jonathan: from new york city, i'm jonathan ferro. this is "bloomberg real yield." ♪ jonathan: coming up, weaker than expected inflation. solid demand for treasuries. the yield curve flattened since 2007. from hope to bust. a year ago argentina issues a century bond. a year later they request help.

populist parties looking to form a government in italy. we begin with a big issue. is 4% the new 3%? >> is there a possibility the growth accelerates, then inflation accelerates? it's higher than you expect, the fed raises rates more than you can expect. both in the short end, in which in my opinion might force it down. you can easily deal with 4%. people should be prepared for that. michael: we're not in a normal situation, but we are getting closer to that state. above 4%, i think the u.s. economy could handle it. it's consistent with economic fundamentals. lawrence: 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 will be when the ecb and the bank of japan will suggest readiness to change monetary policy. michael: the u.s. economy can handle yields.

we get this disconnect where, if you get soft demand in the global economy, we get huge foreign demand into the u.s. four is a little tough any time soon. jonathan: joining me around the table in new york is the cohead of global fixed-income strategy at the wells fargo institute. lisa hornby. and from pasadena, the deputy cio at western asset management. it is great to have you with me. i spent the week talking about this, and every time i've brought it up, i've taken abuse because no one thinks we get into 4%. so where does this 4% conversation come from, lisa? lisa: well, jamie dimon is the one i think brought it up first. jonathan: and everyone else seemed to follow. lisa: the head of j.p. morgan said we have to listen. 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.

that is my belief. if that's true, we should be headed to more normal rates. jonathan: could we get some more normal rates, and is 4% normal in this kind of world? michael: well, i mean, any time that jamie diamond talks here, you're smart to listen. and in hearing that interview, it didn't really -- at least to me it didn't seem like he was predicting 4%. jonathan: good point. michael: what he was saying 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 clients' portfolio can with stand that type of shock. jonathan: george, what i struggle with and others as well, if the fed has to go quicker, why do we forecast this parallel shift in rate as if the whole curve will lift with this federal reserve. that's not how this works? george: it is not how it has worked so far. rates have gone up 60 basis points. you'd see a flattening in the

yield curve. as far as 4% tenure, we don't -- 4% 10 year, we don't see that anytime in the near term. we do think that rates are going will to be going up from here, but not significantly so. we think that real interest rate difference from overseas is going to hold that down. jonathan: in your mind, if the federal reserve had to go quicker, does that lead to an inversion? george: that's why we're only calling for two more rises 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. jonathan: lisa? lisa: 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's talk about the inflation. you had a really downsize surprise on inflation but it's enough to get people excited.

maybe we are still in the goldilocks regime, high output, low inflation, risk appetite. it's going to remain here to stay. mike, is this still goldilocks good? output good, inflation contained, or nothing's changing? michael: i think depending on what market you're talking about, we do see more of the same. we see growth that is probably below consensus, call it 2%, 2.5%. we think inflation is trending higher, but the fed right now is comfortable where it is. he was talking about the symmetrical range. jerome paul -- jerome powell talked about inflation for with the fomc is predicting around 2%. that tells us at least they're willing to withstand inflation that goes 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 function of the federal reserve, and trying to understand the sensitivity of the fed to higher inflation prints. does the federal -- fed move

with surprise for upside or overshooting to some extent? george: 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. jonathan: lisa, would that be your take as well and what it means for the federal reserve? lisa: i think they're willing to tolerate some overshoot. we've heard williams talk about it. maybe we should move the inflation target higher. we undershot for so long. i think that is something they are willing to tolerate. jonathan: might, you bring up the in placement -- inflation story and jerome powell. the other thing 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 markets

overstate the influence of the federal reserve on global financial conditions. that is the takeaway of the speech by a lot of people. do you think he is understating the fed's role? george: you probably do have to look at financial conditions, and understand there is a time and place. the real question is, if financial conditions got disrupted in a meaningful way, would that reengage? is it may beiew off the table. i think the fed understands we are in a difficult situation not only in the u.s., but globally, and that the removal of accommodation needs to be done with care and active feedback from the market. you get signals like if the curve were to come close to inverting, i think the fed is going to pay attention to that. jonathan: let's talk about the fed, george.

