>> from new york city, i'm jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg: real yield." coming up, mnuchin sends a message to the markets, don't worry about the debt, don't worry about inflation. the market absorbs 10 year yields sticking your for your highs and the federal reserve optimistic about growth. investors wait to hear from chairman powell. we begin with a big issue, a big week of treasury supply. this blowout in the deficit in the u.s., from 3% to 5% by

the end of this year, is completely unprecedented. >> for 30 years, the theory hasn't worked. borrowing, interest rates, there is a zero correlation with it. right now, rates are going up because of the fear inflation bankreturn and the central will have to exit a lot faster than people think. >> i agree it is not the deficit, it is growth with reflation attack. -- attached. treasury has more to finance a wider deficit, but also to -- the unwind of the balance sheet. investors this is returning back where they came from. the yields overseas are grinding higher, but the hedging cost is where the challenges have been. if you look at the differences between hedging as a european investor coming into the human at ash u.s. markets, it is no longer a track to. -- once you factor

the hedging costs in. >> joining me around the table, jones and back, kathy mike. matt, it went well. 258 billion and the world is still rotating. >> fancy that, we knew about the supply from a year ago. here it is, the treasury market did a really nice job handling the supply. when you're talking about supply impact on the market -- in the grand scheme of things, the flow impact is very small. there is a whole cottage industry of hedge funds that try to monetize these will impact and their so microscopic that it takes a lot of people to try to pick up just a few ticks in the market. jonathan: kathy, the numbers have been significant. some of these issues have been unprecedented in size. we are not talking about the

bond apocalypse. a lot of fear around finance and the government the past couple of weeks by some fringes in the market. do you think it is overdone? kathy: i think supply will be an because it is just not going to end with the fed pulling back. we are going to have to absorb a lot of supply but otherwise we haven't had that challenge over the last couple of years. i think it is going to continue to push rates up. we will continue to see those grind higher. mike: i think when treasuries headed to 50 to 275, they were basically pricing in the expectation for fed rate hikes and expectations for inflation and growth and this last 20 or 30 basis points has been the pricing setting a clear level for this incremental supply and like matt says, it feels like it is probably almost done. everybody knows what the supply

picture will be for the next couple of years. jonathan: i want to talk tactically just a minute. the short positions in treasuries -- we're looking at monster shorts. how much of a headwind is the positioning to high yields when we are already this short in the market. >> positioning has been short for some time now. people have been underway the -- underweight the front end of the curve for probably the entirety of the fed hiking cycle, sometimes with more success than other times by people have maintained those short positions for some time. they've recently been very successful. i think at the end of the day, what will be a problem for the shorts is if the data starts to roll over. imagine that growth data doesn't keep meeting expectations, it might be difficult for people to imagine. at some point, it is going to happen. jonathan: we caught up with mark at pimco and take a listen to what he had said about treasuries. have been underweight on an interest rate for some time and we are turning more neutral.

we think a lot of this move has occurred. there is no question that the market has to digest the supply but you're getting to a point where bonds are starting to get exciting and we have not been able to say that in three years. jonathan: treasuries looking exciting? >> i am on board with mark on this one, which is unusual. i'm looking at the yields we have on the market. even short duration yields. twoing at the two-year, and a quarter, it is getting more difficult to short that. jonathan: we're still sure on a very front-end. there are still less than three price hikes priced in for this year in the very front end. but it is getting more priced in. our view is they will hike three to four times, so there was a little more value to be squeezed out of being short the front-end but it is getting difficult to be short with that two and a quarter. exciting is not

the word i would use for the front-end of the treasury market, but more than it used to be. i would agree that the two years looks pretty attractive. we think three to seven years, you still pick up a little yield in there, it is not a bad place to be. jonathan: i want to bring up the dot plot. and the federal reserve hand-in-hand for 2018. what the market project, the fred -- fed projects. we want to open up a lot more 2020, how will those spreads reconcile? >> the fed is projecting three hikes this year and basically, two in 2019 and another two in 2020 until they get to 3% and we actually think that is the high end of the range. it is like 0-3 is the new range on fed funds and zero is easy and three is tight. i think if they get the three, you will see economic data start to roll over and you will see the curve continue to flatten and get inverted if they go that

high. i absolutely agree with that. if you look at what we expect the fed to do this year, hiking three or four times, you will be talking about real policy rates on the verge of tight territory already. at that stage, you would expect the yield curve to be completely flat. we are on board with the flattening trade some of that is what we are recommending to investors today. jonathan: where the you tried to understand what the fed thought about inflation -- the treasury secretary steve mnuchin says we can get wage growth without inflation concerns. walk me through the ecological -- economic logic if you can and is it something we can get? kathy: i would say the only way you can get that is to get a huge surge in productivity growth. we have not seen that. productivity has been slowing down for years. it is not just a u.s. phenomenon. it is global, so the idea that we will get fiscal stimulus and it will spur inflation and investment and productivity growth is wishful thinking probably.

