jonathan: from new york city, i'm jonathan ferro. 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, increasing leverage in a rising rate environment. chasing pain into investment grade credit. the transatlantic spread widens. how will committed to gradual hikes, mario draghi going nowhere fast. and pricing in political risk. looking at a string of key elections in emerging markets. we begin with the big issue, corporate america boosting leverage. >> right now it is still pretty attractive to borrow. you have seen a pretty meaningful upsurge and sizable deals.

companies are raising $20 billion, $30 billion, $40 billion of money at one go. >> increased leverage on balance sheets is absolutely a risk. i think a lot of companies are much more healthy in thinking through how much risk they want to take, how much debt they actually need. it is definitely an area of concern. >> the economy is on a very strong growth track, no question, and that supports leverage. the question is -- and it always happened in the past because economies are indeed cyclical. when do hit a tipping point, where is the tipping point? i think that goes back to the elephant in the room, the trade wars. that is the thing that could cause a tipping point. jonathan: a full house around the table here in new york today. with me is jim keenan, oksana aronov, and krishna memani.

krishna, i want to begin with you and bring up the subject of what's happening in credit at the moment. investment grades wider. big m&a story in there. high yield has stayed tight. what is your thought on what is happening at the moment? krishna: investment grade is quite wide compared to the beginning of the year, almost 35 basis points. that is very significant. the reason i think is issuance has been far more robust than in the investment grade market. two, the core buyers of investment grade credit, overseas investors, have been missing in action. that combination has put us in a bit of a pickle. high yield, on the other hand, the technical side, in better shape. fundamentals are really good, together holding nicely. jonathan: jim keenan, anything to worry about? clearly, there are companies out there that will leverage in the balance sheet.

we see that reflected in investment grade. is there a worry for you? jim: i agree with krishna with the widening of ig versus high yield but take a step back, i don't think you are seeing, from the leverage you are seeing in the corporate space, something that you should be worried about from a economic perspective. certainly it is creating more risk at the lower risk quality of the investment grade space as they start to put more leverage on their balance sheet and you see a big boom in bbb leverage. that is more idiosyncratic. they will create some technicals, you are seeing that in investment grade. if there are downgrades, that would filter into the high-yield market. from an economic perspective, the economy is still strong, earnings are still strong and that is why you are seeing support at the high-yield level. jonathan: and we have consensus here? oksana: i'm always here to create dissonance. i would agree certainly that we have seen widening. investment grade is one of the worst performing parts of the

market this year, down almost 4% this year. that is really being affected by three major factors. m&a activity, we have seen these numbers. repatriation is another big one. many of those funds were held overseas in investment type -- investment grade type investments. so there is supply coming in there. and as krishna mentioned, less demand from overseas investment. the interesting thing, too, currently about 14% of the investment grade space has over four times leverage. when you look at the bbb part of investment grade, which is the lowest strength, -- lowest ing, there is four times the volume there than high-yield. historically, that ratio is at about two. when you think of a downgrade cycle, you think, can that bleed into supply in high-yield, given the overhang has gotten so big?

jonathan: is that something you are starting to position for, or just something you are thinking about? oksana: generally, our position right now is quite conservative. we see a lot of these tipping points across different markets , and valuations do not have enough room in them for the kinds of uncertainties that are happening out there. whether we are talking about the yield curve, tariffs, all of these things can go a couple of different ways, but either way they go, it will create volatility for the market. we believe being conservatively positioned here matters. for us, that means having liquidity at the ready. jonathan: a lot of people would say go up in credit quality. what is going up in credit quality actually, when you go from high yield to investment grade? in some respect, that is where it has become less quality. oksana: what has it done for you this year? that is something i've been saying for a while. higher credit quality is no

longer synonymous necessarily with safety, in the classic sense of the word given that we are going through the cycle right now of potentially higher rates. and that has nothing to do with what the fed is doing in terms of the amount of hikes, just hasn't do with supply and demand. jonathan: i can hear krishna. krishna: please give me an opportunity. [laughter] krishna: in the short-term, when you have economic conditions relatively robust, quality does not do much for you especially when rates are rising from the absolute return standpoint. this year, on the exit return basis as well. having said that, if you hit a recession in 2019, 2020, and you are planning, positioning for that, upgrade makes a lot of sense. in that scenario, given the amount of leverage we are talking about, high-yield will have a far worse time than we