has the fed put changed? i don't mean just where the s&p 500 trades i mean global , financial conditions, em, china. we saw the fed back off and em route in 2015. is the federal reserve more or less sensitive to that than they were a year ago? george: i think you're seeing them exit, sort of quantitative easing and rising interest rate environment we haven't seen before. they are setting the precedence for one other central banks are going to follow. there is a good deal of sensitivity. keep in mind, they're reducing their balance sheet at the same time. that's obviously something they're weighing into. lisa,an: the other thing 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 needs to get to the threes,

3.5%. are we going to get normal rates to 3.5% in the federal reserve? lisa: my guess is probably not. 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. i do not think they get there. jonathan: same question to you, mike. can the federal reserve on a real rates basis gets rates to where they once were? michael: it depends on how you define where they once were. the trend higher for rates is going to be methodically slow. i don't think -- you're going to see rates anywhere close to what we might have witnessed historically for some time. i think you're going to see a fed that is just cautious and moves slow and moves with care. jonathan: george? george: yeah, there's no reason for them to move too fast. they are further along than many other central banks.

they're going to be more cautious. i do not think there is reason to push too fast. jonathan: guys, you are sticking with me. coming up, the auction block. african nations set a record for selling bonds. that conversation is next. this is "bloomberg." ♪

jonathan: i'm jonathan ferro. this is "bloomberg real yield." to 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. indirect bidders purchased the most since january. we go over to europe. italy holding a bond option trying to form a populace government. an average yield of 1.34%. the offering was met with solid demand. finally, in emerging markets, ghana defined the recent turmoil as it extends a record setting year for africa. it's on demand for its bond exceeds supply four times. they got more than 8 billion in bids. still with me to talk a little bit about emerging markets is george from wells fargo, lisa holmby, and michael cannon. michael, we brought this up last week on the program, and the em pain has just continued. a year ago june 2017, argentina , can come to market. access and issue a century bond. 11 months later, they're requesting imf aid. is this an argentina issue, or

do we have a broader em story where things got too frothy in terms of access to markets? michael: i think the story with emerging markets right now is the rapid move higher in u.s. rates, the associated stronger dollar has caused a lot of technical volatility. it's not surprising that the argentina is going to suffer more than the other countrys that are out there. we think the fundamental story that supports emerging markets is still there. these are generally economies that are early in their cyclical recovery. they're growing at a faster pace than developed markets. generally supportive central bank policies and inflation. inflation, with some exceptions, that is either stable or many in cases going lower. high real yields and supportive fundamental backdrops. we liked it before.

we liked it before. you're right, things have gotten cheaper and obviously just relative value-wise where we like it even more now. jonathan: lisa, i keep hearing the same thing by investors. it was consensus traded. even after the shakeout 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? 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're working with the imf. i think they're making the right steps. but as you say, there was tremendous amount of influence. that had to be washed out before we can stabilize. jonathan: would you consider buying the century bond out of argentina? lisa: no. jonathan: michael, would you

consider buying them? michael we are buying local : currency bonds. you can buy 20% 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 simple question as you approach anything on fixed income. have i adequately compensated for the risk i'm about to assume? last year, and many of these places, you were not. are you now? george: we think 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. you are looking at yields at roughly the 6.5% range, since sense we't seen this 2016. think overall there are good areas of opportunities. looking atre you single names? how you develop the breakdown of where you put capital to work?

