♪ jonathan: from new york city, this is jonathan ferro. with 30 minutes dedicated to fixed-income, this is bloomberg real yield. ♪ coming up president draghi's dovish words his words fall on , deaf ears elsewhere. reflation trade struggles to find buyers, and counting down to the fed's decision. long-run miss of its inflation goal undermining for another rate hike. we begin with a big issue, a dovish draghi doing his best to push back against markets.

draghi: we need to be persistent and patient. a very substantial degree of monetary accommodation is still needed for underlying and nation -- inflation pressures to build up and support headline inflation development in the medium-term. we are also unanimous in communicating no change to the forward guidance. we only have to wait for wages and prices. nowere unanimous in setting print i -- precise date for when to discuss changes. the last thing the governing council may want is an unwanted tightening for the financing conditions. jonathan: joining me around the table today is the cohead of global portfolio management fixed income at goldman sachs asset management. and the credit columnist for bloomberg gadfly.

over in dallas, the chief investment officer of highland capital management. mike, let's begin with you. yesterday and through today, this really interesting dynamic asserting itself. the first time i have seen in a number of years, the euro is stronger and the periphery's bid. can i continue? mike: i think the euro is a currency that is hard to invest in. recently, you had a situation where heads i win, tails i win. that does not last forever. you need to look at what is going on the fundamentals of the european economy and the fundamentals of the european economy and what is the resolve of the ecb? the bottom line is the resolve of the ecb in terms of maintaining was financial conditions is very significant. the market was viewing the ecb as being a bit more hawkish one month ago, and moving with the fed as far as removing commendation -- accommodation.

not likely to happen when you have inflation in europe at half of the ecb target and weakness in the southern half of europe. i do not think it can last forever. jonathan: lisa, is this a -- when he talks about the tightening of financial conditions, is that a message to the affects market or the bond market, or both? >> that is a message for the bond market. because he is saying let's not get your hopes up. we will not let yields go up too high. we will keep them low. it makes me wonder how much it will allow inflation to pick up in the eurozone, which is supportive of the economy, and actually feeds into some legitimate reasons for the euro to get data up and meanwhile, how much is the euro strength really a dollar story. we have seen the dollar stink -- sink as prospects for a stimulus plan here have faded. >> >> i think it has been interesting to watch the euro strengthen dramatically in here as draghi has tried to take back some of his comments.

but i think the market is certainly going the other direction. that is going to put pressure on euro economy. it is actually pretty positive for our economy and our stock market. of what they are doing with their fixed income market, there sovereign market, and getting rid of this for a long amount of time and changing that focus on whether we will have negative rates in europe. signal,it is a massive really, for what is going to happen with monetary policy in different regimes. jonathan: mike, is this something to be nervous about? from the federal reserve, this has been the loosest tightening in history. surely we are about to seek loosest tightening from history from the ecb and the fed. mike: i think in terms of europe, i do not think it is a great concern to continue to have easy policy and euro.

you have have this and have-nots in europe, so we have eastern europe performing relatively well, and southern europe performing poorly. so the ecb will have to continue to institute policy for the weakest link and right now, it is going to be the periphery. we expect to continue to see accommodative policy. i think that europe needs it. on the other side in the u.s. and mohammed's comments are very accurate, we have an enormous amount of complacency across financial markets. he look at -- there is confidence that the fed will be on a light path towards normalization, and the bottom-line is you can have divergence, and the whole theory right now is that you can't. the ecb will have to be easier, u.s. will be as well. we have global inflation as well, and divergent economies. the u.s., we are seeing strengthen american economies, best in american economies come and everyone thinks the fed will be there forever but they are not.

jonathan: you talk a little bit about the relative value opportunities across major economies, and here is a chart that has the story. walk me through it. michael: this chart is showing the inflation differentials across our economies. while not overly significant, we are seeing a trend downward in terms of inflation on a global basis, and we know that is happening there. we see the united states moving area, we the 1.5%, 1.7 see canada at 1.4%, and the eurozone at 1.1%. we think the u.s. is a transitory decline, pushing back up to the 2% area due to the tightening of the labor market. you have the, target and you are in a situation where you have a labor market that is very divergent within europe. -- lowhave low inflation unemployment in certain areas and very high unemployment in other areas. we expect that to continue to cause inflation to be low in your and caused the ecb to have

to be accommodative. >> i am struck when you are talking about how the ecb continues to be supportive of the weakest link. how long will that be politically plausible. not too long ago, we are talking about an italian exit, a frexit, and that has disappeared with macron's election. are we going to hear about this again if this continues to be the trend? michael: unless you see a rapid convergence in the next 2-3 years around growth, unemployment, and inflation across the eurozone, you will have significant political problems. because in the end, germany does not want to allow for their economy to inflate, and so as a result, it is not sustainable over a long period of time to have extremely divergent growth and then having fiscal policy run by individual countries to be different than a joint monetary policy. so in the end, the whole euro construct comes into question if you continue to see that the urgent growth level. jonathan: can you justify any kind of pulling back on this qe program in september, october,

