jonathan: from new york city for our viewers worldwide, i am a jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, breakdown on international diplomacy. enough to derail global growth? central bank governor in a world of pain asking the fed to help. ecb refusing to be held hostage and planning to discuss the end of qe. we begin with a big issue, emerging markets asking the fed

for help. >> the fed is always clear they are making policy for america. even if you do consider the rest of the world, you are not making policy to bail out countries that are running their countries badly. >> the fed is guided mostly by u.s. factors and it would take a massive global crisis to change the fed behavior. >> when people make the comparison to 2013 and say the e.m. is better place, but we are missing the point there other vulnerabilities, not just external anything but in places like brazil, public debt is a huge issue. >> the emerging markets appears to be contained to argentina and perhaps turkey. this is happening in a period of strong growth globally. if it is going to happen, it is a good time to happen. it's when institutions can best respond. >> this is an asset class where crossover money overwhelms the

dedicated money. when crossover money decides to exit, which is what is happening these days, then most countries are impacted. >> i hear talk about the crisis in emerging markets and it is nonsense. it depends on what the dollar is doing, but there are some stories that are weak. at this point, they should be avoided. jonathan: with that, we have a full house. joining me is andrew chorlton, kathy jones, and jay berry, head of u.s. government bond strategy at jpmorgan. it is great to have you. kathy, this feels like a broader asset class story. not a single idiosyncratic theme we had a month ago. kathy: global liquidity is shrinking and we were not priced for it. we went underway in e.m. several months ago because valuations were too high.

as the fed tightens, this is what happens. risk premium starts to expand and it is where we are. jonathan: do you see signs of contagion? mohammed talked about technical factors. are you starting to see the technical bleed through? >> it was crowded at the start of the year and you have the own elect scenario and you could justify it. now technicals are turning and investor greed has really driven it. jonathan: jay, it is interesting that they were asking for a basic call that the federal reserve balance sheet in the treasury boosting issuance at the moment because of the fiscal stimulus is overwhelming dollar liquidity. it is taking away from emerging markets. they complained on the way up and are complaining on the way down down. how does the federal reserve respond?

jay: this is coming front and center right now. late last year and the beginning of this year, we were in an upswing of growth. it helped miss the point of the fed tightening but now the growth has decelerated in the euro and japan. the u.s. is going alone well above trend. it is coming out to the forefront. with labor markets running well above potential and inflation rising, it is hard for the fed to stop right now. jonathan: the fed faced several calls this week from indonesia and india to slowdown the pace of the balance sheet. is this something you think the fed actually needs to consider? kathy: they need to consider it. i don't think they will do it anytime soon. they seem to be on a preset course to unwind the balance sheet. as long as domestic indicators are strong enough, i do not think that will change policy. they have to see financial conditions tighten or a really significant decline in global growth that would affect the u.s. before they would change the course.

jonathan: andy, let's talk about the potential that these technical factors spill over into fundamental issues. we had an interest rate hike from india and turkey and others as . the hikes in turkey are real. they are real rates, potentially suffocating the economy. that is where the technical factor spills over into fundamental reasons. do you see the potential that growth gets choked in emerging markets? andrew: you have to look at both ways. in some ways you are getting sensible central-bank responses to the challenges. in argentina, good news on the imf. but it does impact short-term domestic economy. it is going to help in terms of funding going forward. but the big story for us is on the blind side, short treasuries are decent value. that stretch for crossover investors, you don't need to stretch as much to make 2.5% on the two-year treasury.

jonathan: that is a good point. elsewhere. you have treasuries more competing for capital elsewhere and a more attractive yield. that attraction to u.s. assets and competition for capital from elsewhere, is e.m. a loser or can they still do well? jay: we have gone neutral on e.m. it is the tension which will make returns more challenging. the u.s. is going to continue to look more attractive, if we are right and get three more hikes, we will get two-year yields over 3%. jonathan: kathy, yield up a 3% in the united states on a front end of a two year yield. if i say 3% on a two-year, do you say inversion? kathy: i think we get close to it. i think two more hikes this year is probably more realistic than three.

we are seeing global growth, it's going to turnover, i don't see the impetus for that last rate hike at the end of the year. we are getting close to the neutral rate. we have two people at thfed now to i am assuming will be the vice chair, and williams, also in the new neutral camp. why rush? yes, if we get a 3% on the short end, we would be pretty close to inverting. jonathan: they were two competing forces in play, the intuitive idea that when the federal reserve goes into a hiking cycle, the curve inverts, that is what history suggests. at the same time, and this is why this time it might be different, we've got unwind of the balance sheet, removal of quantitative easing, which could lead to a steepening of the curve. and the risk premium, the term premium picking up again. how do you put those two competing forces together and what is the curve going to look like?

