jonathan: from new york city, i'm jonathan ferro. with 30 minutes dedicated to fixed income, this is "real yield." ♪ jonathan: coming up, core inflation accelerates, two-year treasuries jump 2% for the first time since 2008. some of the world's most well-known investors say the bull market and bonds is over. credit investors are not showing any nerves. junk bonds with the largest inflows in over a year. we begin with a shakeup in the global bond market. >> this will be a jagged period, the first quarter. >> not so much about china selling treasuries but more

about inflation showing up in the u.s., the risk that keeps most market participants awake at night. >> i think for the treasury market, it is far more important what the actions are coming out of europe and japan. >> you have not only the fed unwinding its balance sheet, we have the ecb slowing purchases, what we have seen from the boj, they are making changes, which we extrapolate, slow purchases as well. is poised to take its foam of the scale, and poised to stop manipulating the 10-year treasury. >> $14 trillion worth of bonds bought by central banks in the past 4-5 years. that appears to be close to an end. >> the bond market is not dead, it is just dealing in a bearish trend that a lot of people in the market have not seen before. they have to learn how to do it. >> we have put in a structure, secular low in yields, 130, 140 on the 10-year.

to say we are in a bond bear market is still premature. jonathan: joining me is matthew hornbach, priya misra, and michael buchanan. the bond bull, were you shaking this week? >> i don't think so. there were a couple of stories earlier in the week that scared people, sent yields higher. obviously the inflation print this morning, a rare upside surprise. a little bit interested again in the inflation story here. really, all of the things we saw this week in the bond market feed the confirmation bias of the bears. give them everything they want and here we go. does it? priya: i think we all came in looking for the big trade, and it is a big trade, this big bear market. i would argue not. but there is enough there. bund yields rose. the fed was fairly hawkish.

michael: certainly something, if you are bearish, we are not. at the end of the day i think it boils down to fundamentals. when we look at fundamentals, still slow growth despite a pickup we will probably get from tax reform, inflation may be picking up but still low by historical standards. jonathan: what does this say about the nervousness in the market? first of all, it was the boj trimming and weekly open market operation. just a little bit. then there were concerns about china, what they may or may not do with treasury holdings. after that, a tweak to a communication from the ecb. it hasn't come yet, people worried about the prospect of forward guidance. what does it say that people are so nervous off of the back of those small events? matthew: i don't think it is nerves as much as this is the beginning of the year, people are ready to go, let's make money. people are taking this as an opportunity to increase bets for higher interest rates. the interesting thing for me about the price action that we

saw in german bunds, after this, the curve flattened. if you are worried about a steepening, or you are positioning for a steepening in the u.s. treasury market, you want the bund curve to steepen, you don't want it to flatten, but it did. anyone out there with steepeners in the u.s., will be concerned that the curve did not steepen. jonathan: i was going to save it for later but i will go with it now. the spread on bunds versus treasuries is wide and gets a lot of attention on the two-year space. something that does not get much attention is the bund curve is twice as steep as the treasury curve. what is the story there? matthew: we are now in a position where the ecb is downshifting their purchases, it has been well telegraphed, everyone understands this. that is the first of -- this is the first step in a normalization process. that will perhaps be to an increase in deposit rates and further increase in the refi

rates that the ecb has. first the curve steepens and then will eventually flatten. it is already flattening, that's what's interesting. jonathan: what is your view? priya: to the extent that the ecb will raise rates rather than reduce purchases, i would agree. if they actually taper quickly, they stop buying. if they stop reinvesting, then it could have a pretty big impact on the periphery. the view from the market is they keep the bund program, they start normalization from negative rates, perhaps to zero. therefore, the curve should flatten. i would say the spread in the front end is all about ecb action. in the long end, that spread is too wide. treasury bonds around 2.5 basis point is arguing if prices can -- are growing as if treasury prices can rise while bund rates stay the same. that does not seem to make sense. jonathan: let's have some thing that does not make sense to people, the amount of debt outstanding that trade for negative yield. i believe it is around 7 trillion.

