♪ jonathan: from new york city for our viewers worldwide, 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. and opec's whatever it takes moment falls on deaf ears. production cuts struggle to stay with 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 sheet reduction, but that the market has been able to absorb that. so 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 now back to the old fed, or is the fed going to try to lead markets? jonathan: joining me around the table here in new york is greg peters, bonnie wongtrakool, plus 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 it will be? brian: absolutely. the whole point here for the fed is to not use the balance sheet reduction as a policy tool, in my opinion. they used it as a policy tool when they wanted to drive rates lower and the point is to get out of this with no disruption. jonathan: this will not be a policy tool for those hoping they would move on balance sheet and pause on rates. are they going to be a bit disappointed? gregory: i am 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. what it does do is introduces each fed meeting into play. and so, theyre talkingbout 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? so i am not as convinced. jonathan: bonnie. 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 credence to the market. it takes targets 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, 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 them having a bit of a countercyclical balance under the structure.

jonathan: i sat down with mohamed el-erian a few years ago before they first hiked, 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 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. so in my mind, and our minds, 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%. so 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 on 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 in 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 more than anything. 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 hikes this year. jonathan: are we going to stay in this range of 220, 240? rbc came out this week and basically said 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 in this environment. on the one hand, you have got geopolitical risk and that will keep ceilings on yields as well as low global interest rates. we still have negative yielding out there. it is way down from the high,

but you still have $9 trillion in debt. so 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 really 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 changed. it has change in a big, big way. we came into this 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, it was time to go long treasuries, and now the positioning has changed. do you have to go the other way to think about where the positioning is? >> on balance, 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 in the speculative positions has often been wrong in the treasury market over the last couple of years. will it continue to be so? >> yeah, i mean probably. right now, i think the market will be relatively calm for the balance of the year, as to the other guests, but the market has a funny way of surprising us. jonathan: i ask this question on almost every show. have we seen the low? the 10 year yield low? the print of about 2.16? 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. because i think there are still a lot of geopolitical risks that could push is below 2.16, so i think that is something as asset managers, we should not try to predict.

on the other hand, 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. so to think that yields could go a lot higher than 275, i would definitely take the under on that. 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 months time it was 270. so i think that helps define the range. i am not saying 170 is the right number, but i think 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. and not a lot has changed since then from an economic standpoint, and inflation

readings were actually more positive at that point, at least from a trajectory standpoint. jonathan: bonnie? bonnie: going back to the positioning and futures, the fact that it is cleaner makes the likelihood of these gap-y 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 it is had in the last year? brian: let me start with the first part. in an average year, the 10 year treasury trades at about 120 basis point range. so either the higher or lower 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 levels for the rest of the year. in terms of your other question, yes, absolutely, the 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 don't look for quite the market reaction we saw in the u.s. because i think they have learned some of the lessons there. jonathan: bonnie? bonnie: we would agree with that at western asset. we have seen growth improve in the eurozone. european credit, especially in the bank sector, but with respect to ecb action, they will be very cautious. they have a singleante, and th is medium-term stability at or below 2%. the rise in inflation they have seen in the eurozone to 1.9%, 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, and in a lot of the peripheral countries the wage inflation is

zero, the only places you have decent wage growth is germany and the netherlands, where you are 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: just quickly to rapid up, for 2017, if you had to hold 10 year bunds or 10 year treasuries, what would you hold? bonnie: we think treasuries hold more value. the bunds are more distorted by that ecb program. jonathan: greg? gregory: same answer. jonathan: brian? brian: same answer. clipping the coupon at 230 is better. jonathan: everyone will be sticking with us. gregory peters, bonnie wongtrakool, and brian rehling. coming up on this program, 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. 23% of the total, the least in about a year. looking at moody's, the pipeline for those bond sales dropped. it marks the lowest level in more than 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.

$9 billion, bringing the year today total to more than $120 billion. i want to bring back in the roundtable. here with me in new york is greg peters and bonnie wongtrakool from western asset management, plus in st. louis is brian rehling. guys, for the first time in about a year, i heard somebody saying, there is no alternative. brian, 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 two any extent? brian: there is a lot of complacency in the market, no doubt. volatility is very low, and so there is not a lot of focus on risk. yeah, but asset prices where they are, if you have to buy something, 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 trade, right? it is basically the crash in interest rates to force investors off the risk curve. you are seeing it. the jury's aspect of it all is that vol is low as a consequence. yeah, 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 corporates has been the issuance. the has not been a lot of 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. it is going to take a while for that hole to fill. are there other alternatives, are people buying because they

have to? i think that 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 move that into bank loans. we think bank loans are a lot more attractive, the valuations there. and 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 jonathan: do you share on bank this point in the cycle. loans? gregory: i am much more skeptical on bank loans. i actually like u.s. high yield better. if you look at the refinance ability, it is 50% to 60% and there is downside but no upside. jonathan: bonnie? 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 have the opec meeting earlier this week, in fact, 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. brian, why has that relationship break and down so aggressively this year? brian: ever since last year's lows, as oil rebounded, that 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. and that is that people are buying the coupon, the income stream and there is not 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 actually 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 a pretty comfortable range. 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, 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, industry to industry, the underperformance has come from most retail associated sectors, and it has come from energy 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 won't go carrying on with the cost efficiencies? gregory: complacency is being built in but they can limp along forever as long as they have access to capital, so these companies can limp along as long as there is 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: guy, 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. the two-year up two. we creep slowly back toward three percentage points on the 30 year treasury. still ahead, the final spread. e week ahead. draghi speaks, the u.k. prime minister race heats up, and we get a payrolls report next friday. this is bloomberg "real yield." ♪

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jonathan: i am jonathan ferro. from new york city, this is bloomberg "real yield." it is time now 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. the uk's theresa may and jeremy corbyn ramp up campaigning, and on friday, the big win, the payrolls report in the united st for a few final thoughts, let's bring in the roundtable one last time. gregory peters, bonnie ngtrakool, and brian rehling. brian, payrolls next friday. the question we keep asking again, again, and 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 at this point. jonathan: greg? gregory: same answer. i think the inflation numbers matter a lot more than payrolls at this point. we were joking, pce is the new payrolls. yeah, i think payrolls are slow and steady and there is no wage growth, and real wage growth is still negative. jonathan: guys, i want to wrap up with a look into next week and wrap up the conversation with a rapid fire round. i'm going to ask each and every one of you the same question. one word answers only. the u.k. election on deck. are you long jeremy corbyn or long theresa may? gregory: long may.

bonnie: may. brian: may. jonathan: have we seen the high for tenure treasury yields this year i'm yes or no? gregory: yes. bonnie: yes. brian: no. jonathan: does opec comply with the latest cuts? gregory: no. bonnie: yes. brian: no. jonathan: just quickly, payrolls, upside or downside surprise? gregory: upside. bonnie: upside. brian: upside. jonathan: there we go. that wraps up the program. thank you very much. 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." ♪ these days families want to be connected 24/7.

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