jonathan: from new york city, for bloomberg worldwide, i'm jonathan ferro. with 30 minutes dedicated to fixed income, this is "bloomberg real yield." ♪ jonathan: coming up, inflation building. labor costs accelerating. price pressures finally getting back to the fed's target. junk debt supply still very much in demand. netflix is upsizing their bond offerings. a resurgent dollar, a consensus trade. cracks appear in a.m.. 10-year yields getting back to 3%. >> i think the 3% threshold is enough to get peoples attention.

by itself, it is not a bad sign. >> i think it is more psychological than anything else. >> we think the path is higher, but it will be a slow pace, and we can probably get up to the 3.25% level. it is going to be hard to break that stay above that. >> we have been saying we expect 3.5%, and the market is coming to that expectation. if it is a measured reasonable pace, and the reasoning is because of growth, it does not mean a debacle. >> if the u.s. 10-year yield goes into the high threes, it will act as a drag on the economy and bring forward a recession. >> the bond market has not been believing the federal reserve. if the fed says they will raise two more times, maybe three in 2019, the 10 year treasury would not tell you they are pricing that in.

jonathan: joining me around the table, george, head of u.s. rate strategy. coming to us from pasadena, bonnie, global head of western asset management. great to have you all with me. i think for most fixed income investors i have spent the week talking to come they are all saying forget about the 10-year. look at where the six-month bills are, one year treasuries, that is where we are seeing it. >> we cannot be dismissive of the long-term rising rates. there have been issuance tied to long-term rates, and general credit has a longer duration profile. it hurts to see higher rates on the backend. i think it is important because for a long time people thought you would get an environment with the fed can lift short-term rates and long-term rates will hardly move. the curve has flattened like a pancake. the long-term is going up as well. jonathan: we will work our way

through the curve. bonnie, it looks like six-month bills is where 10-year treasuries were in september, and two-year notes are were 10-year treasuries were at the beginning of january. >> it has been a remarkable move. the whole treasury market has moved by 50 basis points to date. you have to look at what the market is pricing in. what we are seeing for this year, the market is in line with the fed in terms of how many hikes the fed will do. that seems reasonable where it seems that the unemployment rate is, and how growth is coming in. when you look further out and what the market is pricing in for growth and inflation, that is where it gets interesting. if you look at the five-year yield five years forward, what the market is pricing in is close to 3.25%. you compare that to the fed, and

their long run rate is 2.78. that, to me and us at western makes it look interesting for the first time in a long time. jonathan: let's talk about the diversions with what the fed expects in the long-term and where the market has it priced at. what do you make of that distinction? >> i look at what the curve is telling us. i think the curve is telling us how flat it is, maybe the terminal rates, the endpoint of the tightening cycle is less than maybe what the fed thinks right now. i think it is the rate of change. the 10-year yield has had roughly 100 basis points moved in six months. that is a significant move. at the margins, that is what the market will focus on. some adverse impact. >> i agree. everything operates with a huge lag. we are entering into a period any weakness from a rate drag will be offset by the fiscal

stimulus, so it will be hard to decipher what is happening. you need the debt to do the fiscal stimulus, and you need higher rates to entice investors. it is a vicious circle. jonathan: the story that emerged in the last week, payrolls into next week with that inflation weight growth figure, what do you make of this resurgent inflation story of the last month or so? including the rally in commodities as well? >> we are not surprised to see inflation numbers moving up this year. that is something we expected coming into the year. energy costs have been going up, so we are not surprised by that move in inflation. in wages on that side, our credit research team has highlighted wage pressures in certain sectors, so we are aware of that trend that is ongoing. it is a question of where does it end?

right now, where inflation is, the fed is comfortable with it in terms of wage inflation, they would like to see it reach 3%. it is not there yet. it is well within the range it has been in for many years. on the core pce front, there is an expectation it will rise going into the middle of the year, perhaps stay around there. will it overshoot the fed's target? that, we do not think is in the cards, given structural changes to the economy. jonathan: folding that inflation story into where treasuries trade in a narrow range now, it is not necessarily something that will explode toward 3.5 or 4. >> it is a tall order to achieve anytime soon. there is upside risk, and we are

