lisa: from new york city for our viewers worldwide, i'm lisa abramowicz in for jonathan pharaoh with 30 minutes committed to fixed income. this is "bloomberg real yield." ♪ lisa: coming up, billionaire hedge fund ray dalio. rising yields could spark the biggest crisis of fixed income investors in almost 40 years. plus, investors are earning the least extra yields on u.s. corporate bonds over benchmarks since 2007. are there any gains left? and ahead of janet yellen's last fed meeting, we discussed her legacy and pass forward to the incoming fed chair jay powell.

we start with the big issue, dalio's warning resonating from davos to new york. take a listen. ray: a 1% rise in bond yields will produce the largest bear market in bonds that we've seen since the 1980-1981 period. >> has that bear market started? are we in it? ray: i think we're in it. >> there will be a time the bank of japan and ecb begin tightening. that will be a time when they arbitrage narrows and maybe when bond yields increase. i don't see that now, unless i'm wrong on inflation. and i don't believe the federal reserve will get to the four tightenings they suggested, that will get the 10 year to 3.6%. >> i don't think the bear market is starting. since 1990 we had many, many predictions of a bear market in bonds, but it has not happened. lisa: joining the around the table in a new york is subadra rajappa, and rachel golder, and

coming to us from london is luke hickmore. alright, so i want to start with you, subadra. the big question here is has the selloff in benchmarks just begun, or is this the extent of it and will people pile back in? subadra: that's a good question. i think that there is still more room for bonds to selloff from here. we have seen them pricing higher over the last few months. and i think that we could probably go a little higher. but ultimately, it depends on where the chairman fed funds rate is. the funds rate is still around 2% to 3%. i don't see a big upside from here. lisa: hold on a second. what is the threshold? what is the at which people will pile point back into 10-year treasury yields, which are now at the highest level since 2014.

we are seeing some pretty high levels here. subadra: you can see drips and drops of demand from overseas. especially because the yield differentials between yields in the u.s. and yields overseas is quite large. and i think we can see demand again from pension-type accounts because the back end of the curve looks relatively cheap. so i think you will see some demand as we price higher. lisa: is there a tipping point? subadra: for how high they could go? we actually have 10 year yields ending the year close to 2.7% or 2.8%, so we don't really have that much room for yields to sell off from here. lisa: luke, you're overseas. are you buying treasury yields? are you buying treasuries? luke: no, i wouldn't buy treasuries yet. i think if we actually get into a three, maybe slightly higher context, that will be the attractive level to buy. it feels we could drift up as the year goes along and people realize three rate rises are baked in, maybe we get four or

five, the dollar continues to struggle. that rises inflationary concerns as well. look, there is a lot of debt around. i think that will suppress future returns for all types of asset classes and growth, and probably limit where these yields can go, which is why i don't agree with ray dalio. it's going to be some short-term pain. this isn't a bear market in the sense of massive losses. this is going to be a correction to more of a fair value level, i think. lisa: rachel, what's your base case scenario for 10-year treasury, given the fact that it is essential for credit investments? rachel: right, the shape of the yield curve is interesting. we do think the 10 year continues to move up. it's likely to reach 3% in the next 12 to 18 months. we expect three more hikes this year, and probably two or three next year. so we are maybe a little bit more aggressive than most on the

number of hikes that we expect, ra'sto go -- echo subad point, on the longer end of the curve, we see healthier pension fund finance conditions with higher equity market and higher rates. you are seeing better funded status. that will motivate them to pivot out of equities into debt, which will support the long end of the curve. lisa: i don't understand one thing. the growing consensus is growth is picking up globally. synchronized global growth is the catchphrase of the moment. and yet, why are we not seeing more of a rally? why are we not seeing more of yields rising? bonds should be crushed right now. every news item has been terrible for them and the yield curve continues to flatten. why? subadra: well, growth is starting to pick up, but we are still between 2% and 2.5%. we might reprice it to 2.5% to 3% in the second half of 2017, but for the most part, growth is still very subdued globally. it is better than what it was before, but we are not seeing 4% growth or really large numbers.