there is enough in the market to scratch your head and wonder why we are still doing this. the abnormal can stay abnormal for longer than you think. michael: we have proven that. what this speaks to is, you look where the u.s. is. on a relative value basis, u.s. -- u.s. treasuries look reasonable when compared to a lot of european rates. then you get into the spread sectors and is probably more compelling. jonathan: was the 10-year option evidence of that, on the back of you will get sufficient demand? michael: that is fair to say, probably outperformed what expectations were. that is a reasonable assessment. your view, matt? matthew: it was just classic after all the news that we saw earlier in the week, the backup, steepening. let's face it, if the story on china had any credibility to it, which we don't believe it has, but if it did, the curve should not be steepening. it should be flattening.

because most of the securities owned by central banks across the world are on the front end of the curve. stay --: what does it this say about market practitioners, there was a story about what fx reserve managers in china may do, but it was not the front end that sold off but the long end. priya: i would disagree. i think the steepening made sense. i would argue a lot of the buying from central banks in the last year has been in the long end of the curve. we don't have data on this. all i am saying is there is a significant amount of buying, somebody is taking the place of the fed and that is the official institutions, and the curve is flattening. i am a foreign reserve manager, do i really want to buy your -- by five-year treasuries when the market is not pricing close to what the fed is projecting? why would i buy the two to two told i buy the five-year sector? maybe i buy further of the curve. i actually think foreign central banks may have been buying the long end. if they are stepping away, then the curve can start normalizing.

matthew: my perspective is, you need to look at the last time central banks actually had to sell treasuries. the last time was in 2015. as was suggested, we don't have data on what they sell, but we know the last time the people's bank of china needed to intervene in the fx market, they were, we believe they were selling on the front-end of the curve because we saw dealer holdings of the securities go up. again, it speaks to the idea that if you need to let notional go, you will do it in the front end of the curve. jonathan: there is a huge political dimension to that story i don't think is lost on anyone. mike, your thoughts on foreign demand, whether it is investors or central banks? it is not going away. michael: we are not seeing evidence of that institutionally, evidence from a retail standpoint. demographics support that. there is still very healthy demand broadly for fixed income. we don't see it going away. jonathan: all of you will be

staying with me. coming up on this program, the auction block. the world's oldest bank comes back to the market one year after a government rescue. we will talk about it a , remarkable story this week. this is bloomberg "real yield." ♪

♪ jonathan: from new york city, i'm jonathan ferro. this is bloomberg's "real yield." i want to head to the auction block, we take a trip around the world. we begin in asia, where tencent sold $5 billion of bonds. its biggest u.s. dollar offering, the first time it issued debt since 2015. it drew comparisons to alibaba , which sold $7 billion in

november. in europe, monte paschi received orders to more than triple the subordinated debt it offered. the world's oldest bank sold more than $900 million a year after imposing losses on $5.2 billion of junior bonds during a government rescue. in the united states, a little order restored in treasuries, $56 billion in coupon bearings, the highest level since 2014, wellbutrin your auction -- while the 10 year auction was at the strongest since 2016. treasury auctions calming down. the 10-year according to the highest level in 10 months. bill gross declared a bond bear market. >> 10-year treasuries, which are at 2.55, probably over the year will go to 275, 284 number of for a number of

fundamental reasons. that is a bear market but it does not really significantly affect total return in a negative way for bund investors. it leaves them flat for the euro 2018. jonathan: still with me, matthew hornbach, priya misra, michael buchanan. thoughts? matthew: if 0% is a bond bear market, sign me up. i don't think that treasuries -- it is hard to draw a downtrend line for the past 25 years. jonathan: but you know we will do it. just going to draw and 25 year line for treasuries. matthew: you should do the same for the jgb market. what you will discover is that unless you expect bonior's ago -- you expect 10 year government bond yields to go into negative territory in a significant way, eventually those downtrend lines will be broken. let's think about it from a total return perspective. if zero is the worst we can expect, then given where equities are, it is not that bad of a buy. it is a great hedge if zero is

