scarlet: from new york and our bureaus, i am scarlet fu. we have 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ scarlet: coming up, joining a chorus of investors saying the time to reduce risk is now. plus, elon musk brings his term to the debt market. tesla looks to raise $1.5 billion. new u.s. inflation numbers for janet yellen to chew on, where does it leave the central bank now? we start with the big issues, nerves gripping the market.

>> the reach for yield is apparent in every asset class. we know the insatiable chase for yield continues. >> we should watch for buoyancy getting to a tipping point. >> it doesn't surprise me this hunt for income or search for yield has reached into the high-yield market, at the end of the day you have to ask if i'm being fully compensated for the risk. >> bond funds have to be buying credit somewhere whether it is high-yield or high-quality effort, they have to get to where they can earn in treasuries and as consequence you have a natural buyer for it. >> i'm nervous and for everything there comes a point in investors cycles where the return on capital is better than -- more important than the

return of capital. >> a lot of the people who got it right at the beginning of the rally are saying, this cannot go on forever. scarlet: one of those big names was jeff goodlach. he said if you are waiting for the catalyst to show itself, you will be selling at the wrong price. this is not the time where you say i can buy anything and not worry about the risk of it, the time to do that was 18 months ago. >> joining us now is cohead of global high-yield and greg -- craig bishop, at rbc wealth management. coming to us from st. louis, brian reeling, head of global fixed income strategy. i want to start everybody with a chart showing what jeff gundlach is talking about. this chart shows spreads, the yellow shows option spreads and duration, when duration is really high, spreads impressing.

-- spreads compressing. is the terror we heard of all of those people's voices, is that justified? is jeff right to start pulling back? >> we don't disagree. we have been taking risk down steadily over the past couple of months. we are targeting an underweight to risk assets including high-yield investment grade and emerging markets, but it is nuanced. we don't worry about the current fundamentals. corporate's are healthy, leverages high, but not increasing. they spent the last few years extending maturity profile at a low cost to debt. we see a low default rate. we don't expect it to pick up soon. the question is are you being adequately compensated for the volatility and illiquidity.

we are facing a period where all ability could be higher. high-yield tends to underperform and we see triggers for volatility to go up. scarlet: maybe it is for that reason, brian, you are underweight high-yield. how much performance have you had to give up? >> we have been underweight, high yield since early this year, favoring equities for the risk-based assets. i agree with what everyone else has said, high-yield looks expensive, but when everybody thinks the same thing, sometimes the opposite happens. easily if everything goes as planned, inflation stays low, gdp improves, you can continue to clip coupons in the market, but i don't think it's worth the risk you are taking. scarlet: what is your next plan, lighten up more or rebuild and high-yield? brian: we have seen a pullback, but really nothing on the

broader scale. if we saw more meaningful pullback, we would look for and even weight position. michael: what are people worried about when you're looking at duration, what moves at this point? >> it is more of a question as to what are not investors looking at and concerned about? i think regarding concerns, specifically, high-yield, it gets back to comments that have been made, am i getting adequately compensated for the risks i am taking on? in many cases, i think the decision to move into high-yield in search of yield, those decisions are just made blindly, throwing money at the market to get better yields. i think our caution tone to investors is really focusing on what you are investing in. do you know what you are buying,

do you know what your position is? we have looked at so many portfolios recently that have over the last few years have chased high-yield and the investors don't know oftentimes what their total exposure is. it is time to focus on what you own, do you know what you own? michael: because of length of expansion at this point, when you are talking about the normal sources of risk like central banks, they are going out of their way to say we are not going to move the market, we are going to be slow and deliberate. craig: and we believe that. we believe certainly what the fed is telling us. our view is that you need to listen to the fed, because despite concerns about whether or not the fed will move in december based on inflation, i think our view is they will. they are talking about a gradual path. clearly the expansion we have seen has legs to go.

we see no recession on the horizon, it is two years down the road at the earliest. looking at the equity markets, there is volatility. we expect correction there, but equities and high-yield have run hand-in-hand. there is room to run in high-yield. it is time to be cautious here also. rachel: we do not disagree that there is plenty of time left in the economic cycle, but we do think that the fed will hike at least once probably twice in the next 12 months. frankly we are right on the brink of what we would term quantitative exit. when we see the fed shrink balance sheets at the end of september, that will begin to have a technical impact on the market. in particular, we have seen very suppressed volatility for the last couple of years. we think volatility will pick up, high-yield correlates with high volatility. i have the chart here.

