♪ jonathan: from new york city, this is jonathan ferro. with 30 minutes dedicated to fixed-income, this is bloomberg real yield. ♪ president draghi's dovish words, but his words fall on deaf ears elsewhere. reflation trade struggles to buyers. the tenure tips auction draws the lowest number in five years 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. mario draghi: we need to be

persistent and patient. a very substantial degree of monetary accommodation is still needed for underlying inflation pressures to gradually 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. we were unanimous in setting no 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. guys, great to have you with us. let's begin with you, mike. 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 that 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 two things. you need to look at what is going on the fundamentals of the -- with the fundament is a beer he and -- 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 a month ago and moving with the , fed as far as removing

accommodation. not likely to happen when you have inflation in europe at half of the ecb target and weakness in the southern part of europe. i do not think it can last forever. jonathan: lisa, when he is talking about unwarranted financing and tightening of 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. at the same time 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 bid up and meanwhile, how much is the euro strength really a dollar story. we have seen the dollar just sink as prospects for a stimulus plan here have faded. --to you sure those views jonathan: do you share those views, mark?

mark 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. two lisa's it is actually pretty point, positive for our economy and our stock market. this dynamic of what they are doing with their fixed income market, there sovereign market, -- the sovereign market, and getting rid of this for a long amount of time and changing that -- that scene, that focus on whether we will have negative rates in europe. i think it is a massive signal, 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 not the fed. mike: two issues here. i think in terms of europe, i do not think it is a great concern to continue to have easy policy in europe. you have have this and have-nots

in europe, so we have eastern and northern europe performing relatively well, and southern europe performing poorly. so the bottom line is the ecb will have to continue to institute policy for the weakest link and right now, it is going to be the periphery. so we expect to continue to see accommodative policy. i think that europe needs it. i think 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. you 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 is going to have to be easier, u.s. will be as well. we have global inflation that is low and divergent economies. , looking at the u.s., we are seeing strength, we expect to see inflation resume, 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. mike 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 down to about the 1.5%, 1.7% area, we see canada at 1.4%, and the eurozone at 1.1%. the bottom line is those differences are pretty significant. we have the u.s. where we think it is a very transitory decline, and in the beginning quarter of next year, we see inflation pushing back up to the 2% area due to the tightening of the labor market. but in europe, you have the target, and you are in a situation where you have a labor market that is very divergent within europe. so you have low inflation -- low unemployment in certain areas and very high unemployment in other areas. we expect that to continue to cause inflation to be low in europe and cause the ecb to have

two continued -- to continue to be accommodative. lisa 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? mike unless you see a rapid , over the course of the next 2-3 years convergence 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 very different than a joint monetary policy. so in the end, the whole euro construct comes into question if you continue to see that the -- that divergent growth level. jonathan: can you justify any kind of pulling back on this qe

program in the four, september, october, and we won't have that argument here on this program, but say we get to september. can you justify on the economics alone at this point? mark absolutely. : i think the inflation picture and what is happening right now is getting the fed this 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 from a 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. because 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, -- we will buy, buy, buy. mike there are different forms : of accommodation occurring amongst different central banks and they have a very different strategy than what you see in different one in the u.s. than what you see in europe. i think japan has had some improvement in growth, some modest improvement in the inflation picture, but they are still very, very, way behind and 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 that 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 own the the entire --

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. swell,n: mike' -- mike goldman sachs asset management, lisa berkowitz, mark ro khanna. 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 cap set by the ims. the lifeline may be available as the funds bought said yes to the bailout "in principle." another bond issue, korea ereos 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. a bid to cover ratio under two. they got stuck with 40% of the lot. the few others, they apparently seemed to not want still with . still with us, our guests. mark caught up, and

lisa abramowicz. okada, and lisa abramowitz. 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? mike: a really good time for vacation for people in the industry. it is a function of just unprecedented central accommodation on a global basis. jonathan: yeah. mike you can get very : comfortable with that, and i think for the foreseeable future, be -- the central banks will continue to be extremely transparent, keeping volatility low. risk assets look ok for the foreseeable future. where welly do believe are from a volatility perspective, it is not going to last forever. to make investments based on what has happened in the last eight years in terms of accommodation 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 nd out of the