have had investment grade so far. jonathan: the explanation would be that you see more credit risk and it would not be a duration story. right now it is a duration risk story, which is why high-yield has outperformed investment grade. jim: from an economic perspective, there are a fair amount of balances of risk. some of this is where in the curve are you? investment grade, as you look at 10/30 spreads, they are starting to widen out. we're at a point where inflation is starting to become a question in the economy. at the same time, everyone is wondering where we are in the economic cycle, maturity of the business cycle. they are worried about the downside. one thing that you see right now up in quality means going into senior secured bank loan risks. bank loans have done so well, from a vol adjusted basis, it's done incredibly well because it is at the top of the stack of corporate earnings. that is why it's done well relative to investment grade or high-yield. oksana: it is hard to argue for going up in quality with a

curve as flat as it is today. you are not really getting much of a compensation by taking on more duration risk, which is what would ultimately be the saving grace in a recessionary environment. the curve has gotten so flat, you can earn 2% and then the pickup for going further out is so minimal, but your duration risk you are taking on is so major. the question for investors is whether you expect and believe there is an imminent recession, or if you believe the economic data, the policies of this administration, including tariffs, which is ultimately inflationary, whether all of those things are good for bonds, or an environment in which cash could outperform bonds. krishna: let's not conflate duration risk with credit risk. those are different levers and you can move both of them. if you want a short duration and credit risk, you could buy loans, as jim was suggesting. on the other hand, if you want

real duration risk, you can buy long treasuries. i think conflating the two from a portfolio construction standpoint does not really make much sense. in today's environment, jim is right. i think loans relative to high-yield and perhaps mortgages or treasuries relative to high-grade is the safety trade today. jonathan: is that going back to where you want to be on the capital structure? krishna: absolutely. credit risk on loans is meaningfully lower, and especially when you compare spreads. that makes the case more compelling. investment-grade spreads are widen, compared to mortgages, for example, they are not extraordinarily wide. let's get a trade from you, jim, to wrap this up. where do you go? jim: as of right now we prefer the loan market.

secured loans, tranches, things like that. i don't think you are getting paid in the risk to go down in quality in the capital structure. there is value in the high-yield market, but talking in broad terms, we still like loans, finding opportunity in investment-grade or in the high-yield market. jonathan: jim keenan is staying with me alongside oksana aronov as well as krishna memani. coming up, the auction block. two of the biggest offerings in 2018. a lot more on that in just a moment. this is "bloomberg real yield." ♪

♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield." we want to head to the auction block. this week, we got the second and

third largest u.s. corporate debt sales of the year. bayer offering a $50 billion sale. it also sold nearly six aliens dollars in a euro bond offering, helping to finance an acquisition of monsanto. they were then topped by walmart , who sold bonds to help fund its acquisition of flip kart. afive alien dollar sale -- -- a $5 billion sale. indirect bidders bought 81%, the largest share they had taken ever for that maturity. still with me is jim keenan, oksana aronov, and krishna memani. oksana, i want to begin with you and talk about what we are seeing in rates. the story with the ecb and the fed, they are worlds apart in terms of their guidance for interest rates.

how do you expect that story to evolve in coming months? oksana: it seems like they are couple years apart. it seems like the ecb is where the fed was a couple years ago in terms of guiding toward the end of its bond purchasing program. it looks like the end of the program is on track to the end of the year, over 8 trillion dollars in negative yielding debt. it is unclear where the demand for those bonds will come from. we got a taste of that here in the u.s. and the fed is not even yet in net negative liquidity mode yet. there is a lot of focus, i think too much focus and noise around how many more hikes the fed will do this year, what will happen with the flatness of the yield curve, etc. the most important thing happening in the bond market, with rates right now, is the reduction of the fed's balance sheet. kahuna.the big certainly, the supply-demand

imbalance of that is creating, along with other demand provider stepping away, such as sovereign buyers, russia -- not one of the largest but there was a story this week that they reduced their treasury holdings by $50 billion. china and japan are holding less. banks are becoming less regulated which means they will provide less support for that part of the market. everything from that 10-year in point of the curve will continue to struggle and move higher, not in a straight line, but it's hard to imagine a scenario in which the 10-year goes back to the high 1's. thethan: let's bring in picture she is talking about. basically, quantitative tightening from quantitative easing for several years. you have the fed, boj, and european central bank, and you get to the back half of this year, things get interesting. what are the implications for thatts from essentially point? when the ecb stops buying and the fed's balance sheet rolls off more aggressively? krishna: i think trying to figure out the direction of rates based on just that supply and demand picture, i think, is

