jonathan: from new york city, i'm jonathan farro. this is "bloomberg real yield." coming up, weaker than expected inflation. ♪ solid demand for treasuries. the yield curve flattened since 2007. from hopes to bust. a year ago argentina issues a century bond. a year later, there are requesting ims health. we begin with a big issue. is 4% the new 3%? >> is there a possibility the

that growth accelerates, then inflation accelerates, it is higher than you expect. my opinion, it is on the short and which might force the tenure down. but you can easily view 4% bonds. people should be prepared for that. >> we're not in a normal situation, but we are getting closer to that state. so certainly, above 4%, i think the u.s. economy could handle it, and it is consistent with economic fundamentals. >> the real catalyst to getting us to a four handle on 10 year treasuries is probably not the fed. government issuance in this country as demanding that it will be for the market to absorb. it is really going to be when the ecb and the bank of japan signal their readiness to change monetary policy. >> the u.s. economy can handle it, but the global economy can't. then we get this disconnect where if you get soft demand in the global economy, we get huge foreign demand into the u.s. 4%, i think, is a little bit

tough anytime soon. jonathan: joining me around the table in new york is the cohead of global fixed-income strategy at the wells fargo institute. investment institute. lisa hornby, and also from pasadena california, deputy chief investment officer at western asset management. it is great to have you with me around the table. after spent the week talking about this, and every time i have brought it up, i have taken abuse. because no one thinks we get into 4%. so where does this 4% conversation come from, lisa? lisa: well, jamie dimon is a one i think who brought it up first. jonathan: and everyone else seemed to follow. lisa: if the head of jp morgan said it, we have to listen, right? the point he raised was a good one. we've never had q.e. we've never had the reverse of q.e. term premium is still negative. central banks will exit these programs eventually, at least that is my belief. and if that is true, we should be headed to more normal rates. jonathan: mike, could we get some more normal rates, and is 4% normal in this kind of world? >> well, i mean, any time that jamie diamond talks here, you're

best jamie dimon talks, you are smart to listen. and hearing that interview, it did not really -- at least to me, it did not seem that he was predicting 4%. what he was saying was that we need to get prepared for the possibility of 4%. we don't see 4% happening. we don't think growth and inflation are consistent with that. but we do have to make sure our client for folios can withstand that type of shock. jonathan: i think what i struggle with and others as well, is that if the fed has to go quicker, why do we forecast this parallel shift in rate as if the whole curve will shift. the federal reserve? that is not really how bond markets work. not how bondat is markets have worked so far. we have seen rates go up 60 basis points. you'd see a flattening in the yield curve. as far as 4% tenure, we don't see that anytime in the near term. we do think that rates are going to be going up from here, but not significantly so.

we think obviously that real interest rate difference from overseas is going to hold it down. mind, if theyour federal reserve has to go quicker, does that lead to an inversion in the base curve? >> that is exactly what we are calling for, to more raises this year. we do think obviously you've crossed through 40. so you've got a flat yield curve. we do think if they move too quickly can cause an inversion. lisa?an: lisa: absolutely. we have to focus on two things. one is inflation, and the other part is what other central banks do. if we see a surprise move out of the b.o.j., let's just say that could change the dynamic. jonathan: let us talk about the impression front. a really downsized surprise on inflation, but it was enough to get people excited about the fact that we are still in this goldilocks situation, risk appetite and high outputs are here to stay, low inflation as well.

mike, is this still goldilocks good? output good, inflation contained, or nothing's are things changing? mike: i think depending on what market you are talking about, we do see more of the same. we see growth that is probably below consensus, call it 2%, 2.5%. inflation come ashore it is trending higher, but the fed right now is comfortable with where inflation is. i think jerome powell talked about asymmetry or asymmetric range for what the fomc is predicting, around 2%. that has told us that they are willing to withstand inflation going above 2%. jonathan: this is a really good point, george. it is something i think we've all got to try to understand, the reaction from the federal reserve. trying to understand the sensitivity of the fed to higher inflation prints. does the federal reserve move with surprises to the upside, or is in it overshoot to some extent? aboutly on, they talked

prints. >> early on they talked about transitory factors and the idea they were not willing to withstand an overshoot. right now, we think they can go over 2%. actually, 2% to 2.4% is a reasonable amount to overshoot. lisa: yes, i think there are willing to tolerate some overshoot. we've heard williams talk about it. maybe we should move the inflation target higher. given that we under shot for so long, i think that is something they're willing to tolerate, as long as it is not a germanic overshoot. jonathan: mike, you bring up the inflation story, the other thing that was interesting in the speech this week, is whether they are still sensitive to global financial conditions. in jay powell's mind, he is basically saying, that this market and investors, overstate the influence of the federal reserve on global financial conditions. that was the takeaway from the speech this week by a lot of people. do you think he is understating

the federal on global financial conditions? >> i think, no. you probably do have to look at financial conditions, and understand there is a time and a place for financial conditions. the real question is, if financial conditions got disrupted in a meaningful way, would the fed reengage? i personally think, and i think our view is, maybe off the table, that right now the fed understands that we are in a delicate situation, not only in the u.s., but globally. and that the accommodation needs to be done with care and active feedback from the market. you get signals like if the curve or to come close to inverting, i think the fed is going to pay attention to that. jonathan: let us talk about the fed put george. has it changed? has the fed put changed? and i don't just mean that domestic story with where the s&p 500 trades.