starting to embrace this idea that inflation is moving higher and in the direction the fed wants. could the fed dial things back in? it really can't, it has to keep hiking. they are unwinding the balance sheet. we think we will go to 3.25 with upside risks, and it will happen over the course of the summer. we will naturally test 3%, and by the way it is a long-term bull trend in place since the 1987 market crash we have had a bull run, and every time we touch it has more damage for the equity market then the fixed income market. we are testing global rates. we think we will consolidate and stay above three. jonathan: we have seen a serious divergence, more fuel into the spread widening between bunds and treasuries. i have been asking for months whether that two-year spread in bunds versus treasuries. if you look at the situation, global fixed income, can treasuries decouple from bunds

from europe? >> to a certain extent, we operate to our own devices, and that will remain the case. the fed is not going to blink. the moment we sense the fed is blinking, that is when the spread between u.s. rates and european rates reconverge. >> there are two things. every time draghi speaks, at his core, he is dovish. he will continue to be that way. the euro has had a good move here. there is no free lunch. it has slowed the european economy. you are on different cycles with what is going on in the u.s. and europe, and that is reflected in treasury yields vs german bund yields. jonathan: that takes us onto the next leg of the conversation, emerging markets. a lot of people have sat around this table comfortable with their em exposure and a local currency debt because the dollar has either weakened or stabilized around weak levels. the story changed over the last week.

>> we tend to be longer-term. jonathan: i would hope you are longer-term than a week. >> i cannot tell you what will happen a month from now. currencies are going to have countertrend the moves. the currency markets have shifted their focus a little more toward relative monetary policy, so we know the fed is well along in their tightening cycle. i could see the dollar doing better here versus the euro and the yen. we still think em currencies have value. they have lagged since 2011. this will not be a one or two-year phenomenon and the new -- then they will roll over and die. jonathan: that two-year spread, bunds versus treasuries, that should mean ultimately toward the front end of the curve. it should be a stronger dollar story that emerged. the worry is the rate for richie -- differential asserts itself more, and the consensus em trade

comes under real pressure. what do you think of that scenario right now? >> we have a lot of conviction on emerging markets. we think they offer a lot of value. i do think in this particular cycle, that emerging markets are starting from a better point in terms of currency valuations in terms of real yields, if you look at the spread between developed market and emerging-market yields, it is a 10-year wide. the valuations are compensating for some risk. we are cognizant of the currency risk. there are trade risks from trade wars. we still think em offers the best value in the market right now. jonathan: next up, the auction block. wework becoming the latest company with negative cash flow to tap into it investors

desperation for junk debt and the recent yield. that is coming up next. this is "bloomberg real yield." ♪

♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield." i want to go to the auction block where $274 billion were auctioned this week alone in treasuries. it had the highest yield since 2010. over in corporates, the focus on junk bonds. netflix had a high-yield market selling $1.9 billion in its largest ever dollar-denominated offering. that was up from $1.5 billion. the real headliner, selling $702

million in bonds from wework in its first ever offering backed by softbank. the yield 7.8%. bonnie, i want to begin with you. why did the credit rating agencies struggle so much with this issue? it was rated bb-. b+. ccc by moody. they did not know what to do with this. why not? >> it is always difficult when you have issuers who are negative cash flow, and have projections for growth and cash flow going forward. and so, in addition to that, we have a disruptive business model that is different from what is traditionally seen in the market. rating agencies had difficulty digging into that. in this market like any market,

you have to do your homework to understand the credits, and who you work with, no exception. jonathan: the secondary market is looking softer. in the primary market, demand is still there. do you take positives from that? >> i do. the positive is capital. there is still biased toward searching out yield. there is still broad-based global growth environment. maybe it is not as strong as it was at the end of last year, the global economy is still doing well. there's not a lot of inventory overhang. we will probably get a cap-ex cycle. i still think we still go to be risk neutral. there is a lot of capital on the sidelines that is going to be put to work in deals like this. jonathan: do you think in many ways we are incentivized to de-risk? you can get a vanilla yield at

the front end of the treasury curve. >> it depends on what you want to allocate that capital. treasury yields are competitive on a risk adjusted basis. if you have a portfolio that is clearly skewed risk on, maybe it is a good time to get insurance. jonathan: how are you thinking about that at the moment? the incentive to take duration risk not really there. the incentive to take credit risks even how tight yields are at the moment compared to investment grade. where's the incentive to take on that risk? >> we have taken off some of our curve flattening or given how much the curve has flattened, and given how much is priced into the front end. we think longer dated treasuries provide a good ballast in your portfolio. treasuries remain the deepest and most liquid market when there is a risk off move, investors will buy there. we maintain that as a part of

