jonathan: i jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ fed chair janet yellen hikes interest rates once again. that's even as the data and the u.s. starts to soften. treasury yields drop to new 2017 lows. bill gross says the market risk is like 2008. we start with a big issue. hawkish fed chair janet yellen. >> the statement and this forecast is more on the hawkish side. >> they are trying to nudge the markets in a direction that is more favorable to the fed. >> they are determined to be steady as they go until the

evidence is overwhelming that they have to go the other way. >> we can talk as much as we want about taylor rule and phillips curve and things like that. the one thing this recovery has proven is the fact that all of those are things of the past. >> we should be seeing the gradual upkeep and inflation that we were seeing for a while and then it stopped. i find it puzzling. and i think she does too. >> i think of yellen andf connie and of draghi of being

pilots and the plane and they are trying to soft land the plane and the instruments are not giving them proper readings. that is really hard to do. they do not have the visibility enough to the runway. jonathan: joining me today from blackrock is the chief investment officer of fixed income. alongside him, jeff rosenberg. thank you for having me in your

house for once. you're usually in mine. let's begin with the federal reserve. a hawkish bias from the fed chair. is that your take as well? >> given what it has been historically, it has been hawkish. i thought it was the press conference janet yellen has done. i thought she was a directed, committed, unwavering. there were questions that have been distracting. she laid out the pn. fry i ink some of the short-term data, she rightfully ignored and thought about the

bigger picture. she is focused much more today on financial conditions. those financial conditions since march, they have gotten easier. jonathan: last year we were talking about a fed that did not stick to the forecast and they had a credibility problem. now we talk about a fed that ignores the data and somehow makes a mistake. which one is it? are they stuck within a rock and and a hard place? >> it is not clear they are making a policy mistake. they are sticking to a forecast dependency. they moved off of data dependency. there are some really good reasons for that. they cite the inflation data being temporary. that may eventually be an error, but right now, it is not clear that it is at all.

this makes a lot of sense and it's important to the market that it is still data dependent, but this fed has moved on to forecast a dependency. >> i think broadly they are data dependent. to week. the data dependency has to be over what the cycle of operating. data dependency has to reflect where we are in terms of market conditions. i think they are data dependent. i would argue that the two years prior, much less data dependent when they had a window to go. johnathan: talk about what you and the team at blackrock is doing. what is the world that you see? >> a couple of things are happening. there is always this misconception that we have to be

at 2%. the fed mandate is not to percent for stability. -- not to percent, but the fed mandate is price stability. if you look at what is amazon -- if you look at this inflation report, there are some pretty extraordinary things happening with inflation around services. it has been pretty darn stable. the only reason you are trading down is because of wireless because of obviously the cuts. technology is pressing down, the central bank can't lift. it is good for the consumer. it is good for net disposable income. we show you the pressure on wireless and these are all good things that are four disposable. the fed should not be targeting. if technology is helping the

consumer and helping lower income, not present down on inflation. >> when you think about a fed that is going to have to be dealing with two important forces right now. first, you have the short-term inflation shocks and the fed is looking at the long-term inflation expectations. the second is how the fed is going to articulate the difference between what they have done on the balance sheet and the cyclical movement. there is a high bar of change for the unwinding of the balance sheet, but on the other hand come they still have the ability to hike or not hike or cut. how to articulate this is going to be the challenge of thing going forward. jonathan: your story at blackrock, breakevens are rolling over, the 10 year treasury yield is lower than when they started hiking back at the back end of 2016. i find those two things hard to reconcile, do you? >> to take today's movement in terms of the yield curve, and i don't know, but i have chart we

may pull up on this as well. we have an unwind going on us of expectations around fiscal policy that was part of the yield curve steepening and part of that tenure rates increasing. that's unwinding as well. you have a conflation potential between how much this is inflation and inflation expectations happening in the same week. there's a big focus on that. a lot of the trend towards lower rates were perceiving that. that was unwinding some of the expectations for a much bigger impact for fiscal policy uprising that out of the market. jonathan: something a lot of people find quite odd and myself included is that the fed is now forecasting rates medium forecast for the back end of 2018 at 1.4%. 10 year treasuries are just north of 2.1%. either someone is wrong or we're going to have a very flat yield curve. which one is it? >> the fed can influence the curve directly. if they are not doing qe, they