and more importantly, i think inflation is extraordinarily contained, not just in the u.s., but globally. and the third factor i'd say that's keeping bond yields relatively low is the fact there is a huge stock effect of central bank holdings of bonds. so that, again, will be something that will prevent yields from rising meaningfully. lisa: alright. so luke, i remember when people used to care about negative yields and debt. i remember when people used to worry this would be a problem. no one seems to care anymore, even though the amount of negative yielding debt in the world is at $9.6 trillion. yes, it's gone down a little. not that much. are you worried about this? are you buying negative yielding debt? luke: i'm not buying negative debt. i think european debt is really expensive. actually, it faces a lot more problems and probably closer to a bear market than u.s. treasuries. you will see growth coming through in europe now. you are starting to see capacity

come out of the system across northern europe, and even spain and italy are starting to see a lot of big improvements in the employment market. so for me, the german bund in the 50's or 60's is the wrong level. that should be 90 or 100. and that, i think, will end up taking a lot more attention than a trickle upwards in the u.s. 10-year to the 3% level. lisa: so you think there could be a potentially violent unwind still in this negative yielding universe? luke: yes, very much so. and i think mario draghi was kind of telling you yesterday we will stop buying this stuff in september. if the bank of japan stops or starts to stop their program as well, that is a risk factor for the european bonds, not u.s. bonds. lisa: wow. rachel, i am wondering how much do you look at the yield curve when making product decisions? how much do you look at that and say, this indicates a falling down. that should be bad for

particularly high-yield credit. rachel: yeah, absolutely. interestingly, the investment -grade market is more correlated with treasuries. they tend to react more in line over short periods of time. inversely will correlate. if rates are going up, spreads can come down. we saw that very much happening over the big rate rise over the last four or five months when we saw intermediate treasuries -- i look at five-year treasuries. because high yield is a four year duration asset class. you saw them move up by 60 basis points. high yield spreads came down by almost 60 basis points. still a positive total return. so the pacing of any selloff is very, very important. a steady leaking, wider rate can absorb positive total return. i do think that spreads are pricing in a very benign outcome. and we expect to pick up in inflation and volatility this year that are likely to exert some pressure on credit spreads, but more towards the back half of the year than the front. lisa: just walk us through the sort of contagion effect. let's say there is some kind of

mass selloff in negative yielding debt. how quickly does that translate into much higher yields in the u.s.? subadra: i actually agree with luke's comments on the fact i expect bund yields to rise more. i think that overseas, whether it be in japan or germany, i think yields are a lot lower than they are in the u.s. so i think the selloff will be mostly led by what happens overseas. whether that's going to be a contagion, i don't believe in that scenario. because of the fact that i think central bankers across the globe are extraordinarily cautious. they're watching every metric. even in the u.s., we've we have had one hike per quarter. that's very gradual. i think that's what will happen overseas as well. they will be extraordinarily careful and cautious. lisa: definitely an interesting time. thank you so much. we will be discussing more. sticking with us is subadra rajappa and rachel golder and luke hickmore.

coming up, the auction block. emerging-market bond sales at a record pace in 2018. from new york, this is "bloomberg real yield." ♪

♪ lisa: i'm lisa abramowicz. this is "bloomberg real yield." i want to head to the auction block now. we start in the u.s. with a junk bond offering. t-mobile said it sold $2.5 billion of bonds to refinance debt. the wireless carrier sold the notes in two parts, following the collapse of t-mobile's talks with sprint in november. over in europe, spain drew orders for its biggest syndicate offering since 2014. orders for the 10 year notes

totaled more than $52 billion, compared with more than $12 billion on the offer. and emerging-market bond sales at a record pace this year as investors scrambled to lock in low yields. borrowers from argentina to china have raised $65 billion in euro denominated bond sales. still with me is subadra rajappa, rachel golder, and luke hickmore from aberdeen standards investment. they're joining me to help the show, because you can hear that my voice is totally going away. also with me as julie hyman. welcome back and thank you for helping me out. so the big question to me is the biggest consensus trade of the moment is emerging-market. everybody seems to be piling in. my question is, where is the opportunity left? and luke, i want to start with you. do you see opportunity, and if so, where do you see it? luke: so i've been sitting in the emerging markets team this