i mean global conditions. e.m., china, we saw the fed back in china in happen the e.m. rout in is the federal 2015. reserve more or less sensitive to that than they were a year ago? >> i think there are more sensitive to it right now. you are seeing them exit from the quantitative easing and the rising interest rate environment that we haven't seen before, and they are sensitive to that. they are setting the precedence for one other central banks are going to follow. there is a good deal of keep in mind sensitivity. they are also reducing their balance sheet at the same time, obviously something that they are weighing into. jonathan: and it is still obviously a very accommodative federal reserve. i had a conversation with week with an investor who said that typically real rates of the fed get to about 1.5% that would suggest the rate nominal rate right now needs to get somewhere in the threes, 3.5%. are we going to get normal to three point 5% of the

federal reserve? lisa: my best guess is probably not it will probably do 2% or 3% . it will probably do 2% or 3% next year, but i think we're facing a significant slowdown in both fiscal stimulus and monetary conditions by the end of 2019 or 2020. so i don't think they get there. jonathan: the best question to you, mike. can the federal reserve on a real rates basis gets rates to where they once were? mike: it depends on how you define where they once were. i think that trend higher for rates is going to be methodically slow. you're going to see rates anywhere close to what we might have witnessed historically for some time, i don't think so. i think you are going to see a fed that is just cautious and most slow and with care. jonathan: george? is no reason there for them to move too fast. they are further along than many other central banks. they're going to be more cautious here. i don't think there is any reason for them to push it too fast. jonathan: guys, you are sticking with me. coming up, the auction block.

amidst the turmoil in emerging markets debts african nations , set a record for selling bonds. that conversation is next. this is "bloomberg." ♪

♪ jonathan: i am jonathan ferro, this is "number grill yield." to the option block. -- the auction block. the united states sold $3 trillion this week in bonds. i want to focus on the record size auction for that maturity. it drew a yield of 3.3%, the -- 3.13%, the highest since march 2017, with indirect bidders purchased the most since january. we go over to europe. italy holding a bond option

auction trying to form a populist government. an average yield of 1.34%. the offering was met with solid demand. finally, in emerging markets, ghana defined the recent turmoil in e.m. markets as it set a record-setting year for africa. i demand for $2 billion for euro bonds, exceeds supply four times. still with me to talk a little bit about emerging markets is rusnak from wells fargo investment institute, lisa holmby, and mike buchanan. mike, i would like to begin with you. we brought this up last week in the program. ago, june 2017, argentina could come to the market, access them quite easily an issue a century bond. a year later they're requesting imf aid. is this an ims issue, on argentina issue, or do we have a broader em story where things got too frothy in terms of access to markets?

mike: i think the story with emerging markets right now is that the rapid move higher in u.s. rates is associated with a stronger dollar, and that has caused some technical volatility. it is not surprising that the highest beta play with emerging markets, argentina, will suffer more than the other countries out there. we think the fundamental story supporting emerging markets is still there. these are generally economies that are early in their cyclical recovery, growing at a faster pace than developed markets. generally suppor supportive of central bank policies. inflation with some exceptions that is either stable or in some cases, going lower. so higher yields and supported fundamental backdrop. if we liked it before, you are right, things have gotten cheaper. relative value-wise, we like it even more now. jonathan: lisa, i keep hearing the same thing by investors. if you liked it at the price last week, you'd better like it

now because it's bet getting better. is that your take to? lisa: whether or not argentina has stabilized yet at these levels, i don't know, but i will say that their central banks have regained credibility. they are regaining credibility as they have taken their rate up to 40%, and they are working with the imf on getting their fiscal health and order. i think they have made the right steps, but as you said, there tremendous inflows last year, which needed to be washed out before we could stabilize. jonathan would you consider : buying the century bond out of argentina? .isa: no jonathan: mike, how about you? mike: right now, no. we are not buying any century bonds, but we are buying local currency bonds. jonathan: interesting. get 20%s, we can yields. you do get paid for the risk, and we recognize there is volatility, but i think there is

a price for most assets, right there with the century bond. jonathan: george, that would be the big question, a really simple question when you approach currency. i'm a adequately compensated for the risk am about to assume? last year, and many of these places, you were not. are you now? couldthink that it contract -- we think that you are right now. right now, if you look at emerging market data backed up to 360 spreads, we think it can contract down to roughly 320. we think overall there are good areas of opportunities. two michael's point, it is pockets. you have to be selective. especially in emerging markets. jonathan: are you looking at credit sectors, single names, or are you looking at regions? africa, asia, how do you develop a breakdown of where you put capital? george: more than regions. we have switched more favorable to latin america and also to asia right now. jonathan: lisa? lisa: i think you have to look at each country individually, to

be honest. each country is having its own idiosyncratic story, whether it be elections. i don't think you can look at the block of e.m. and allocate it. the markets don't trade like that anymore. i do think there are pockets of opportunity, as we say. brazil, south africa, those are countries that are undergoing reforms and they have made tremendous strides on their current account deficits, and reliance on external funding is less. jonathan: mike, how important is central bank credibility? lisa mentioned she thinks argentina has regained central bank credibility. the turkish leader out today basically saying, he wants lower rates, even though inflation is climbing higher this makes urea and things difficult. a lot of people are wondering whether he is sending a message to the central bank. do you look at pockets of e.m. where typically you think there might be undervalued, and then you look at the situation as to whether it has credibility and then you back away? mike: yes, there is no doubt. central bank credibility and central bank policy plays a key part in emerging markets.

