jonathan: from new york city, i am jonathan ferro with 30 minutes dedicated to fixed income. this is "real yield". ♪ jonathan: coming up, president trump reveals tariffs. trade war worries. chairman powell opening the door to four rate hikes this year, and the week looking resilient. we start with the big issue, chairman powell opening the door to four rate hikes. >> the phrase that headwinds have become tailwinds is a reflection the current economy

has gained steam, and if they go four times we think it is going to be for the right reasons because growth is good and inflation is not out of control. >> it is a favorite inflation metric, and to say the fed is behind the curve, they are doing the right thing. three times, probably four times this year. 1.5% core pce, the fed target is 2%, and it is not that scary. >> the fed has imprinted on their brain a phillips curve -- maybe it is slow to rise but it is not a bad type of inflation where it is suggestive of an overheating or over levered market where prices are out of control. this is because of better growth. >> if we rolled the camera to two years from now, we will have a lot more stimulation, particularly in the united states because of the tax bill and also because liquidities -- so we are going to be in a park

were central banks are going to have a problem getting it right. jonathan: joining us is henry peabody, matt toms, and coming to us from boston is lori, great to have you with me, and i want to begin with you, henry. what happened to our low rates guy the president nominated? i did not get a sense of that this week. henry: it is a change in narrative, and we have to get used to that. bear in mind we had and it -- an acknowledgment of data coming into the meeting. markets are leaning that way a little bit. the storyline and narrative is changing and is going to take a while for the market to adjust to that and move to a higher rate, higher inflation regime. matt: i think you have a person

more inclined to speak as a money manager and the potential of a fourth hike doesn't signal action, it signals a skew. jonathan: the upside looks like four. we bake in three for the year and the potential for four this year. lori, is that your read of things at the moment? did we open the door for four rate hikes in 2018? lori: our view is three hikes in 2018, there is a balance, stronger growth but not a lot of fears on inflation and it is inflation the fed will be watching to see. we don't think that is going to happen. jonathan: the trade at the moment on the 2-year note in the united states? henry: remember when the 2-year note was trading sub 60 basis points -- the most vulnerable part of the curve, and people wanted to come in shortened durations. the risk is if you move to liquidity too much that is

exactly when you are in the crosshairs of those demanding liquidities. watch out for the front end. matt: i agree, we have seen a dislocation of high-quality spread product which is sitting there for more than two minutes, it has been sitting for a couple of weeks and that will persist. it tells you liquidity is no longer free. you are going to see leverage to increase to suck out this dislocation, and it is quite attractive for a bond manager. jonathan: what do you think really explains that softness more specifically? matt: the softness is foreign assets held overseas by u.s. multinationals who have hundreds of billions of dollars benefited from short term bond strategies. of billions of dollars benefited rebuying stock, rebuilding plans -- dislocation that should last more than six months to 18 months but it is real and has provided opportunity.

jonathan: where is the buy, right now? matt: it's the time to start buying. you can only get so cheap until money manager balance sheets -- you move 20 or 30 basis points, it is unlikely to get dislocated because liquidity is not expensive yet. we think it is worthwhile trying to nibble that right now. jonathan: is that short term duration a great story? lori: i am not so enthusiastic about it. i think what is driving is the fear of the long end. one of the challenges of the short end is susceptible to two things, is susceptible to higher real rates and even if we don't get inflation coming through if people are concerned about future inflation prospects and demanding higher real yields. the curve is vulnerable. jonathan: i want to get your thoughts on the idea that the front end shifts and capital is elsewhere and something we have talked about on this program for several weeks.

are we there yet? henry: i don't think so. where we are now, that marginal change is positive for buyers, but let's think about the fed is trying to do here. the fed probably is trying to let inflation rise and maybe exceed the 2% number. there are two ways out of the situation when you are over indebted, one is default and the other is inflation. the first is not too good. the idea of inflating ourselves globally is something to think about. at which point if the fed does get behind the curve, we are going to see a sharp repricing on the front end. jonathan: if we can bring up ecsc, look at the forecast -- 2019 and 2020 and beyond that as well. the top right, 2.7% at the moment, 2.4% is where economists see growth next year and 2.0 the year after that.

the trend for growth is not going to be aggressively higher according to economists we surveyed. do you disagree with that? henry: yes, and that comes with the idea of a shifting narrative. we have been in an environment where you have the right correlations between equity and rates, low rates, low inflation, disinflationary trends, and to dislodge that narrative into a newer one is a process of adjustment and will come in fits and starts. we will see disappointment and data this quarter because expectations have gone higher -- which will be that water -- higher, that will muddy that water, but we need to shift to a new narrative and it is going to take an adjustment. jonathan: his view is that you progress towards the end of the year, the picture best case is going to look like those numbers on that screen than your best case. are you saying mr. peabody is right? matt: the truth is in between.