cannot control the back end of the curve. i would argue that the ecb and the bank of japan are as much influencing the long end of the yield curve. our assets are reasonable so we think what happens when we talk about your show, we think what happens is that you can move a dynamic where the fed to move the front end of the curve up. it is hard for them to move higher. the world is moving very, very glacially towards normalizing policy, but until you get other central banks to start to move, our tenure rates are going to stay low. jonathan: are we going to see the two-year yield doing all the lifting? >> possibly. there's a lot of focus on the fed, but the point he was just making is that it's part of the global market environment. it is not just the u.s. yield curve flattening. global yield curves are flattening. while we are very interested in the shift in the language and the future balance sheet runoff, the rest of the world is still far behind and the pace of that change will be very glacial. we can anticipate at this some point. right now, for the short-term, the term premium is under incredible pressure because of the combination of negative interest rates and ongoing aggressive qe between the boj and the fed, which is going to be less and start unwind it. the effect of that is a huge dampening on that term premium. jonathan: can you get a treasury market that decouples from the global bond market? >> there's two things happening. we live in a global world.

we also live in a demographic dynamic where the rest of the world is aging faster. the poll in terms of assets -- listen the markets ourselves, you will go to the place where you will get the best risk-adjusted yield. the best risk-adjusted yield sits in the u.s.. >> the thing we need to reconcile fear are two things to drop in the mix. the dollar -- what happens if we get a flat yield curve? what's going to happen with the dollar? in europe, they are going to be removing a combination and not necessarily doing anything on the front end. we are used to looking at the slip of the yield curve in the u.s. and making an assumption about the state of the economy. the yield curve #of recessions. how will the fed and the market react to that as well? >> this is a really important point that the interpretation of yield curves is a textbook interpretation. you have to throw the textbook out when you have re-written it when it is about negative interest rate, zero interest rate policy, and massive qe. as you get further along where you might have expected flat or, we may start to see steeper curves. it's about the impact of global withdrawal from policy accommodation.

jonathan: i wonder if something else is going on. i keep looking at the yield curve, and a lot of people are approaching the situation like something is wrong. if the two-year reprice is based on what the fed is doing, the market has interpreted the fed has gone to quickly to sin and has taken inflation and growth away from the future. the back end is well supported because of that and not what the ecb is doing. is there a decent argument there? >> somewhat. there's this debate on whether the equity market is right or the rate market is right. but both markets are right. there is extraordinary demand for income in the world, nothing like anyone in this generation has seen. that poll for i have to get yield -- it does not go away. there may be some pernicious view about future growth and

inflation. the stability of inflation is much better than it has ever been. you think about where we were a decade ago with oil gyrating extraordinarily. the go from $40 to $150 -- we go from $40 to $150. look at what oil is doing. $40 to $55, more stability, you can be more comfortable holding interest-rate exposure with that dynamic. jonathan: blackrock's rick rieder and others. coming up on this program, over the next 10 minutes, a little nervousness in the markets. we are weighing in with forecast for more volatility. you might've heard that one before. from new york on the blackrock trading floor, this is "bloomberg real yield." ♪

♪ jonathan: i am jonathan ferro. this is "bloomberg real yield." this is from black rocks trading floor in new york city. goodlatte making more headlines this week. the manager of the $54 billion double-blind return fund says that the days of volatility markets is numbered and if you are a traitor or speculative come you should be raising cash today, literally today. u.s. markets are at their highest risk level since before the 2008 financial crisis. with us from black rock, jeff, risk and a lot of talk about the return to volatility. everywhere is rich right now. equities, fixed income, does that mean that is necessarily a risky environment? >> i am in a habit of disagreeing with your premises. jonathan: that's the whole point. i intro a premise and you give back. >> your premise is everything is rich. we don't see everything as rich. we are on the fixed income side so it is not so much about rich or cheap, it is about are you paid for the risk. you have asymmetric downside risk. you don't to the upside. you have a lot more downside risk. it argues for a bit more caution. you look over on equities, where valuations change and the valuations are a little better in some areas outside of the u.s., but the key differential is that you have upside as similar to the downside you are taking.

in fixed income, you do not get that and that is what you are hearing in terms of the caution. we share some of those views in terms of recognizing spread are -- spreads are at tight levels and risk is more asymmetric. jonathan: is european credit rich? >> european credit is absolutely rich and highly affected by central bank behavior. your forcing people into levels that are not -- you have negative interest rates forcing people into underwriting levels that are noneconomic. you have a noneconomic driving force. jonathan: you're going to have viewers thinking is this cheap?