and we won't have that argument here on this program, but say we get to can you justify on the september. economics alone at this point? mohammed: absolutely. i think the inflation picture and what is happening right now is getting the fed an amazing opportunity to start to shrink the balance sheet. their goal, or what they need to do for the next 3-5 years is to shrink the balance sheet and normalize the front of the curve. amazingly, with rates so low, they can do that without much pain. i mean, that has been the worry of the market is that as they exit the balance sheet they could be doing this at the same time that draghi is pivoting to a taper, and the japanese are already full out. there is nothing more they can do for my monetary policy standpoint. so i think it would be foolish for the fed not to start to exit as quickly as possible, to start to shrink the balance sheet. let's face it. they have to reload their guns for the next recession. and they are way late in doing that, because it will take a long time.

jonathan: why does no one talk about the boj anymore? the boj came in earlier this week and offered unlimited amount of ability for people to sell, sell, sell, and buy, buy, buy. michael: there are different forms of accommodation occurring among central banks and they have a very different strategy than what you see in the u.s. -- than in europe. somenk japan has had improvement in growth, some modest improvement in the inflation picture, but they are behind and very, way still have a significant amount of recapitalization that has to occur in the banking system to get lending with the economy going. so you will see different forms of stimulus coming out of japan for the foreseeable future. jonathan: is that enough to keep the central bank in the market, lisa? the boj hanging in there? lisa: the boj, the question is when will they run out of assets to buy? i mean, doesn't the boj on the entire japanese stock market at

this point? they own 60% of the etf right now, they are controlling their 10-year yields and i think is that why nobody talks about that because the mystery is taken away. jonathan: thank you to our guests. coming up on the program, the auction block. hey gathering revolt among high-yield investors. this is bloomberg real yield. ♪

♪ jonathan: from new york, i'm jonathan ferro. this is bloomberg real yield. i want to head to the auction

block now, where i got to say, not much action recently anywhere. starting in greece, the return to the bond markets postponed. that is partly due to a debt cast by the lifeline may be available as the funds bought said yes to the bailout in principle. another bond issue, korea halting its $200 million sellout. high-yield investors finally getting the upper hand of the -- after years of central bank asset buying and pushing back against some of these issues. in the united states, a 10-year option absolutely flopped. offering $40 billion for the lowest amount of nine years. with a bid to cover ratio under two. they apparently seemed to do not -- the few others, they apparently seemed to do not once. still with us, our guests. let's start, mike with the lack

of volatility that we have seen. the lack of action, the lack of issuance. year to date it has been stellar, but the last couple of months, what do you make of it. michael: a really good time for vacation for people in the industry. just a function of unprecedented central accommodation on a global basis. you can get very comfortable with that, and i think for the foreseeable future, central banks will continue to be extremely transparent, keeping volatility low. where wereally believe are from a volatility perspective, we aren't going to stay here forever. to make investments based on what has happened when the central banks, particularly the fed, have said we are changing, we are changing the game. we are changing the game. we are going to stop buying every asset. when they take the long and out of the market, via treasuries or

mortgages, they take volatility out of the marketplace. when they put it back, particularly mortgages, that -- investors hedge that volatility and that causes volatility to spike. so i think to assume to this trend of volatility will continue is a mistake and you are not getting compensated for that across a lot of the markets. look at credit spreads, they are historically tight. you are not getting compensated in terms for the spike in the fed. jonathan: and you have written about investors sitting on their hands playing a game of chicken. lisa: you have the extra yield that people are receiving to own investment grade bonds over benchmark rates shrinking to some of the narrowest levels we have seen in the post crisis era, and to your point, i wanted to make a point about the volatility. look at the move index, which implies volatility in treasuries.

the lowest level on record. the last time we saw rates like this was right before 2007. this is june 2007. he saw what happened after that. here point, this isn't going to last forever. the more people that get complacent, saying look, we do not think we are getting compensated for the risk that we are taking, 61% of investors surveyed at bank of america believe these spreads are too rich, and they keep buying because they think everybody else will. this is going to end badly, but people don't seem to see it company. -- happening. jonathan: is this pushing you to take more risks than you would like to? mohammed: no, we have been getting defensive and taking chips off the table, but i think this is very interesting as they -- a corollary to what is happening in these marketplaces. you had an amazing amount of flow into the corporate credit market from tourists from overseas. the question everybody is asking is, what is going to happen when they go back home.