matterhorn back -- jonathan: matt hornback? matt: i agree with that. if you think about how the fed is characterizing their vision in the economy, they link it to things like productivity and the demand for safe haven assets. we know one thing for sure is the demand for safe haven assets should be higher at these elevated levels of premium than -- risk premium than other times. michael: i can paint a picture where the tax reform for tax cuts are somewhat disinflationary. companies have this new found a bottom line, these newfound earnings and market expansion, and there is a decent chance they get some of that back to their customers in the way of lower prices to maintain market share. there is tremendous price competition across a wide range of industries where companies are fighting for market share. jonathan: kathy jones for charles schwab. coming up on the program, the

auction block, the appetite for high-yield looks strong as sprint makes a call to the bond market for the first time in three years. that conversation, next on bloomberg: real yield. ♪

♪ jonathan: i'm jonathan ferro, this is "bloomberg: real yield." i want to head to the auction block. to break them down, what a week it was. there was 200 $50 billion of debt sales from the treasury. the auction showing this demand for treasuries, but investors requiring higher yields. over in u.s. high yields, sprint sold junk bonds for the first time in three years.

the deal did put pressure on sprint's existing bonds and investors still craving african bonds this week. billion of$14 kenya's offering, proving the african dollar debt still has plenty of buyers. still with me, matt hornback from morgan stanley. kathy jones from charles schwab. i am pleased to join from london david riley. that push higher in treasury yields, at what point does that move start to compete for capital elsewhere into credit, investment growth and high-yield? david: that is the big question. think yields will move higher, that the fed is still underpriced. we have seen a big move of late of taking down some of our short

duration, but we think ultimately, we will be getting 3.5 and above for the 10 year and the fed will do another four to five hikes by the end of next year. the question becomes, when you , is 5.5 toates 2.5% 6% enough to be invested in high-yield credit? i think there is a danger that we see some repricing of credit to clear for that. that does make us a little wary of u.s. high-yield and u.s. credit more generally at this juncture. michael: everybody talks about the flattening of the yield curve as being signal for recession, but there is actually a behavioral impact and that is what we're talking about, when the fed gets the fund raise up to that 2.5 or 3%, it starts to become really appealing to move into cash.

if you could buy a money market is athat 3.5% today, which huge positive real yield above inflation, i think a lot of people would sell all their stocks and all their stocks and other bonds and go into money markets. that is one of the things that causes recession. a change in behavior. we got a money fund of 3.5%, i just wonder if we well. michael: if the fed gets the fund rates 3% which everybody is going to. i think that is a high water mark. if they do that, it is probably a policy mistake. you have money market yields in the threes. jonathan: let's say we get the 3.5% mark, there is more vulnerable in credit? is a high-yield? where are the pockets that are looking vulnerable? david: i think high-yield potentially is more vulnerable to that. not because of the underlying fundamentals -- those were looking reasonable because of the strength of corporate earnings and because of the

generally positive growth outlook, but i do think there has been quite a lot of move into from -- -- from investment-grade into the double be space. i think there is a lot of duration an extension risk within some segments of u.s. high-yield, particularly within the bb space. it is interesting -- the credit held up pretty well in the face of the equity correction that we had but the pockets where we had weakness was not in the emerging markets but it was actually parts of u.s. high-yield. i think that is where we can see -- positive u.s. high-yield. i think that is where we can see some of that pressure. we have seen outflows already on a consistent basis coming out of that segment. jonathan: kathy, for you, what is the story? for me, sprint still comes to market, the door seems wide-open for issuance. i don't see signs of tension yet. high-yield, you still have the reach for yields, it is

still strong, the fundamentals are good and we think it continues to grind down here until it doesn't do that anymore. if you look at the previous cycle in 2006, everything was great, spreads were tight and at some point in the rate hike cycle, the money starts to shift out. we haven't hit it yet, but we do think it is awfully rich here. you have an interesting trade and i want you to lift the hood on it. it is idiosyncratic, nothing to do with shorting data treasuries, it has to do with the tax bill. walk me through. >> it is supply and demand which drives market in the near term. it is really a spread curve flatteniner. so spreads are actually going out and it is not because people are worried about rates, there is a little bit of that. the short duration because they're feeling the brunt of the fed rate hikes. but a lot of the overseas money that is now being repatriated, all the big tech and biotech had