year. they are struggling to find the easy opportunities for sure. even in frontier markets on the edge of those emerging markets and the things investors are interested in, even that part of the area they have been reducing their allocation recently. so, you know, they are looking at venezuela, argentina. they are having a lot of thought about mexico and the elections, but not getting too involved in these assets until they actually get to attractive levels. and i think we see those emerging-markets spreads in the kind of 220 to 230 area, but a lot of that is venezuela. because those yields have just blown up over the last few weeks. so it's still an attractive area compared to investment-grade. but if you look at it, you need to be more and more cautious and a lot more selective about what you do actually buy. so, you know, i think things like brazil, safer countries, are benefiting from the oil

price coming up like russia. these are better places to be invested, i think, in emerging market debt recently. lisa: rachel? rachel: at goldman sachs, we do still like emerging markets, but recognize they have gotten relatively rich. local currency is still a preferred area. we feel that the strength of emerging market economies is still very, very compelling. but valuations have extended within the fixed income opportunity set. we do like being short u.s. rates. we like securitized credit. i think in high quality clo liabilities and in student loans there are some opportunities for really attractive yields. we are not negative on credit, relatively neutral based on valuations, but those are some of the preferred trades. lisa: subadra, do you agree with what you are hearing? subadra: yes. i think the macro environment is extraordinarily accommodative. you have strong global growth, you are continuing to see a very strong rally in risky assets, and you've seen some decent

credit upgrades in countries like spain and portugal. fitch upgraded them. we had a very good -- a very good demand for bonds globally. so any new issue that hits the markets seems to be well received. lisa: i'm struck by -- i want to move from emerging markets the u.s. investment-grade credit. luke, i want to direct this to you. we saw another inflow into u.s. investment-grade bond funds last week. the spreads on investment-grade credit in the u.s. have narrowed to the least since 2007. you can see that with that chart right there. does this concern you, luke, especially given the fact we are in a rising rate environment and we count on those spreads to absorb any rise? luke: so, it has been a remarkable start to the year, hasn't it? spreads have gapped. doesn't matter what currency you look at. we were hoping for spreads to have a more gradual pace this year, to have a chance to be selling these rallies rather

than buying the dips. that is possibly the attitude we will be having as the year goes on. if we remain at these type levels, we'll just be selling more credit. it's fine, fair value, not particularly expensive. economies are doing well. you're supported by xp markets hitting all-time highs on a regular basis, but you know it is a year or a year and a half and we will be running into problems with the economy and possibly with credit markets as well, so it is a time to be recognizing this is probably the best you get from credit rather than actually there is more to go for. lisa: so rachel, you focus on high-yield credit market. i want to look at that because spreads are similarly tight there. i'm just wondering are there still opportunities? where are you seeing that? rachel: we are not at the extremes of high-yield spreads yet. we have widened out materially in november. we've covered half of that widening since then. they still compensate very adequately for the risk of

default going forward, which is very, very low. we see the defaults less than 2% in 2018. however, rising rates don't have a lot of room to be absorbed in the spreads that exist. so there is some risk of widening spreads in high-yield. volatility is the greatest driver of that likely going forward, and we think that animal spirits will create more activity amongst corporate leadership. we think m&a is likely to pick up. we've already seen a degree of acceleration over the last couple of months. that will bring new supply to the market on the one hand. it will benefit the valuation picture. it should help the equity markets, as well. investment-great companies who tend to be the buyers, they may see themselves leveraging more. high-yield companies are often the targets of that. so they can benefit from it. and another thing i want to mention was leveraged loans. they are a floating rate asset class. they still have relatively attractive yields and spreads

relative to high yields. higher-quality. so they are a relative safe haven. lisa: alright, thanks so much. we will ask you to hang around. luke hickmore, rachel golder and subadra rajappa here on set with us. we will be right back with more to discuss. still ahead, the final spread. the week ahead features the fed decision, a state of the union address and the u.s. jobs report. this is "bloomberg real yield." ♪

