jonathan: i'm jonathan ferro. with 30 minutes dedicated the fixed income, this is "bloomberg real yield." ♪ jonathan: goldilocks dominating 2018 again. central banks say yes, predicting high growth and low inflation. text negotiation is hours away from making a congressional compromise. an uneasy calm hangs over treasuries. is this year credit fails to match a massive rally in equity? we begin with the big issue, high-growth and low inflation in 2018. janet yellen: real gdp growth is

a little stronger. the unemployment rate is a bit lower, and inflation is essentially unchanged. mario draghi: the strong bills momentum in this significant reduction of economics, gives grounds for greater confidence that inflation will converge towards our inflation aim. yellen: i want to see it move up to 2%. most of my colleagues and i believe it is being held down by transitory factors, but there is work undone there. draghi: the degree of monetary stimulus therefore remains necessary for underlying inflation pressures to continue to build up and support headline inflation developments over the medium-term. jonathan: joining me today from the morgan -- jpmorgan asset management is bob michele, the global head of fixed income. lisa coleman, the firm's global head of investment great corporate credit.

great to have you with us on the program. it is your turn to grill me. bob: don't you worry about that. jonathan: let's talk about goldilocks growth. we have experienced this for so long. high-growth, low inflation and central banks staying in the game that is positive for risk. next year?hange bob: what is not to like about it? i love the central banks this week. they acknowledge the higher growth. they acknowledge moderate inflation. when i came to policy, they are looking the other way. you got very benign rundown of the balance sheet. almost no rating increases except for the fed. it is great for asset prices. certainly the first half of the year. you throw in any sort of policy stimulus out of washington with tax reform, you got to go with it. lisa: i agree. from my perspective, what is not to like? you got accommodative conditions.

you have great growth. central banks are not raising globally, at a rapid pace. you have the fed outlining what they are going to do. i think it is ideal conditions. jonathan: it makes sense for high yields to perform? we have had some very sector specific issues going on, whether it is any retail sector, there are things that have people concerned. when you take a step back and look at where defaults are, look at the positive benefits we will see from the tax plan. coupled with good growth we are in a good environment for high-yield. bob: it is not that high-yield has performed poorly. it has been ok. there is a lot of rotation into equity now. if you're going to own the top of the capital structure of the company, you have to like the bottom. if you have some stimulus from washington coming through, you have to own the bottom. jonathan: i spoke to someone from morgan stanley thinks credit might be targeted. -- might be topping.

that is a warning for the xp market. is that is something you are thinking about? bob: i don't see it. i look at credit spreads, at 370 basis points over, look pretty generous for the default rate that's about 1%. if you think about some of the tailwind we will see in corporate america next year with tax reform, the reduction in the tax rates down to 21%, that is really nice for corporate profitability. i think we have a while to go. you typically see high-yield spreads come in through 300 towards 250. jonathan: i spoke to you a few weeks ago. you sounded less bullish. what is behind that? bob: we've had a good run for a number of years. the central banks are definitely taking the punch bowl away. it is a question of how much longer do i want to ride it? the next couple of quarters for sure. jonathan: 5.5% will not do it in

high-yield. will they keep going down? if you look at the capital structure and think financials are going to be ok, why be at the top of the stack? lisa: i get the point on equity, but i'm a fixed-income investor. you got to be somewhere. i like high-yield. you know what i like more? at1's in europe. you got an improving europe, growth is great. think about where we have come from the banking sector in europe from the crash back in 2008. you have capital ratios just under 15% in the banks we cover. why not come down and capital structure? jonathan: they've had a great year. more to go? lisa: i think it is the weight of money. think about where we are in terms of negative yields. you have a large swath of the market trading get negative yields. probably about 18%. even if you look at the central banks starting to correct that policy, we have looked at

forward rates. maybe in the worst case you have another 3% that is no longer negative. where are people going to go? they are looking for yield. go to the area you get the best opportunity, which is banks in europe. jonathan: a lot of people have become more constructive about europe. it makes sense, the economy has improved. the ecb is still in the game. when i think about how difficult it has been to push that positive asset classes across europe, yields just stay low 30 basis point on the german 10-year, multiple expansion in the xp market. it is not happening. coco has had a great year and maybe another one. bob: people have got it wrong. i will horrify you. we have been adding european high-yield in the last couple of days. the total yield is 2.5%. jonathan: why have you been doing that? bob: because when you swap it back to dollars you are getting the yield of just over 5%. i look at that.