what we are talking about the new rate hikes in the environment, and it brings uncertainty if you fall from that higher level of growth, so we are entering a new phase where the cost of volatility and interest rates will have a feedback loop. if you move beyond the percent -- three and three and a quarter percent on the 10 year, the feedback self corrects and the growth number start to move lower and yields cannot escape to quickly. jonathan: 3.25%, is that it? matt: it is hard to put an estimate but you probably will see a demand coming on around the premise. jonathan: lori, does that make sense to you? that basically we are topping out further along the curve and the bind comes from pension funds. this is a buy from them, does that make sense? lori: it does, we have been selectively adding two positions here. we could touch three or three and a quarter, but the pressure

will be to go lower from there unless we see major inflationary staying and we are not seeing that. the wildcard here is what is going on with trade. jonathan: lori is sticking with us because we're going to be talking about trade. alongside henry peabody. matt thomas. up next on the program is the auction block with investors turning to bonds. real yields are higher in the u.s. 16 of 21 e.m. markets, that conversation is next. this is "real yield". ♪

♪ jonathan: i am jonathan ferro and this is bloomberg real yield. emerging-market dollar bonds have struggled in 2018.

the local currency bonds have fared better, and the trend extends to issuance and borrowers are raising more money than ever before, and those bond sales have exceeded $1 trillion. almost triple from last year. one company from e.m. set to make a notable offering is teva, holding its first offering as a high-yield issuer, selling $3.5 billion in euro -- and over in asia singapore's auction of 30 year bonds cover a ratio of 2.21, which is the highest level for 30 or debt since 2012. with me is henry peabody, matt, and lori, henry, emerging markets -- a conversation of a trade war holding up really well, why? henry: it is hard to make a blanket statement about e.m. but we like the space and there is a narrative around better growth.

a narrative about the early cycle compared with the u.s.. there is this dialogue around the dollar being broadly weaker for the foreseeable future to provide a tailwind to that em position, and volatility has come in dramatically. those who take a long view of a fundamentally changing em stories are pretty well rewarded. jonathan: let's show you where things are as i see them right now. the mexican peso in emerging markets against the u.s. dollar, on the session, here is the move. zero point -- 0.1%. matt, if this was 18 months ago and this was the president's base case that would have a 25% tariff on steel and aluminum

would theto come, peso move at 0.1%? matt: we take the over. this is less of a specific issue of mexico, and nafta, this is a global issue and a stance of trade policy change and i think the saber rattling will keep the market concerned. this is more about canada. it is also more about japan and u.s. manufacturing and you see broad volatility -- nothing that is poked at mexico. jonathan: the details remain to be seen, but we may get them next week. if you shifted around em when these details came out? matt: we believe it makes a lot of sense on the equity side. the spread you get in hard currency is not similar of what you can get in high-yield corporate's, it is modest, but if you see trade tension or global volatility increased -- you could have volatility and you are not compensated for it.

the local side makes more sense because the dollar is likely weak when you are hurting the trade policy stance. jonathan: does what matt said resonate with you? lori: it does. we have been a proponent of em debt for a while. improving growth prospects and policymaker flexibility. dollar not likely much of a had -- headwind there, and improving credit quality, across the board we are constructive on em that debt and local currency debt. jonathan: what about risk mitigation? is it interesting that we have a safety bid into treasuries? is that a one-off or is there something more to that? henry: i think long-term or medium term i think it is one-off, and it seems to us that the push higher in inflation, the fiscal mess we are in, frankly, could call into question that traditional

relationship between stocks and bonds. if rates sell off and it causes that risk off environment, you really need to think about what your portfolio is in and do you have the risk mitigation you think you have? jonathan: what is the risk mitigating asset? if it is not treasuries, what is it? henry: liquidity, cash, probably gold. we're seeing today with rates, the recent trade has been for a better rates for risk off but you need to question that relationship and think about liquidity more than anything. matt: yen has acted that way, the correlation we wonder, it has come back -- it is a funding trade. when the world gets uncertain, people buy back yen. we have seen that in effect. but the dollar may lose that mantle, and if you lose that status you see the dollar yield increase. if you lose that status.