piled into these short duration corporate bonds as a way to print some yield on that money and now that is being pulled back. there is selling pressure on the front end and the back end of the corporate curve as yields have gone up you have pension plans and insurance companies licking their chops at the yields they can get on long-term corporate bonds and for a pension plan, that is home to them. 14 duration corporate bond portfolios are natural resting place, they are buying. you are getting a spread curve flattener. jonathan: to be clear, the tech companies that have been issuing -- a lot of it has been the long and as well. the demand may not be there. the supply might not be there on the long and. have you been looking at investment-grade on the back of the tax plan? david: we have been looking at a number of trades, including those potential tariffs on steel and aluminum and so there is opportunity there where we can get a bit of kicker by getting

information from equity as well and the bonds as well. on the tax specifically, the tax side then, yes, basically where we see less issuance going forward, because of that repatriation of cash. it tends to be things like tech. jonathan: david riley joining us from london. bloomberg asset management strategist. alongside matt, kathy and mike. let's get your market check for you, to's, tends and 30's. -- two's, 10's and 30's. down the basis point on the 10 year, you've got to say that despite all of this noise around the issuance, treasuries have been pretty resilient through the week. still ahead, the final spread. featuring comments from both jay powell and mario draghi. we will have that conversation very shortly, this is bloomberg real yield. ♪

♪ i am jonathan ferro, this is bloomberg real yield. it is time for the final spread. coming up over the next week, one of the main highlights will be the new federal reserve chairman jay powell testifying before congress. we will get a fresh round of economic data including numbers on gdp, plus ecb's mario draghi and theresa may will both be speaking. with me to wrap things up, matt hornback, kathy jones and david riley from bloomberg asset management. matt, what are we looking for from chairman powell next week? >> i've read every speech he has written, i've read the transcripts. jonathan: couldn't have taken long, there weren't many. >> there were a number of interesting speeches from powell. i think he will have his eye on financial stability more so than we have seen for other chair people.

with that in mind, even though we don't see risks to financial stability today, if financial conditions continue to ease as they are trying to tighten monetary policy, that will change. that will encourage the fed to a -- accelerate the pace of rate hikes. our is something that, in view, will keep flattening pressure on the yield curve. jonathan: this question comes from a viewer, it a terminal client. near 2% on the 10 year? yields to bect substantially lower than they are today. as the market is forward-looking and by the time we get to the end of this year, we think investors won't have as bright and outlook as they do today. people are very bullish on everything today except treasuries. we think that will be different at the end of the year. kathy: we think the 10 year

aroundould peak midyear 3.70 -- 3.25 or so. they could interest off and that there. 2% is much lower than anything we would look for at that stage of the game. i keep focusing on this negative -- the term premium, which is still negative and i think that as the fed withdraws the stimulus over the years we will see that term move into positive territory. that will likely keep yields higher. to getn: david riley, some final thoughts from you, do you see the hot -- catalyst for higher risk term premium? and what are you looking for from chairman powell next week? david: certainly the catalysts are there for higher termed premia. i would anticipate that we see 3.5 on the tenure during the -- on the 10 year during the course of this year. i think it is actually underpriced. i think the fed is underpriced. i don't really accept the notion that that will be an excessive degree of timing. -- fiscale physical

stimulus coming through, including the tax cuts but also the public spending will be kicking through 2019 and the fed will be forced to respond to that. in terms of powell, he will try to emphasize continuity, gradualism, but i think he will be hard for him not to sound a little hawkish given the backdrop in inflation and growth. buying,: matt forte bok what is your view mike? the fiscal situation is a big negative for the markets in general. all of the supply and the deficits -- these runaway deficits and the spending and borrowing is a long-term negative. jonathan: what is chairman powell's job? what does he do? thingl: the fiscal creates a boom in the near term but is a real negative for the medium-term, three or four years out. i think that they have to look through that to a large extent. he has to be really careful about over hiking late in the cycle with the enthusiasm continuing to go up and not take away the punch bowl.

jonathan: i've got four of you this week. i have to wrap up with quick questions. let's run through this very quickly. on treasury specifically, by the selloff -- buy the selloff or keep on running? >> buy. >> buy. >> buy. >> keep on running. jonathan: does credit still look to be a good place to be, i think what it will hang in for a couple more years. david: not yet. jonathan: we have had a greenspan perp, the bernanke put, the yellen put and i wonder if this time is different. will we have a germ -- chairman powell put? matt: not this time. kathy: yes. michael: yes, a fed put is always there. david: it will have a much higher price. jonathan: great to catch up with

you. ornback, kathy jones, and david riley. that does it for us from new york city to read will see you next friday at 12:30 p.m. new york time. 5:30 in london. we will bring you those comments and reaction with a full round table we finally hear from chairman powell in his semiannual testimony. this was "bloomberg: real yield." this is bloomberg tv. ♪

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