the worst-case scenario. priya: i would say 3% or higher is what i would define as a bear market. i think we are far from it. 2.65 is already priced into the forward market. if you think 10 basis points above what forwards are pricing in, that is not a bear market i would argue. michael: it doesn't feel like a bear market. if you go back to year, we were at or near the levels, great opportunity to buy duration. proved to be a head fake. that related to fundamentals. i still see the fundamentals suggesting rates are not overdone here. you could see movement lower. jonathan: looking at the fundamentals, i want to strip back what is happening with yields, the inflation component. inflation expectations are rising, but term premiums in the u.s. are not picking up. i would have thought any recalibration of inflation expectations would have been a catalyst for higher term premium in the united states in the treasury market. what is happening? matthew: putting aside today, we

had a great cpi report today, breakevens are probably up based on that. as they should be. but if you look at the past three months, which is where we have seen the most dramatic widening in breakeven inflation rates, my view is that was a more nominal treasury supply story. beginning in september, the market became refocused on tax reform, tax reform was signed by the president in december, it came on the higher end of our expectation for the impact on the deficit, which means the treasury will have to issue more coupon securities, in our view. that is what is being priced into the market. the widening and breakeven inflation rates were less of a global reflation story simply there are more nominal coupons hitting the market this year. jonathan: do you share that view? michael: i don't think i could say it any better than matt just did. tax reform -- we will probably talk about that -- but that plays into this. it is big and probably filtered

into how the market reacted. jonathan: from a supply perspective, but what about an economic fundamentals perspective? does the tax bill change your views on the potential for higher inflation at this year? michael: at the margin it does, it is additive to economic growth, but you have to put it in perspective. we are talking less than a half percent. the near-term benefits will be noticeable and strong, but over time, that goes away. priya: i think we heard from the fed. i think the fed needs to be taken in context. they are telling us they will hike. we heard from new york fed president dudley yesterday. not that concerned about inflation. that is why breakevens have risen while inflation term premium has not. you have inflation picking up, the fed saying we are going to hike three times, we will hike in 2019, so the idea that they may be behind the curve is not there. so therefore term premium remains low. yet inflation risk rises because you have the fed trying to push

back. the whole tax story is making them i think marginally more likely to hike this year. jonathan: you all seem pretty constructive on the 10-year treasuries in the united states. mike, looking at the situation with bunds versus treasuries, a lot of you have talked about the attractiveness of 10-year treasuries versus bunds, but that advantage disappears when it is currency hedged. matthew: i think that is accurate, and you look at european high-yield trades, inside of 3%, 2.8%. that is eye-popping. you converted into you -- into u.s. dollars, that adds about 200 basis points. you have to factor in that currency translation. it is important, but does not really take away from the story. there is a big gap between bunds and treasuries. i think that trade is exploitable, one that you want to take advantage of. we are taking advantage of it. matthew: i would add to that, not every investor currency

hedges. central banks do not currency hedge. there are pension funds in the world that do not currency hedge. there are life insurance companies that do not currency hedge. there are different types of investors in the world, they look at things in different ways. for those that don't currency hedge, the treasury market is the best place to be. jonathan: the story for you mike, going to credit now, credit remarkably solid coming into the new year. rallied a lot higher than many people thought it would go, never mind in the first couple of weeks. maybe throughout the whole of the year. have you been surprised by what we have seen in the early part of the year? michael: not really. maybe to some extent. if you look at the past two or three years, going into every year, most investors could contract a bearish story on credit. it was always around valuations. i think you have to put about -- put evaluations in the context of fundamentals, and