george: we have switched favorable to latin america and also 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. 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. i think brazil, south africa there are countries undergoing , reforms. they have made tremendous strides on deficits. reliance on external funding is less. so they're going in the right direction but again, it's individual. jonathan: mike, how important is central bank credibility? lisa mentioned she thinks argentina has regained central bank credibility. the turkish leader out today saying he wants lower rates even though inflation is climbing higher. this makes things difficult. a lot of people 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 value, and then you look at the situation as to whether it has credibility and

then you back away? michael: yeah, i mean, there's no doubt central bank credibility and central bank policy plays a key part in investing in emerging markets. you look at brazil right now, lisa mentioned brazil. we also like it. you have a reform-minded central bank. the paths for rates have been lower. they've gotten to inflation that a point where it is the lowest that they witnessed for at least 20, 25 years. you have to evaluate not only the macro factors with respect to the economy, but central bank policy is crucial. jonathan: dollar-denominated or local? michael: depends where you are. i think the case for local currency is, from our standpoint right now, the most compelling because we think that the real yields when compared to real yields in developed markets really stands out. that's where most of our incremental money is going right now. jonathan: george, what about

you? george: our bench is dollar-based, but i agree the local is the best opportunity for greater returns. jonathan: george's sticking with me from wells cargo as well as mike and lisa. i want to get you a market check on where bonds have been this week. yields up on the front end by four basis points, 253. i've got to say the ten-year has been really remarkably stable over the last several fridays, in and around 2.95, 2.97 today. still ahead on the program, the week ahead, featuring a governing coalition in italy that someone has called his worst-case scenario for investors. what does it mean for bdp? that is next. this is bloomberg. ♪

jonathan: i'm jonathan ferro. this is bloomberg "real yield." it is time for the final spread. over the next week, a possible governing agreement by monday between the five-star movement and league parties in italy potentially ending a deadlock. china and the u.s. in trade talks. u.s. retail sales is a data point to watch. the e.u. giving an update on brexit talks. the central bank decision in mexico, where there has been a lot of pain in the peso recently. guys, 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 btp's when the policy does not back it up. lisa: that's when you have to have the short on. we've had it on for a little while. it's not worked in our favor recently. but when you think about where

the italian bond spread was ahead of the french elections, we are talking about 215 basis points. now we see a populist movement the coming 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 shouldn't that market get tighter? george: the market doesn't seem to care about 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 italian that and having the ecb insulated it? george: i mean, that's a valid point. we think that if you start getting some populist movement or issuance of debt, it's going to do nothing except pick up the yields. jonathan: the united states trade has come out. they have boosted a lot of issuance. it hasn't made a massive difference. just walk me through the idea here. 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 more about bonds. which is more overpriced, bonds or b.t.p.'s? michael: jonathan, you highlighted a big opportunity just on a relative value basis. whether you are looking at bunds or -- this is treasuries. u.s. treasuries really 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 vs. bunds or btps. jonathan: do you agree with that trade, george? you have to fold in the idea that you have some pretty effective hedging costs there too. 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've seen that movie before and we know how that plays out. jonathan: you think the risk is in the risk-free asset? george: yes, right now we do. jonathan: we'll wrap up this program and the themes through this week and looking ahead to next week. would you short btp's or bunds into year-end? one or the other? what does the performance come from? what would you short? george: b.t.p.'s. jonathan: lisa? jonathan: b.t.p.'s. jonathan: -- george i'm going to : short bunds. jonathan: would your take u.s. high-yield or e.m. credit? george? george e.m. credit.

:jonathan: mike? michael: i'm going to be an outlier. i wish you would have said e.m. local. i am going to take high-yield. jonathan: there we go. after the big debate, i thought i would pose the following question. 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. 4% or 2%. george? george: 2%, i would guess. jonathan: lisa? lisa: i would say two. jonathan: mike? michael that's a wide spread. : i guess i'll go with 2%. atathan: where in the middle three. i thought i would ask the question. guys, it's great to have you with me on the program. george from the west fargo investment, lisa and michael. that does it for us. from new york, we will see you next week. ♪

scarlet: i'm scarlet fu. this is "bloomberg etf iq." ♪ emerging-market debt going down. what opportunities does that create for the opportunistic investor?