market, via treasuries or mortgages, they take volatility out of the marketplace. when they put it back, particularly mortgages investors , hedge that volatility and that causes volatility to spike. so i think to assume to this trend of volatility will continue is an error and the bottom line is you are not getting compensated for that across a lot of the markets. we have an incredibly tight yield curve. look at credit spreads, they are historically tight. you are not getting compensated in terms of where we artan cycle that are in the cycle 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. to your point, i wanted to make a point about the volatility. you can look at the move index, which is implied volatility in treasuries. the lowest level on record. the last time we saw rates like

this was back right before 2007. this is june 2007. you saw what happened after that. so to your 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 by bank of america believe these spreads are too rich, and yet they keep buying because they think everybody else will. this is basically -- this is going to end badly, but people -- see it to be happening. jonathan: is this pushing you to take more risks than you would like to? mark no, we have been getting : defensive and taking chips off the table, but i think this is commentary around summer and tourist is very interesting as 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 happenwhat is going to

when they go back home? there is 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 ig credit. that is why we are getting defensive, i think it needs to because valuation is not there. the complacency -- did that chain? -- change? i don't know. but at this point, you are not getting paid a whole lot to take a lot of this risk. jonathan: a lot of people talk about the sovereign debt side and how people have been pushed but at this point, you are not getting paid a whole lot to take 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 a little bit more? mike we have been talking about : it for a while and i agree with the point about the tourists 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 -- unless you see a significant slowdown in the u.s. economy. they are not going to bail out

from outside the u.s. i think there will be a change. it has slowed down on the margin. i think there are yields out there that are attractive. we do not just go away into our own cash when we are defensive we look for opportunities. , the emerging markets, both debt and equity space, are very , 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 local currency in emerging markets, you have really attractive yields. yields north of 6%, and real positive yields. so very, very high real returns there. and so we think the emerging , markets are poised to do better. particularly not just from a rate perspective, but currencies. currencies 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. and with global growth improved and developed markets and emerging markets, we think risk is relatively low. jonathan: lisa? lisa: you think there is any value left in hard currency? emerging markets, dad we have debt, weging markets, 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 this index has been deteriorating. mike: so 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 many, many years of significant outflows. so it is concerning that these plaza been very, very significant. that is typically, in a emerging markets debt, a pretty negative signal. i think the hard currency debt has tightened pretty

significantly, and there is not much value there in local -- there as there is in local currency. michael swell, lisa abramowicz, and mark okada staying with us. let's get a check on the markets. where we have been throughout the year. here is the performance as follows. yield writing lower, 10 points on a 10 year 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 -- week 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. coming up over the next week, the big one to watch. fed 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. you get some big issuers reporting earnings throughout the week. at&t, deutsche bank, and shell. and you get the first rate of fish first read -- first read of the second quarter gdp. that will come to you friday. for a quick look at the week ahead, our guests. stay 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 -- auction that we had earlier this week. the price of reflation, not cheap enough? mark: look the inflation numbers poor, been very right? the question is, does that continue to be the case as we roll forward? we look at this interesting graph of gdp backed 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. let's say i would say in the , beginning of 2018. that is going to change the dynamic for really what is happening with rates and to your comment around demand for inflation protection. jonathan: michael, you talked about risk reward, is that were -- where the opportunity is now? michael: not yet. not yet, we are moderately overweight from a strategic standpoint, because we are thinking later this year, you see a significant resumption of inflation. you are in a pretty seasonal negative period in terms of inflation. you are also in a situation where you have had for really bad prints -- four really bad prints. you do not really want to own that. 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 wrap things up, get you and your boxes and to the rapidfire round. one question and one word answers, if possible. >> can you belong the periphery in europe and the long 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 in high-yield? retail or energy? mike swell? mike: retail. jonathan: mark okada? 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. mark: yes, that's right. stay on vacation. lisa: happy friday. jonathan: i am so happy we have the fed coverage for you next wednesday. thank you michael swell, lisa abramowicz, mark okada. that does it for us from new

york. we will see you next week at 12:00 new york time, 5:00 p.m. in london. for our viewers worldwide, this is "bloomberg, real yield." ♪

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