you look at brazil right now, you know, we also like it. you have a reform-minded central bank. the paths for rates have been lower. they have gotten inflation to the lowest they have witnessed for the past 20-25 years. notou have to evaluate, only the micro factors with respect to the economy, but central-bank policy is crucial. jonathan: dollar-dominated or local, mike? you are.depends where again, i think that the case for local currency, from our standpoint right now, it is the most compelling because we think that the real yields when compared to the real yields in developed markets, really stand out. that's where most of our incremental money is going right now, into emerging markets. jonathan: george, what about you? george: our bench is greater returns. jonathan: i want to get you a market check on where bonds have been this week.

they will be sticking with me. i would like to get this. yields are up on the front and buy for basis once, to i've got 253. to say the tenure has been really remarkably stable over the last several fridays, and an -- in and around 2.95, 2.97 today, up two basis points to close out the week. still ahead on the program, the the final spread, the week ahead. featuring a governing coalition in italy that someone has called his worst-case scenario for -- some have called it the worst case scenario for investors. that is next, this is "bloomberg "real yield"." ♪

♪ jonathan: i'm jonathan fehro. this is bloomberg "real yield." a possible governing agreement by monday between the five-star

movement and league parties in italy, could happen next week, potentially ending a deadlock there area plus, china and the u.s. are in trade talks. the e.u. giving an update on breaks it talks. and as central bank decision coming up from mexico, where there has been a lot of pain in the peso recently. it's great to have you with me. lisa, i'm not giving you a hard time because you did disclose last time you were on, we talked about that short italy trade. how difficult is it to short btps when the politics at the moment don't seem to matter? lisa: that is when you have to have the short on. we've had it on for a little while. it's not worked in our favor , at least recently, but when he think about where the italian winds spread was ahead of the french elections, we are talking about 215 basis points. now we see a populist movement in it of the governing party.

five-star, northern league, and the market does not seem to care. we are 130 basis points on that spread. jonathan: why should this get tighter, george? george: the market doesn't seem to care a lot right now. i don't think it should get tighter right now. it should widen out. the risk associated with italy is pretty significant. jonathan: what is associated with it, what is the risk? george: that is a valid point, however, we think that if you start getting some populist movement or issuance of debt, it's going to do nothing except put pressure on yields. jonathan: mike, the united states treasury came out, it hasn't made a massive difference. walk me through the idea here to read i guess fundamentally, you look at that spread, you have to ask, not just one question about b.t.p.'s. you have to ask another question about bonds in riyadh which one is more overpriced, bonds or b.t.p.'s?

mike: jonathan come i think you just highlighted a big opportunity, just on a relative value basis. looking atu are italian bonds, spanish bonds, compared to u.s. treasuries, u.s. treasury's stand out on a global basis. you wonder how high rates can really go just in terms of relative value and flow of funds. we think there's an opportunity to own treasuries versus boones for instance, and play that compression trade overtime. jonathan: do you agree with that trade, george? you have to fold in the idea that you have some pretty fx hedging costs there, to them. george: you do. those are coming down with the dollar strength here. i do think that right now you're going to see some more flows into the u.s. i think the risk is still with developed market debt. we still have not seen the ecb play out. they will probably get out of quantitative easing this year, start raising rates next year. we have seen that movie before, and we know how that plays out. we would rather be early then

late on it. jonathan: we'll wrap up this get a few more questions, we will put you in the box to wrap up the program. looking ahead to next week. the first question, would you short etp's or bonds into your and? outhere does the performance comes from, or rather, the underperformance? >> b.t.p.'s. >> lisa? >> b.t.p.'s. jonathan: mike? mike i'm going to short bunds. : jonathan: would your take u.s. high-yield or e.m. credit? adding risk? george? >> e.m. credit. >> mike? >> i'm going to be an outliar. lisa? e.m. credit. jonathan: there we go. after the big debate, i thought about the potential of a hidden 10 year yield

hitting 4% sometime soon, what do we see first? what do we see first, 4% or 2%? 4% or 2%, what do we see first. on a 10 year treasury yield? four or two? george? george: 2%, i would guess. jonathan: lisa? lisa: two percent. jonathan: mike? mike: that is a widespread. i guess i'll go with 2%. jonathan: well, we are back in the middle now at it's great to three. have you with me on the program. thank you to all of our guests. from new it for me york, but does it for us. we will see you next week on friday at 1 p.m. new york time, 6 p.m. in london. ♪ 6 p.m. in london. ♪

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