fundamentals are very supportive. no question. like i said earlier with tax reform, they are about to get even better. valuations should be compressed, spreads should be tight. it is not a table pounding opportunity but we are finding opportunities. jonathan: is your view predicated on a treasury market that behaves itself? michael: yes, to an extent. i think credit can do well, reasonably well, even if rates rise. if the 10-year goes to 2.55, 3% throughout the course of the year, there is room for spread compression. if we see a quicker acceleration of that, it starts to damage fixed income and spread sectors. jonathan: i had this conversation with blackrock earlier in the week, i asked, are you derisking? they say it is right at the bottom of equity, not credit. king, and is there

a difference between that and saying the optimal place is not in credit and high-yield, but right at the bottom in equity? michael: we are, and that is the byproduct of valuations. as they look less attractive, it you derisk your portfolio. that means selectively selling high-yield, keeping our best that's on, keeping our local currency market positions. jonathan: anything in high-yield and you are selling off and you can tell us about? michael: we have been selling some of the lower quality. we are taking gains in the triple c's, single b's, concentrating more on the double b's. we think there is an upgrade b's. in the double that is something that investors can take advantage of. jonathan: mike buchanan will be sticking along with us alongside matthew hornbach and priya misra.

the treasuries are the stories. healed higher yield higher through 2% for the first time since 2008, up or basis points for the week. higher on the long end as well. 2.87 on the 30-year treasury. still ahead, the final spread, the week ahead feature more bank treasuries and a potential government shutdown. this is bloomberg's "real yield." ♪

♪ jonathan: i'm jonathan ferro. this is bloomberg's "real yield." it is time for the final spread. coming up over the next week, a shortened trading week here in the united states with equities and bonds markets closed for martin luther king holiday. you have more u.s. bank earnings starting tuesday, bank of canada decision, china gdp, and potential u.s. government shutdown. everyone is still with me. a viewer question for you,

priya. do you think the bank of canada will hike rates next week? priya: we are not looking for a hike. we are looking for two hikes in -- two hikes this year, which is the market consensus. the debt overhang and canada cannot be overestimated. a lot of their debt is floating rates. the bank of canada hikes too fast. if they start hiking now, the market is pricing in for this year. you wonder about what all of that overhang does to the consumer. even though we are not looking for a hike, we are also looking for fewer hikes throughout the course of the year. jonathan: mike, getting your view on something else, possibility for next week, a government shutdown could be the of session in washington, d.c. certainly not in wall street. not on anyone's radar. kind of like, they will sort it out, it doesn't matter. is that your view? we think that is accurate, that they will sort it out.

one thing to watch closely is spending that comes as a result of that agreement. i don't think the market is fully priced in, you could get some cohesion between the president and congress on military spending, nonmilitary spending, and if that comes together in a meaningful way, that could be pretty powerful, lead to some curve steepening. we will watch that closely. i think an agreement is worked out by the end of the week. matthew: we are of the same mindset, we believe the government wants to try to avoid a shutdown at all costs. there are clearly some issues on the table, daca, border security , that will need to be hashed out. from our perspective, the most likely outcome is there is a short-term extension while they continue to debate these other issues which are important to the process. jonathan: three questions, short answers. we will wrap up the last 30 minutes and look ahead to next week. do you sell into the bear market drama or do you buy it? buy.: nu

>> buy. >> buy. jonathan: the term preemie and adjust higher this year on treasuries? michael: i was a higher. jonathan: duration risk or credit risk. it is a question i ask sometimes. matthew: duration. priya: duration. michael: i say credit risk. jonathan: you have got to. great to have you with me. matthew hornbach, matthew buchanan, and priya miserable. see you next week. this was bloomberg's "real yield." this is bloomberg tv. ♪ retail.

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>> welcome to the "best of bloomberg markets: middle east." a major stories driving headlines from the region this week. , 11 people are detained following a protest in this audi capital. why did they so brazenly risk their freedom? the head of saudi arabia market regulator runs us through the role changes they are bringing in as the king looks to spur for investment. high asn a three-year u.s.