bloomberg "real yield." ♪ ♪

jonathan: i am jonathan ferro, this is bloomberg "real yield." i want to head to the auction block now. the u.s. treasury with three main offering so far this week. i want to focus on the $34 billion 5-year note sale. it had a ratio of 2.67. 23% of t total, e least in about a year. look at the moody, the pipeline for those bond sales dropped. it marks the lowest number in two months. it continues a borrowing slow down in the moody market. where there has been no slowdown was in the u.s. high-yield, the biggest week for issuance since march. the year to date total more than $120 billion.

here with me in new york is greg peters and bonnie wongtrakool from western asset management, plus in st. louis is brian rehling. for the first time in about a year, i heard somebody saying, while they were buying something, there is no alternative. it has been 12 months since i heard that kind of language, there is no alternative and that is why i am buying this stuff. does that concern you to any extent? brian: there is a lot of complacency in the market, no doubt. volatility is very low so there is not a lot of focus on risk. asset prices where they are, you have to buy something. jonathan: there is no alternative, is that what is really driving spreads tighter even though issuance has picked up? gregory: i do not think it is a new phenomenon personally. i think that has been the qe

e. crush interest rates to force investors off the risk curve. you are seeing it. the curious aspect, that vol is low as a consequence. issuance has been high but to stick with the high-yield market, the benefit in high-yield over the past couple of years relative to investment grade corporate has been the issuance. the has not been a lot of ofthere has not been a lot issuance in u.s. high-yield but there has been a ton on the investment grade side. it is something to watch, but i do not think one week makes a trend. jonathan: something greg mentioned, the qe trade. we are still talking about the qe trade. why? bonnie: you have to differentiate between the stock and the flow effect. there has been so much duration taken out of the market by qe and it will take a while for that hole to fill. but going back to -- are there other alternatives, are people buying because they have to?

i think valuations are a lot fuller than they used to be, particularly in high yield. in high yield, we have taken some of that exposure down and moved it into bank loans. we think bank loans are more attractive. i think there still are good opportunities out there in not just bank loans but emerging markets. for active managers there are opportunities that remain at this point in the cycle. jonathan: do you share on bank loans? gregory: i am much more skeptical on bank loans. i like u.s. high yield better. if you look at the refinancabil ity it is 50 percent to 60% and there is downside but no upside. bonnie: i would concede the culpability is a negative for the sector but when you look at the spread in high yields historically it is on the tighter end. we feel like that in addition to the fact that it is a floating rate asset and we are in a fed hiking cycle makes it more attractive. jonathan: we had an opec decision to extend cuts for nine

months. i want to fold in the opec story in high-yield, and show how resilient energy has been. if you take the energy index and compare it, this is the correlation for crude and high-yield energy. it has completely collapsed and completely rolled over. why has that relationship break broken down so aggressively this year? brian: ever since last year's lows, as oil rebounded, the correlation eventually broke but i think this is just another testament to kind of the overall high-yield market, whether it is straight high-yield or bank loans, etc. people are buying the coupon, the income stream and there is much concern about risk. the problem here in that whole market is there is not a lot of

price upside left anymore, so it is a coupon clipping market at best. and if the conditions where volatility stays low, interest rates stay relatively low, economic growth is ok, you can continue to clip that coupon, no question, but i think if those more positive economic conditions continue, i think you would probably be better off in some other asset classes where you have some price upside rather than taking a risk in the high-yield market. jonathan: bonnie? bonnie: i think we are more constructive on energy in general. with oil prices, they have been moving, but they are moving within a range, and that is what we anticipated. we had a global oil task force that put together a couple of years ago, and the expectation was that oil would trade in the $45 to $55 range. that is pretty comfortable. you have opec on one side and shale on the other side. it is a little bit predictable so the volatility is taken out of the market, which is a good thing for high-yield although we prefer it in the investment grade space.

jonathan: let's look at high-yield and break it down by sector. the underperformance has come from most retail associated sectors and has come from managing as well. out of those things, where do you want to pick up the pieces? gregory: i think the interesting thing about energy at the start of the year, it traded right on top of the high-yield market so there was no risk premium built in. we are actually still worried about high-yield companies in the energy space, so access to the capital has helped balance sheets limp along. but the retail side is definitely this year's energy. we are broadly avoiding that. we think health care is a much better sector to play. and it is done well this year. jonathan: on the energy side, is there the risk of complacency now that we have the opec put that some of these shale producers will not carry on with the cost efficiencies?

gregory: of course there is that complacency built in but they can limp along forever as long as they have access to capital, so the bridge to financing is still there. it is when "the music stops" and they do not have the capital when things go awry. jonathan: you will be sticking with me. let's get a market check on where bonds have been, 2's,10's and 30's. yields grinding higher. in a really high range. the two-year up two. we creep slowly back toward three percentage points on the 30 year treasury. still ahead, the final spread. the week ahead. draghi speaks, the u.k. prime minister race heats up, and we a payroll report next friday. this is bloomberg "real yield." ♪ ♪

jonathan: i am jonathan rro. from new york city, this is bloomberg "real yield." it'time for the final spread. a look ahead at what is coming up in the next week. mario draghi will be speaking to the european parliament just a week and some change away from another ecb decision, as the market starts to look to what the ecb may or may not do with that quantitative easing program towards the end of this year. then, we will be looking ahead to the election. theresa may and jeremy corbyn ramp up campaigning, and on friday, it's the big one, it's the payrolls report in the united states. for a few final thoughts, let's bring in the roundtable one last time. gregory peters, bonnie wongtrakool, and brian rehling. the question we keep asking again, unemployment keeps grinding lower. where is the wage growth? brian: very slow to come about and probably will continue to be so.

that has been a problem for the fed. i think it goes into those inflation expectation numbers that are trending slightly lower. but that said, the jobs report has to be a total disaster for the fed not to move in june. june is pretty much set. jonathan: greg? gregory: same answer. i think the inflation numbers matter a lot more than payroll. the pce number, we were joking, pce is the new payrolls. i think payrolls are slow and steady and there is no wage growth, and real wage growth is still negative. jonathan: i want to wrap up with a look ahead to next week and wrap up the conversation with a rapid fire round. one word answers only. the u.k. election on deck. long jeremy corbyn or long theresa may? gregory: long may.

bonnie: may. brian: may. jonathan: have we seen the high for 10 year treasury yields this year? gregory: yes. bonnie: yes. brian: no. jonathan: does opec comply with jonathan: does opec comply with the latest cuts? gregory: no. bonnie: yes. brian: no. jonathan: payrolls, upside or downside? gregory: upside. bonnie: upside. brian: upside. jonathan: that does it for bloomberg "real yield." up next week, same time, same place, 12:00 p.m. new york. 5:00 p.m. london. you have been watching bloomberg "real yield." ♪ david: what propelled you to

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