i look at what i could do in the dollar high-yield market of equivalent credit quality. i might as well take some up 50an high-yield back basis points, swap it back to dollars. jonathan: so this is exclusively about yield? bob: i think it is both. i will pick up a couple percent on that. i have been saying all year, you if you waiteedy, for the pullbacks to be greedy and want more, you will miss it. we have had a pullback and that is enough. jonathan: we've also had a massive rally in europe. bob: we've had a tremendous rally and all asset classes for a while. the ecb is the one central bank that is telling us they may actually extent qe beyond when

they said the taper would end. the don't foresee raising interest rates in the near term future. you think about the minus 4/10ths of 1%. you have to go with it. jonathan: at some point, there has to be a re-price in a place like jeremy. you have to recognize there is interest rate risk in the corporate debt market because of this method asset purchase program the ecb has conducted. you are not concerned at all about european credit? the ecb is not stepping up. lisa: think about those negative yielding assets. until that point happens, you have to find a place to go to get positive yield. it is corporate credit. the other thing to carry on from that, it is not just europe. think about japan. japan has been the big story and continues to be the big story for us. japanese investors still can find value, albeit less than it was over the past couple of years, but they can find value by buying u.s. corporate bonds, heading back into japanese yen. jonathan: final word on europe.

is 2018 the year they get away from the front and? bob: i think so. i think the growth looks wonderful in europe. it will put pressure on the ecb. i think you will see inflation drift higher on the core right then the 1.1% expectation. i don't know they will be able to do a continued stub qe in the last few months of the year. the focus by midyear will be one -- will be to return to when are they going to raise rates? bob michele and special thank you to lisa coleman. next up we focus on emerging markets. china follows the fence lead in monetary policy. this is "bloomberg real yield." ♪

♪ jonathan: from new york city, i'm jonathan ferro. this is "bloomberg real yield." at j.p. morgan asset management headquarters for the year that was in the year ahead. in 2017 it was definitely the year for emerging markets. em credit has ripped higher. outpacing the developed market. still with us, bob michele, global head of fixed income, and joining us is pierre-yves bareau, the head of emerging-market debt. when you think about the things to fear in 2017, one of them was emerging markets. we were all thinking about this relationship between the united states and china, the potential for trade wars and the idea you want to steer clear of em in a big way. that was a bad call. what happened? pierre-yves: growth is good for em.

when you look at history, it's always good. into 2018, it seems it is very conducive. growth is good. moderate inflation is good. commodity is in good shape in china is doing well. jonathan: that investors overestimate the impact of politics? pierre-yves: it is something we need to care about in 2018. we have some headwinds coming to em from politics. 40% of the country's will be going through political transition. second challenge will be the central bank normalization of the main central banks. jonathan: what is the argument it was just treasury yields staying stubbornly low and the aggressively and everyone ended up disappointed. it wasn't about em. it was about elsewhere. bob: there was some of each and -- each in those statements.

the emerging-market teased us all year long. it had the high real yield when he had zero real yields in the developed market. coming out of the trump victory, the emerging-market currencies were a bit undervalued. you can pick up high real yield and get a tailwind on the currency. i think actually you did not get the trump stimulus. that was clear by the end of the first quarter. the dollar came off the boil and emerging-market debt looks pretty attractive. jonathan: you have been a treasury bear for quite a while. the 10-year will not come through. bob: we go back and forth on this, don't we? you point to the 30-year as rallied over 35 basis points this year. entirety --to the that the funding rate of the u.s. government, raising 30 basis point. it surprised us that yields in the long end haven't gone up a bit more this year. i think certainly when there was a failure of the administration to get through stimulus at the

start of the year we had a -- we had to revise our expectations. the fed is committed to raising rates at least three more times. we will see what happens when qe winds down and we go from balance sheet expansion to contraction and the buyers exit the market. i think you will see a bearish steepening of the yield curve next year. jonathan: you are still a treasury bear. can you be a treasury bear and an em bull? bob: it is the pace. right now, the developed market central banks are being overly cautious in how they normalize policy. pierre-yves: in the past two hikingthe fed has been more than expectations. as long as central banks are telegraphing what they are doing, we have to keep an mind they have balanced the books a lot. jonathan: where do you have the most conviction around em?

the surprising thing for many people might have been emerging-market europe, eastern europe. latam not great, southeast asia very mixed. pierre-yves: we see big opportunities next year. we think high-yield in emerging-market. we are more or less away from the 10-year average. that is the value trade right now in our portfolio. we are targeting the countries re-rating ofs those countries. south africa and central america as well. the second opportunity is countries that are growth related. central europe and asia. we think that carry will be more of a challenge next year. carry will be less appealing. jonathan: in terms of the sector breakdown in credit, that a -- the big story is technology. technology in emerging markets thinks something i don't people have valued enough.