scarlet: she brought her own chart. >> it shows a long-term history between volatility and high-yield spreads. now just in the last three weeks, it has picked up a bit. they are 40 basis points wider and there is a valuation question. people were really concerned about high-yield when it was very tight, it is a cautious period. scarlet: another chart that has gotten a lot of attention, one that shows how the european high-yield spread has come down. the white line is the european high-yield spread. in 2003, the european high-yield spread came in below the ten-year yield and it stays that way for about four years. it took four years for that to change. it ended in late 2007. now if you go to the far right of the chart, we are on the cost -- on the cusp of the european high-yield spread coming in below the ten-year yield, again. rachel: in europe, rates will

lag u.s., see a slower pass of -- path of quantitative exit in europe, also in europe you have in the high-yield market, a higher quality market, more of a double b market than a single b market. it doesn't have the double exposure that has added to u.s. volatility recently. it is only about a three-year duration market. it is keying off different things from the u.s. treasury. scarlet: what does that mean for you, how does all the warnings about this credit cycle that we have heard from jeff gunlach, from pimco, what does that mean for europe? strongave seen really gains there as spreads have tightened. i think spreads can continue to stay relatively low. we are even weight overseas in emerging markets. that said, are you really being

compensated for the risk you are taking? it is at best a wash. i don't think it is worth putting a lot of chips on the table, so rates should stay relatively low and support that market. scarlet: ok. everyone stick with us. coming up, the auction block has a sale of $1.5 billion in bonds causing a stir in the market. we will go over all of it here in new york. this is bloomberg real yield. ♪

♪ scarlet: i am scarlet fu. from new york, this is "bloomberg real yield." let's take you to the auction block. there were 62 billion dollars in treasury auctions this week. you had the sale of three-year,

10 year, and 30 year debt your debt. indirect bidders to the highest share on record. in the three-year, primary bidders at the lowest share in the past 14 years. on the corporate side, british american tobacco selling at $17.25 billion of bonds your proceeds of the deal will refinance bat's buyout of reynolds american. the debt sale that has everyone talking this week, tesla priced at about 5%. the $1.5 billion sale of senior notes will again shore up its balance sheet as it ramps production on the model three. >> craig bishop and brian reeling from the wells fargo investment institute, since we are talking about high-yield, rachel, let's start with you. in terms of tesla, i know you cannot talk about tesla the

company itself, but in general does it reflect a strength in the market or weakness of the market now? are we seeing companies taking advantage of yields while they still came as -- can as the central banks raise rates, or is there so much cash anyone can bring anything to market? rachel: we will acknowledge that this is an early stage company that got the big launch of the model three. it is 18 months out and they are collecting deposits for it now, but they are using the money to build the capacity to build that car. that is pretty venture like in terms of use of proceeds. i wouldn't call it characteristic of the things we have seen year to date. we had those issues in the last couple of weeks, but actually, the backlog of deals in the market is quite light. m&a is running well below the pace of 2016, 2015. in terms of tesla financing, the thing that jumps out is covenants are pretty challenging these days.

we are not getting the same sort of protections we did 15 years ago, but that has been the trend. michael: is that what you are seeing as well, people putting more protection into their contracts? >> i would say in general the demand for debt out there is a very strong. i do not see that fading. there have been large debt deals in recent weeks, many times over prescribed. -- multiple times over subscribed. i think that trend continues not just over the short term, but over the long term. there are structural issues around the u.s. and the globe that will drive demand for debt and duration. scarlet: craig, to pick up on that point, how has the market been able to absorb all of this without so much as a blink? craig: it is a seller's market.

you can come to market and cut deals, the demand for risk remains strong. global markets are a wash in liquidity. there is money that needs to be put to work, that wants to be put to work. the chase for yield is still out there despite warnings. about the concerns right now. it is about liquidity and demand remaining strong. rachel: i would like to add that technicals are strong in the market. we have seen record new issuance in the investment-grade market year-to-date. in anglo markets in particular the use of proceeds has been largely refinancing pushing maturities further out to the future. actually, post financial crisis we have not seen a resurgence of the lbo boom we saw before him, so aggressiveness is not that exceptional and triple c issuance was quite light. there is some triple c issuance, but most of it is refinancing.

scarlet: things don't look terrible from the bankruptcy perspective. rachel: i have another chart on my screen. 12 months ago we were dealing with energy recession and a -- and bankruptcy spiked to about 4% across the market. they are now down below 2%, below historical averages. you can see that energy dominates the largest liabilities stacks in the last year, but you have a couple of consumer products companies in there as well, pay less and gymboree, an area that is a focus and concern but is a smaller part of the market. michael: craig, when you look ahead in 2018, do you worry about what we're going to see in terms of default rates and does that change how you look at things? we started the show with people talking about how worried they are right now, are you anticipating a spike? craig: we aren't.