there are areas in the equity markets that are more attractive. we are valuing equities against an environment where you are not going back to 5%-6% interest rate environment. if you are in a particularly low interest rate environment, the whole valuation paradigm has to be rethought. that is one of the key issues when you are looking at these long-run histories around where valuations stand. jonathan: one of two things happen on bloomberg tv. people say they want to buy europe or they like em right now. is that becoming somewhat crowded? >> if you look of the returns the first half of the year, they're mostly driven by the flow and this drop in

volatility. back to the area of valuations. if you value em today, em is not that expensive, but if you think there is a refreshing involved as has been said in earlier comments, then the story changes. the significant amount is coming into emerging markets. that is one of the portions of the asset class that is actually better price. i would say not that expensive. >> as pablo said, we are in a world that by the way -- is volatility too low in the world? low volatility does not mean things have to go down. that is a hugely important point. what has been distorted today? what drives financial assets higher? central banks push real rates down and then you inflate assets. your point about europe or emerging markets -- the reason we love emerging markets is that they are away from the distortion. the ecb is not buying mexico. you trade closer to equilibrium. do you buy places like emerging markets where inflation is coming down? you can get easier policy while the developing markets are raising rates. going into europe, i don't think people are saying i've got to get into european interest rates close to zero. when the discount rate remains low and growth can be pretty good, they can drop the equity -- drive the equity market up in europe. there is still value in fixed income. volatility going up, we like to buy a lot of front end assets. get away from the distortion, create balance in your portfolio so that when volatility picks up, you do not have too much beta attached to your portfolio. jonathan: e.m. has been one big fat directional trade for

people. does that change in the back half of this year? >> we are expecting to see way more dispersion in the first part of the year in emerging markets because we are expecting some of the promises of the campaign in the u.s. election to generate that dispersion in emerging markets. we ended up having nothing of that. i think the second half will be driven with more relative value than the first half is been. jonathan: rick rieder is with us as well. let's get a check on where markets have been this week. yields lower across the curve. we did hit a year today low earlier in the week. it is the final spread with a look ahead to the week ahead with the fed stress test on the horizon as well and some u.s. housing data to talk about. this is "bloomberg real yield." ♪ ♪ jonathan: i am jonathan ferro. ♪

♪ jonathan: i am jonathan ferro. this is "bloomberg real yield." let's get you up to spirit of what is coming up over the next week. the queen's speech comes up and brexit talks commence as well and we get the fed stress test as well as data on u.s. housing. let's wrap things up with black rock. let's wrap things up with a look at europe. the economy looks stable. i just wonder what that means for the bond market when the only thing that matters is the ecb. >> the growth is better. we think the growth will be durably better. you are seeing the lending markets improves, you are seeing consumption and employment has picked up. core inflation is not picking up fast enough for the ecb.

you have got a dynamic where growth is good and you have a central banks that is going to be accommodated for a longer time. it's a pretty good environment. that's why you described people coming into europe. that is a good combination. jonathan: this is a recipe for steeper curves? the ecb is not a rush to go anywhere. >> it should be when the markets have the ability to start pricing that in. with the ecb pressures downward on interest rates and the persistent pushing out of expectations around when that balance sheet turn may occur, that helps to limit that effect. when we are talking about balance sheet normalization, that is your recipe for a steeper yield curve, but it is a glacial pace. jonathan: was the base case for the ecb now? >> they're going to taper down it. start announcing it and get some closer in september and the new

start tapering again in the beginning of the year and then wait and do the deposit after that. 60 billion a month after the markets. maybe start at 40 billion at the beginning of the year. jonathan: as of the ecb leaving the door open for the federal reserve to get the ecb going? >> for a number of reasons, the fed has an incredible window to move. we talked about the dispersion between the bank of japan and the ecb. there's a lot of talk about to be issue long debt in the u.s.? what is much more important is quite likely where the central bank's are going to go. jonathan: we're going to answer

some questions with one word answers. behind the curve or too far ahead? >> behind the curve. jonathan: european high-yield or u.s. high-yield? >> u.s. high-yield. jonathan: long brazil or long south africa? >> long brazil. jonathan: returns before yellen is out? >> no. jonathan: short or long-term duration? >> short. jonathan: chair yellen to hike three times next year, yes or no? >> i would say yes. that is the general direction. jonathan: rick rieder and the guys at black rock. this is "bloomberg reayield." ♪

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