he's draghi telling them it is time to go back home, back to europe and to get out of our market? i know the japanese have a huge amount of exposure in id credit, -- ig credit. that is why we are getting defensive, i think it needs to because valuation is not there. the complacency -- did that change, i don't know. but at this point, you are not getting paid a whole lot to take a lot of this risk. a lot of people talk about a softened debt side and how people have been pushed out into treasuries. not many people talk about the corporate buying program at the ecb and how the same thing is happening in u.s. credit. do they need to think about that more? we have been talking about it for a while and i agree with point about the tourism and how long they stay involved. they will stay involved until they stop making money and stop assuming that the fed will lower rates whenever they start to lose money. and so, i think the fed is not going to continue to lower and this you see a significant slowdown in the u.s. economy. they will not bailout investors from outside the u.s.. i think there will be a change.

it has slowed down on the margin. i think there are gilts out there that are attractive. , we lookjust go away for opportunities. the emerging markets, both debt and equity space, are very interesting. i know we talked about lofty levels in u.s. equities and lofty levels in u.s. and developed market bonds. but the emerging markets are still very attractive. you look at currency in emerging markets, you have attractive yields north of 6%, and real positive yields. so very, very high real returns there. had so, we think the emerging markets are poised to do better. not just from a rate perspective, but currencies. they have underperformed massively for the past three years, and that is a good thing for the forward because you have much more competitive economies. and you also have a situation where a lot of these countries have basically reduced their debt load by devaluing their currency. and most of these countries are issuing most of their debt in local currency instead of

dollar, which is a historical mismatch. so we think there is a lot of opportunity, goal -- global growth to improve and developed markets and emerging market. risk is relatively low. jonathan: lisa? lisa: you think there is any value left in hard currency? we have seen a flood of cash into these indexes, broad indexes of u.s. dollar emerging markets, credit. some nations have been deleveraging, and others have not. frankly, the credit quality of the index has been deteriorating. michael: you have the entire food chain of capital flowing into the u.s. market. it started out with treasuries and mortgages, and then it went -- as that wasn't enough yield, they went to investment grade credit. now you are seeing the flows into emerging markets after years of significant outflows. so it is concerning that these flows have been significant. that is typically, in a emerging market, a pretty negative signal. i think the hard currency debt

has tightened pretty significantly, and there is not much value there in local currency. ,ichael swell, lisa abramowicz and mark okada staying with us. 11 on a 30 year, a flatter curve once again. you know the story. still ahead, the final spread. fed chair janet yellen's difficult task of unwinding the balance sheet and the year ahead. this is bloomberg real yield. ♪

♪ jonathan: from new york, i'm jonathan ferro. this is "bloomberg, real yield." it is time now for the final spread. over the next week, the big one to watch. the chair janet yellen, you will not hear from her but get a

federal reserve rate decision and a statement as well. that comes on wednesday. we get some big issuers reporting earnings throughout the week. at&t, deutsche bank, and shell. and you get the first rate of the second quarter gdp. that will come to you friday. for a quick look at the week ahead, our guests. ,tay with us, michael swell lisa abramowicz, mark okada. mark, i want to begin with you and talk about that lousy 10 year tips option that we had that option that we had this week. the price of reflation, not cheap enough? mark: the inflation numbers have been very poor and the question is, does that continue to be the case as we roll forward? we look at this interesting graph of gdp stacked 18 months versus the cpi numbers, and that is a good correlation. if you think back 18 months, we had a soft patch going through the u.s. economy, and that really turned pretty hard in the second half of 2016. so -- and then the fact that the

health care bill died, you will have some more medical inflation. i think inflation comes back pretty significantly into this market at some point. i would say in the beginning of 2018. that is going to change the dynamic for really what is and to yourth rates comment about inflation protection. jonathan: he talk about risk reward, is that were the opportunity is now? michael: not yet. not yet, we are moderately overweight from a strategic standpoint, because we are thinking later in this year used it -- you see a significant resumption of inflation. you are in a seasonal period in terms of inflation. you are also in a situation where you have had -- we think as we move later in the year and start to see more weakness in inflation, we will see in the end a lot of fundamental value there. and a lot more cheaper levels there. jonathan: we want to get you and

your boxes and to the rapidfire round. one question and one word answers. can you belong the delivery and -- long the periphery in europe and along the euro? yes or no? michael: no thank you. mark: no way. lisa: i will not disagree with them. [laughter] jonathan: the most oversold sector oh in high-yield? retailer energy? michael: retail. mark: he's right, retail. lisa: i would agree. jonathan: and a final decision. fed decision next week. go to lunch or stay at your desk? michael: go on vacation. yes, that's right. stay on for addition -- vacation. lisa: happy friday. jonathan: i am so happy we have you for the fed coverage of next wednesday. thank you michael swell, lisa abramowicz, mark okada. we will see you next week at

12:00 new york time, 5:00 p.m. on london. for our viewers worldwide, this is "bloomberg, real yield." ♪

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