andrew: it is not easy. the first question is what to do if it hits 2% or 3%, you buy them. in terms of the curve, short term up until september. the pension plans could impact the shape of the curve. the challenge with domestic policy in the u.s., is you have inflation coming up. if you go to the macroeconomists that showed us all the credit analysts, everyone is feeling cost pressure and inflation could be a problem. it doesn't give much room for maneuver to react to market concerts and it impacts the curve outlook if inflation comes through. jonathan: in a moment, we're going to talk about europe and bcp and italy. i spoke to steve major and asked him an important question, when he asked me where financial conditions are, i would respond things are still using.

but if you look outside the united states right now in an issue with btp's, credit stress abroad, an issue in turkey and brazil. you are seeing credit stress and significant tightening in global financial conditions. is that what you are seeing? kathy: we are seeing the early stages in the u.s. we are starting to see credit phases are widening. we are seeing the early stages. domestically, it is easy which is why the fed will continue on a fairly preset course to shrink the balance sheet. globally, we are seeing financial conditions tightening. jonathan: my guests are staying with me. coming up, the auction block. this might be the year of the u.s. convertible bond, twitter out with $1 billion. we will go through the numbers. this is bloomberg. ♪

♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield." let's head to the auction block, where twitter entered into the s&p 500 selling $1 billion of bonds. there is interest at a quarter percent rate a year, maturing in 2024. who knows where we will be. twitter is a broader trend for u.s. convertible bonds, issuing is on pace to top the greatest volume since 2007. changes in the corporate tax code helping. finally, u.s. investment grade bouncing back from a slow week from last week, with more than $30 billion in issuance. union pacific was one of the highlights with $6 billion in a seven part transaction. with me around the table is still kathy jones, jay berry, and andrew chorlton.

i want to talk europe. andy, i have to give out a shout out to your colleague. lisa hornby came on the program for months and i continued to give her a hard time aboutt btp's. then it suddenly paid off. let's talk about the trade and what you did that tuesday when things blew up. andrew: lisa did a great job and withstood a lot of pressure from you and internally. it shows the reaction last tuesday, coming off of a holiday weekend, shows you how fickle d over positioned markets are. we cut position on tuesday. we are looking to reinstate it on the basis that you had headlines, but fundamentally, it is a deteriorating story. the only way to justify in my opinion any yields in europe is qe. as you said in the lead before, we think qe is going away in europe pretty soon.

on that basis, with liquidity withdrawn in the u.s. and europe, sell it. jonathan: have you got an idea of where you would like to reenter, or the curve, if you're looking to do it, what are you looking at? andrew: if we had a time machine, we would have covered it on tuesday and sold on wednesday. we are looking for some kind of relief rally. we feel high-yield credit and investment credit and european markets, it is looking for some sort of respite and you sell that relief. it is a tricky one. we are discussing it. jonathan: i imagine you are. and you as well, kathy. looking at the situation in italy right now and across europe. and ecb, they are incredibly reluctant to be held hostage by politics. what do you make of that and how does that set up for next week? kathy: they have a tough line to walk. they have pressure coming from a populist push that has been underappreciated for about two

years right now. they have to deal with that and they have to show they are not taking that into account and setting policy. i think we are not going to get much out of the ecb next week. i think they will say they discussed the idea of ending qe, and that will be all we get. jonathan: kathy, to your point, these are risks on the table for years, months, especially in italy, and we are still vulnerable to sudden reversals in risk appetite. why, when we are aware of the risks at the time are we pricing in doom and risk suddenly? kathy: because we did not price it in initially. markets were not priced for anything to go wrong. we had a scenario where spreads, it doesn't matter if you go from the u.s. high-yield market, em, everything else, spreads have been very compressed, partly because of qe and the idea that there would always be a central bank to step in. the whole market has to reprice. jonathan: it is concerning when you consider the rest of europe

as a fixed income universe. typically, we think about central bank stepping back and fundamentals taking over. i go back to a conversation i had with mohammed and he talked about the typical handoff you would look for. in europe, i struggle to see how any economic example in history would justify the price of credit, or where rates are, when a negative six-year on bund, negative yields. it doesn't make sense. there is no economic scenario that justifies that. how does the ecb get away from doing this without creating many examples of the btp blowup we saw last week? will we see more of that? andrew: as kathy said, people hadn't priced it in before and we are coming after free money around the world. that is our problem. arguably if you look at the financial assets that have done a good job, real assets that affect real economy, less so.

people now need to take a hard look at the risk reward across many asset classes in fixed income. it is not a pretty picture until we get a correction. price is so important is often forgotten. jonathan: jay, they are two different things. there is some liquidity risk at ecb and saw an example of that several weeks ago. is that a broader issue that we need to pay more attention to? jay: it is not just happened to btp's, and one could argue yesterday and four years ago, what we notice with liquidity is when the volatility picks up, much more sensitive to the pickup in volatility and liquidity can disappear. i think the point andy made before, if you look at our colleagues in london, they were looking at many clients overrated peripherals which exaggerated the move.