energy mining. is that something you are focused on? pierre-yves: that is why we are big in china. contrary to market expectation, which is down on china. the reason why we think this slowdown is much more solid in terms of growth. one of the reasons is this industry upgrading. the fact that more than 50% of the and china is going to makeslogy sectors, which the growth more robust. jonathan: there has been a bond route in china. why has that not bled to em? pierre-yves: there is tightening, more defaults, with it is good news because leveraging is finally happening. economy rebalancing its from the old economy into the newer sectors we were talking about. rebalancing from the supply model to a demand oriented model. consumption is now 70% of gdp growth in china.

that is the reason why, with those two drivers, china is on much better footing the people think. jonathan: i should be bearish on old economy china exposure? pierre-yves: china is a big factor for em. being a more optimistic on china makes us comfortable with em in general. again, not everything in em. we are coming to a tighter level right now. the big thing next year will be differentiation. one factor will be politics. you have the big value opportunities in local markets. a lot of countries are beyond 10% of yield. the election will matter. jonathan: i'm assuming you share his confidence around emerging markets? bob: i do. by the way, i'm impressed with the way china policymakers have handled things. we want them to rein in credit a bit. we talk about how the pboc snuck in a decorative rate hike on the yields of the fed.

they are doing all the right things. if they are doing the right things, and you got this stimulus coming out of the developed central banks, you are going to have a pretty good environment for emerging-market debt. jonathan: they delivered a rate hike on christmas day as well. a number of years ago. bob michele, pierre-yves bareau, thank you for joining us. next up, we have a look ahead to 2018. before we get there, a check on where bonds have been this week. two's, tense and 30's. it is a flatter yield curve on the front and rally. -- bob will give us the annual bond market awards next from j.p. morgan asset management. this is "bloomberg real yield." ♪

♪ jonathan: from the new york city, i am jonathan ferro. this is "bloomberg real yield." at j.p. morgan asset management

trading floor here. it is time for the final spread. coming up over the next week there will be a slew of u.s. economic data released. you will also have bitcoin futures. we won't deal with that right now. a boj decision, regional elections in catalonia, and all voteon washington for tax and a potential government shutdown. what i want to do is something that bob does every year, the annual bond market awards. i think it is absolutely brilliant. we're going to rattle through them. you have chosen bond of the year. can you walk me through bond of the year? bob: in distorted markets you have to look for something that is most distorted. i went with the violia zeroes. a three-year triple-b rated issue. forget about the fact that money -- fact that they are owed money for three years at zero coupon.

they got lenders to pay them to take their money. a yield of -3 basis points. that is not a sign of distorted markets, i don't know what it. jonathan: lifetime achievement award? bob: got to give it to janet yellen. i actually think she is a really cool lady. she got into the fed. she helped normalize policy, and she is also the fed chair in 40 years to have a term without a having occurred. jonathan: comeback player of the year? bob: lots of potential candidates. it has got to be developed market government bonds. every time i am on, you keep telling me, they have not gone up in yield. i said we were going to have it. they should have. don't they know growth is where it is accelerating? jonathan: is it going to happen next year? bob: certainly by this time next year it will, because the distortion by the central banks is not going to be there.

central bank balance sheet expansion turns to contraction. jonathan: unsung hero? bob: another good one. the yield curve. it has to be. the front end of the market went up in yield. if you're a short-term investor, looks great. what about if you're a long-term investor? you made some money. jonathan: most valuable player of the year? i want to spend some time on this. bob: most valuable player, i went with quantitative ease. there is a number of ways to look at it. if this were january 1, 2017, we could've put all the sectors and asset classes on the wall, throw at them and the portfolio would have been up in value. are we just good dart throwers? the fact that central banks keep printing money, $160 billion a month at the peak this year. it ripples through. it means you don't get corrections. it is why the equity market has

not corrected more than 3% this year. jonathan: are we approaching an inflection point next year as far as qe is concerned? and its impact on markets? will the size of the balance sheet remain powerful? bob: it will remain powerful, but because the inflow will turn down, i think that is something for the markets to digest. the way the central banks have laid it out with the ecb doing $30 billion over the next nine months, the fed stepping up its rundown to $20 billion a month in january, it steps up every quarter. we will see with the bank of japan does. balance sheet goes from expansion to contraction. when you have a correction in the market, say the summer of 2018, you will not have that big pool of money being printed that will come in and support bonds and then spillover into everything. jonathan: when we do this this time next year, the two-year in

germany will not be yielding -70 basis points? bob: i don't believe it will. it may still be negative, but not 70. jonathan: my special thanks to j.p. morgan asset management's bob michele, lisa coleman, and pierre-yves bareau. that does it from j.p. morgan asset management. my special thanks to them for letting us do a full hour for bloomberg radio and on bloomberg tv right here from new york. i will see you next friday at 12:30 p.m. new york time. 5:30 in london. this was "bloomberg real yield." this is bloomberg. ♪

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