it goes back to the current market environment. it gets back to the story about this market -- the markets have room to run, yet. i think as long as we continue to see this slow and steady growth, you will not see the cup -- you will not see the pickup in default or bankruptcies. high-yield equity markets are going to be supportive, but it will just in our view drive spreads a little bit tighter. scarlet: talk about the inflows that we have seen this summer, how has the amount of new money being put to work being changed over the past few months? brian: i think you continue to see investors want to get into the market. for the first time in a long time, at least with the retail investor, we are starting to see investors move out of cash, not investing in the fixed income markets, but more in the equity markets.

it is a change we have change -- yet, but it is a little change from anything we have seen over the last six to seven years. scarlet: everyone is sticking with us. let's get a quick market check on where bonds have been this year. looking at the 10, 2, and 30 year, yields are all coming down. 1.29% for the 2-year yield right now. still ahead, we have the final spread. the week ahead features the minute from the fomc. all of that coming up. this is "bloomberg real yield." ♪

♪ scarlet: i am scarlet fu. this is "bloomberg real yield." time for the final spread. coming up over the next week, you have u.s. retail sales, nafta discussions, missile defense talks in washington, as well as minutes from the fomc.

we are getting ever closer to the jackson hole meeting as well. michael: we were just talking about whether assets are overvalued at all. the federal reserve of minneapolis bank president speaking out and he says no asset class is flashing red to him. craig: our view is we are comfortable and confident with the steps the fed has taken to deal with the rescue from the great recession as well as managing recovery going forward. looking at the upcoming fomc meeting with regard to the balance sheet, we don't see a repeat of the taper tantrum. michael: i want to take you guys into the short end of the market, the very short and of the market, g# btv 8582, this is the spread between one month and t-bill yields and the

last time we had a debt ceiling problem we saw a spike below zero for that spread. we are not quite there yet, but you can see us moving down here. let's start with brian. are you concerned that we will have something happen in the debt ceiling debate that will cause the markets to react significantly? brian: no. i think the debt ceiling plays out as it has most of the other times. we go to the last minutes and they will eventually pass it. it will cause market concerns, in the near term but it will , pass and play out -- i just don't see -- they don't have any other choice than to pass it. michael: rachel, is that too much complacency? rachel: i'm not sure you call it complacent when we feel there will be brinksmanship to the last minute. we do expect volatility to pick up, but we do think everyone senses the underlying importance of clearing the debt ceiling. it will happen, but it will be last minute, and there will be a flurry of a volatility before

hand. scarlet: what will volatility look like before this one like the last debt ceiling debate? >> given the uncertainty out of policy coming out of washington right now, and who is leading the way, i think that will create volatility. we went to the t-bill market, if you look at late september into early october, you pick up 10 basis points already. there is some concern playing out in that market. we are not concerned. we think the debt ceiling will be fast. ryan mcconnell and the white house are all on board running to get a clean bill passed. an uptick in volatility should be modest. michael: brian, quickly, you could have the fed starting its balance sheet reduction at the same time. does that worry you that you have two competing elements? brian: no. i'm not worried about the balance sheet impact on the market. if you look at the fed's

maturity schedule, they actually have over 200 billion extra maturing securities next year then they have this year. they will be buying more this year than last year even though they started reducing the balance sheet. very little worried there. scarlet: does that mean nobody is worried about the balance sheet reduction? would that not be a reason to worry here? craig: i think you are right to play the contrarian here, but i think what is different than 2013 and the taper tantrum is the fed has been so careful and cautious in explaining what they want to do. i think that has helped pave the way for a reduction in volatility. scarlet: first question to rachel, what will we be talking about in five years time, quantitative easing or quantitative exit? rachel: probably be back on that

easing side of it, because i do think there will be a cycle between now and then. craig: i think we will be talking about interest rates, lower for longer. brian: easing. five years. michael: 4% fed terminal rates are overpriced, 2% says they are overpriced, 4% says they are ok. what is the terminal rate? rachel: 2%. brian: 2% to 2.5%. scarlet: our thanks to everyone for joining us today. this is bloomberg. ♪ got you outnumbered.

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♪ >> coming up on "bloomberg best", the stories that shaped the week in business around the world. heated rhetoric between the united states and north korea sending a chill through the markets. president trump: they will be met with fire and fury like the world has never seen. >> the rhetoric continues to ratchet up almost by the hour. >> south africa's president of dividing a political challenge, and china's tourism boom spurs a surprising partnership. >> the marriage of off-line to online, or online to off-line. >> sheryl sandberg saying that facebo i