treasury showed a high degree of sensitivity and it was short in the u.s. as well and that amplifies the moves that occur. jonathan: if this can happen in treasury, it can happen anywhere. kathy, what are you worried about when you look across the world and the fixed income universe? kathy: now that em is starting to react, we are less worried about it because it is starting to price in a more rational way. i am worried about the domestic investment grade and high-yield. the reason is, the deterioration in credit quality, especially in investment grade, we have half the universe is triple b and even the single a category is looking less robust these days. i am worried about that. markets are not priced very well for it. jonathan: how do you convince people there is a concern there where the macro banks so solid in the united states when the g7 is going to take place over the weekend and everyone is talking about the g6 and plus one. the plus one is the outperformer.

they are alone because they are better than the other six. how do you convince people there is a concern when there is no problem with the economy in the united states? kathy: that's the reason we are neutral. they are waiting for the domestic economic indicators to ve a signal there really is going to be a problem and that may not be the case. if we get some excess cash to buy back debt, that would be alleviated. we would not be that concerned about it, but right now leverage on balance sheets is what we really worry about, and global indicators are rolling over and the u.s. may have a hard time continuing to outperform. jonathan: do you share these concerns? jay: on credit, our hike grade team has a target for year end. the supply picture for the balance of the year looks better and we think part of the reason we are here is because of the demand in the rest of the world has disappeared in the backdrop of currency adjusted yield

pickups, which are worse than they were. against the backdrop of fundamentals should be pretty stable. jonathan: kathy jones, jay berry, and andrew chorlton are staying with us. we want to get a check of the market for you. across the bond curve in treasury, yields up three basis points on a 30 year. a mild week if you take the last five days together. that is the story in the bond market. still ahead, the final spread. the weekend, featuring decisions from the fed, ecb and boj, the three big ones. we will discuss them. this is "bloomberg real yield." ♪

♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield." it is time for the final spread. over the next week, a trio of central bank decisions by the

fed, ecb, and bank of japan out with announcements, a ton of economic data as well, including u.s. cpi and retail sales. plus, the trump-kim summit in singapore. the president set to publish a final list of targets on chinese imports. unbelievable week ahead that we have coming up. with me around the table, andy chorlton, kathy jones, and jay berry. is international diplomacy a risk for the global bond market? is that something you even have to think about over the next week? kathy: we have had a few surprises recently when it comes to the international diplomacy. obviously, the big thing we worry about is the trade outlook. that has the potential to impact global growth and fed policy and central-bank policy and inflation, etc. at this stage of the game, we tend to shrug these off quickly. jonathan: because they take so long to burn through, jay. i guess the markets looking at the situation thinking, is a breakdown of diplomacy a risk to

the global growth story? does it derail global growth? jay: from our perspective, we do not think it does what has been announced on trade, it takes a little off of u.s. growth this year but nothing that changes our view on inflation or the fed or those developments. jonathan: andrew, is that your view? andrew: it will matter next week because people like to focus on these things and they like a reason to justify a market move. longer-term, it won't matter and even trade, it should matter but you never know what the final result is going to be from the initial blows. jonathan: if you had to pick a central-bank decision out of the three and i could give you video, which one would you pick? kathy: i would pick the fed. i do not expect much out of the other two for noteworthy information. it will be interesting to see how the fed projects forward in terms of the dots and the summary of economic projections and how powell handles the press conference.

jonathan: are you expecting some changes for the federal reserve outside of the rate hike? kathy: i think we might see a little more consolidation of the dots. we've had dispersion that has been wide and i think they may consolidate. i want to see the longer term target and has it changed? it is hovering under 3%, and if it stays there, that means not much change in the 10 year treasury, but if it moves, that is significant. jonathan: we'll leave it there and wrap things up. we have the rapidfire round. apparently you are either alone em or long u.s. dollar? which is it? andy: dollar. kathy: dollar. jay: dollar. jonathan: that was a struggle. traditional complainers of emerging markets, one is india and one is brazil. do you buy india or do you buy brazil? the two complainers of emerging

markets. andy? andrew: brazil. kathy: brazil. y: no difference between the two. [laughter] jonathan: final question. treasury has acted as a shock absorber. is treasury still the ultimate fixed income haven? yes or no answer. andrew: 100% percent. kathy: yes. jay: absolutely. jonathan: thank you very much. really interesting stuff. from new york city, that does it for us, i will see you next friday ahead of a massive week ahead and i'm looking forward to it. this was "bloomberg real yield." this is bloomberg tv. ♪