our portfolio diversification. jonathan: through the year, ccc offered some insulation. i wonder if that can continue. >> part of it is due to the duration, obviously. for ccc borrowers, it is hard to say it is just from market sentiment. the move we saw earlier this year, a lot of investors were trying to sell what they could, and that was higher duration, higher quality. at western, we have been derisking. if there is another move down, we think that ccc's will probably underperform. we know there are opportunities within that. we look at it on a case-by-case basis. jonathan: we see credit widening and high-yield, you look at the picture that equity investors give you over the last couple

months, it seems volatile and rough. if you look at credit alone, you would not see it, would you? >> it looks like a lot of volatility in the six-month chart. you zoom out to three to five years, these are narrow and tightly wound up. all these things are true, and your points on cash alternatives is a great story. i think investors have a hard time moving around their portfolios quickly. you are seeing it in the divergence from underlying cash, people are looking for insurance, they just can't put it all in at once. jonathan: there has not been much high-yield supply coming into the market. is that affect as well? >> there aren't supply and demand dynamics that influence where yields are spread. i would go back, we do not find

a huge valuation anomalies. in credit. we are skewed more toward the emerging world. i think that is a longer-term and if you are looking for that yield, i put more money in emerging markets. jonathan: we joked about one week time horizons. give me a little more on what you think about em. >> i am looking at a three-year horizon. this has lagged since 2011. this is going to be a multi-year cycle. jonathan: i want to get a market check on where bonds have been through the week. two's and 30's, -- tens, and 30's, yields up at the front end, the 2-year note climbing back. unchanged on a 10 year despite all of the media coverage of the u.s. 10 year kissing 3%. a little bit of curve flattening with the yield coming in at

3.13. the week ahead, and a decision from the fed. and the u.s. jobs report. it is may already. this is "bloomberg real yield." ♪

♪ jonathan: i am jonathan ferro. this is "bloomberg real yield." next week, we get another round of earnings including apple and tesla. more importantly, the fed deciding, and we get the u.s. jobs report. that treasury refunding announcement on the same day. in your view, george, the more important thing on fed day, the treasury announcement. why? >> it happens early in the morning. and we will be teed up.

if there is a big increas in supply, and they have to continue to do so, that may weigh more than anything the fed says. >> you look at the tax reform, how much it is going to be, and whether growth, tax receipts can offset that. we've got supply to digest. where is it going to come? at the front end of the curve? then it will have curve implications. we know there is a ton of supply out there. jonathan: is that what you are looking at more specifically? >> partly, but i think the markets are looking at the front end paper, understanding what happens for long-term issuance is what markets are looking for. >> if we are right about the dollar strengthening, if you are a foreign investor, treasury yields look pretty juicy. tack on a stronger currency. and that's a pretty good return. jonathan: let's be clear, i don't have a view. what do you make of the treasury issuance we will hear about next week?

>> there is that expectation we have to fund the fiscal stimulus. i also think it is attractive to overseas investors, even though currency hedging costs have risen, with these higher yield it is attractive. we have heard that from overseas investors in general. i think there will be support for the market. we can't forget about the structural pension bid. there is a constant demand for bonds from the community, particularly going into the end of the year. they are try to get their contributions in before their deductibility decreases on september 15. i think putting all that together, you have decent technicals for u.s. dollar assets. jonathan: there has been some concern about the foreign bid sitting some of these auctions out. are you concerned? >> not necessarily. we think there have been optics, what is creating an opportunity for those who don't want to fully hedge, you can buy

treasuries at a higher yield level. overall, the foreigners are going to be more discriminate. jonathan: i want to take the opportunity to wrap up the program and look ahead to next week. take a look at some of the price action and get some short answers from you. 10-year treasury, is 3% a buy? or is there more to come? >> you start nibbling on treasuries. >> more to come. >> buy. jonathan: cracks in em, a buying opportunity or a brewing pain trade? >> it is a buying opportunity, be selective. >> buying opportunity. >> i have to say buy again. jonathan: opportunity in high yield, weworks or tesla? of a similar maturity. >> i'm going to pass. >> can we go to other tech the companies?

>> i would say wework. jonathan: it tells you about the sector right now. more about the high yield in that asset class than anything else. great to have you with me. thank you. from new york, that is it for us. we will see you next friday. this is bloomberg. ♪

scarlet: i am scarlet fu. this is "bloomberg etf iq." focus on risks and rewards focused on funds. -- exchanging funds. ♪ scarlet: a safe haven within big tech, the return of volatility has been less than kind to tech names. u.s. software shares are holding up just fine.