you could see dollar volatility and yields increase. jonathan: let's put these together. when you say liquidity, i think treasuries. liquidity i need, and that is why i want treasuries, so if it is not treasuries, where am i going? if it is not dollar-denominated assets, where on earth am i going? henry: you are holding cash, a diversified cash position and waiting for volatility to pick up, and you are not in duration. we talked about the 2-year note potentially being overpriced with downside, but that is relatively limited from in total -- from a total return standpoint. it will be less negative than other asset classes. jonathan: lori, are you comfortable holding treasuries? the risk mitigating asset? lori: there is no risk mitigating assets, cash is the only thing there because we are in an environment where rates are going to go higher. the question is how quickly they go higher, and we are in an

environment where there are lots of risk out there that may not be priced in the market yet. there is no safe place to hide. from a u.s. perspective, it is fine to go into treasuries and think of them as a safe haven. but if you are sitting in china or japan or any where else in the world with currency risk, u.s. treasuries are not a safe haven. jonathan: lori, thank you, alongside henry, and matt. let's check where markets have been throughout the week. this is what it looks like in the united states. treasury yields, believe it or not, unchanged throughout the whole week. a slight bit on the 30 year, down two basis points. still ahead on this program, the final spread of the week ahead and rate decisions from the boj and ecb and coming up this weekend, the italian election. this is bloomberg.

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♪ jonathan: this is bloomberg "real yield." it's time for the spread. next week, we have rate decisions coming from the european central bank and bank of japan and the beginning of the national people's congress annual meeting in china, the u.s. jobs report, and the italian election. still with me, henry peabody, matt thomas, and lori. why are we so calm about the italian election? lori: i think we have become numb to the continent. realistically there are not a lot of great choices there, so it will be status quo prevails but it won't be without a lot of drama. henry: we are at a point in time where europe is in a multistate situation which gives us a sanguine view of it, and lori's

point, probably the same, it seems like extremists are not going to take too much of a chunck in that election. matt: i think it is noise from the u.s. political framework. compared to italian politics, maybe we win. jonathan: true. matt: and they have gone numb to figuring this outcome and easy the reason -- and teresa may's speech says nothing to brexit, so it is unlikely to see major change, but the ecb dialogue is important. jonathan: i am struck about how sensible markets are behaving to italy, concluding that the situation politically speaking is so messed up we can't get anything done, so it doesn't matter who gets in because we won't able to get anything done, therefore none of this ultimately matters, but for me there is massive distortion in the market. i went to pick out a chart that is interesting that generated a whole lot of conversation. the idea that credit yields in

italy trade below sovereign yields sounds counterintuitive to so many people. why is this happening? henry: your guess is as good as mine. to me this is something that should probably be exploited and it seems the ecb has taken a chunk out of the italy debt stack and is essentially financing the sovereign. that is a relationship that shouldn't hold on long. matt: if you look at the broader corporate emerging spread, you have a diversified array of companies that have for revenue -- that have foreign revenues as well, so i agreed that the ecb should be enough to keep the sovereign yield lower, but the market is liking diversification in foreign revenue. jonathan: lori would you take that? lori: it is about willingness and ability to pay and it is easier to get your hands around

a corporate view on that then the sovereign view, and i agreed that the relationship should normalize. when you at willingness and ability, right now corporate is looking willing and able. jonathan: what is in trouble in terms of mispricing and distortion in europe, is in credit or the sovereign space? henry: i think it is an credit, and the sovereign space has room on the upside but credit right now, take european high-yield trading inside u.s. treasuries, it doesn't make sense. the downside in credit is probably greater at this point. jonathan: matt, you agree? matt: agreed, and further volatility will happen, and that could be spooked so we like things like a crossover to widen towards cbx trading. jonathan: some rapidfire questions where we wrap up the program and some key things this week into next week as well.

i want to begin with bonds 10-year through year end. bunds or btp? henry: can you pass on that? jonathan: no. henry: will go with bunds. matt: bunds. lori: bunds. jonathan: u.s. high-yield or e.m. high-yield? they are the same across the board, pick one until the year end. henry: em. matt: us. lori: em. jonathan: final question, bank of japan, kuroda talking up the potential to exit qe in 2019. the ecb versus the boj -- the european central bank against the bank of japan, who hikes first?

the ecb or the boj? henry: ecb. matt: ecb. lori: ecb, absolutely. jonathan: fantastic. thank you for your thoughts of what has been an eventful week. that does it. from new york, we'll see you next week, this was "real yield". this is bloomberg tv. ♪

♪ scarlet: i'm scarlet fu, and this is bloomberg "etf iq," where we focus on exchange traded funds. ♪ scarlet: are passive funds looking to engage? state street joins blackrock in taking up the issue of gun violence with weapons makers following the florida school shooting. vanguard goes where it has never gone before, active quant etf's, and we speak with john ameriks about why the firm is making the leap from plain-vanilla passive