♪ julie: i'm julie hyman, helping out lisa abramowicz on "bloomberg real yield." it is time now for the final spread. coming up over the next week, president trump gives his first state of the union address. also, fed chair janet yellen presides over her last fomc meeting. the u.k.'s theresa may visits china. and we have another round of earnings with a heavy round of technology names reporting. and we get the u.s. jobs report.

still with me is subadra rajappa, rachel golder and luke hickmore. thank you all for being here. we're talking about the fed now, i think. lisa: we're talking about the week ahead and what we are most focused on right now. rachel, i want to start with you. is the jobs report the most important thing to look at, the trump speech? what are you focused on? rachel: the jobs report, we don't think it will be that material this coming week. we do expect a fairly consensus high-hundreds number that will continue to move the unemployment rate down. so, we think the market is expecting a pretty good jobs number on the back of it. the gdp number was a bit of a disappointment. but we call it a high quality miss, if you will, in that consumer spending and corporate spending were good. it was inventories and trade that negatively impacted it.

we think the two good numbers there are good supports for the economy going forward. subadra: i think we could get a lot of interesting soundbites next week, especially given the state of the union. we could get some more -- for me as a treasury and rate strategist, the treasury announcement will be interesting. we can get some initial hints on how the treasury will be changing its financing over the upcoming months. the fomc meeting will be quite interesting given the fact it is janet yellen's last meeting of her career. so i think it's -- and all of these have potential to the -- to be market moving. and i agree with rachel. i think for the employment number, the focus will be on earnings because that's really where i think we need to see some gains. that's what has really lagged. julie: in terms of the fomc meeting and janet yellen's final appearance there, do you think we will get any more color from jay powell?

obviously, she's presiding. presiding. he will presumably defer to her. but do we get any more flavor from what we are in store for from him? luke: i think he is probably going to rely on his confirmation hearings to give people a sense of where he wants to go. and it feels very much like it will be a continuation of janet yellen's approach. as jay powell comes in, this is all about janet yellen leaving. she will be given some space to explain how she feels about the economy and she will go off into a different realm. i don't think we get anything from the fed. i personally am never particularly interested in the numbers for nonfarm payrolls. it will be very volatile. lisa: what is the biggest economic indicator, rachel, that you are looking at that affects more broadly the u.s. credit and frankly emerging markets? because the dollar has been the story of the day, of the week.

what could make it go stronger and actually disrupt a lot of the consensus trades right now? rachel: a single indicator, i would cheat a little bit and say the financial conditions indicator. it combines a bunch of things. i think the signals we have gone back to as loose financial conditions as we have seen since 2014. we think this means party on for the near part of the year. but as we go into the back half of the year watching volatility, which has begun to move off the floor -- if it does more so, it will decompress assets. lisa: it is time for the final rapid fire. we ask questions to each of you. and you have to answer really short answers. the first one is what is more likely to selloff in the next nine months, u.s. high-yield or investment-grade bonds? luke. luke: investment great bonds. rachel: u.s. high-yield. subadra: u.s. high-yield. lisa: alright, what is the better bet over the next three

months, buying 10 year government bonds in greece or germany? luke? luke: greece. rachel: the horizon is critical, greece. subadra: greece. lisa: the last one is, unexpected big surge in inflation or unexpected big drop off in growth? luke. luke: inflation. rachel: inflation. subadra: inflation. julie: alright, everybody agrees. subadra rajappa, luke hickmore, rachel golder thank you so much. this is "bloomberg real yield." ♪

♪ scarlet: i'm scarlet fu. this is bloomberg's "bloomberg etf iq," where we focus on the risk and rewards of exchange-traded funds. ♪ scarlet: we have more than $1 billion dollars flowing into capital index funds, and we get an explanation of why these index funds are freeloaders. and a similar theme in the market persists. investors short the vix, and we speak with ther