not right, for the following reason. at the end of the day, in economic terms, you get to an equilibrium. interest rates are a determinate, but something that comes out of reaching that you -- equilibrium, rather than supply and demand getting you there. what that means is it depends on what your expectations are with respect to the economy. the ecb may not be buying bonds anymore, but the european economy continues to slow down the way it is, then the implications are very different. the same applies for the fed as well. that is, the u.s. economy is accelerating going into the second half. as long as it continues to do that, i think rates probably rise as a result. if that is not the case, things will revert that. -- revert back. jonathan: let me stress tests of that argument. if the ecb was not in the game, do economic conditions exist to justify the german curve to be negative about six years? krishna: ecb is in the game, so that is like saying, if the sun was not there, how would the day look like?

central banks have an enormous influence from a policy standpoint on where rates are. ecb is in play because they want to support the economy. i don't think you can take it out and arrive at some natural rate of interest rates. jonathan: i'm guessing from the way you are sitting, you are more worried about what is happening in europe than krishna is. oksana: yes, and here is why. you cannot discount what the ecb has done. the ecb has created a essentially, a completely artificially priced asset class in europe. the reason that it feels like europe is a couple of years behind the u.s., asset class was guiding us run with to do. the markets were dismissing it, continuing to price based on the sentiment that the fed would back off. that is what's happening in europe. i just spent a week with investors in europe, and that is

the sense you get. investors are generally discounting for now that the ecb will really end this bond buying program by the end of the year and move toward normalization. i think once that sentiment is even out, starts to move out, you'll see significant movement. what are rates, academically speaking? the short-term rate plus the rate of inflation, plus the rate -- plus some sort of long-term premium. in europe, that does not even get us to a -30 rate on the german five-year. jonathan: jim, away from rates in europe and toward high-yield, if it is hard to justify economically speaking on its own, what is happening with german rates, even harder to say what is happening in the corporate bond market in europe. you get the feeling that it is in a bit of trouble going into next year. when you get the handoff from the ecb, for the fundamentals, it is hard to justify where

high-yield europe has been viewed -- has been. i may take a different position. with quantitative tightening versus easing, this is a global picture. no doubt coming out of the commodity cycle where you had enormous stimulus coming into the market, the business cycle maturing, central banks are starting to remove policy, and you are seeing tightening. i think that policy is becoming far more localized than in the past 10 years, so you will see variations of asset prices and returns between regions. but there is no doubt when you look at the economic picture in europe, there is more volatility. it is not as stable as what you see in the u.s. you don't have the same kind of backdrop of support from the economic picture right now which is why you still need the central bank to be more accommodating than what you are seeing in the u.s. jonathan: in terms of rates for the ecb, looks like they will be for a long time. you are all sticking with me. the markets. let's get a check on the

treasuries. the two-year yield has been remarkably stable over the last couple of months. around 2.55. unchanged in the week. the 30 year yield coming up a basis point. the 10 year coming in a basis point. not a lot of action considering the news we have had the past few weeks. still ahead, the final spread, elections in turkey and mexico. em is next. this is "bloomberg real yield." ♪

♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield." time for the final spread. coming up over the next week, this weekend, we get the elections in turkey. next weekend, we have the mexican election as well. plus, another round of u.s. economic data and the second leg of the u.s. bank stress tests. also, closely watched seven-year treasury auctions. still with me is jim keenan, oksana aronov, and krishna memani.

i just want to wrap up with some em goingoughts on in -- into the mexican election. are you still positive on emerging markets? krishna: yes. we have been positive and wrong but we are sticking with that position. the underlying piece was driven by the fact that economic growth in emerging markets is relatively stable and the dollar cannot strengthen. what has happened is the dollar has strengthened. i think at some point, the demand for capital to fund the u.s. deficit will bear on the dollar and that will be the turn that we are waiting for. valuations in emerging markets have improved, so we are sticking with that position. jonathan: didn't we see that affects related moved to the deficit last year? are we seeing enough of that? krishna: we were not counting on the budget deal last year. the deficit picture has certainly deteriorated.

in that environment, for the dollar to strengthen meaningfully and sustain itself, i think, is unlikely. jonathan: oksana reminds me, negative and right on emerging markets. what is next? oksana: all the reasons remain for why we were negative going into 2018, the fed normalizing, all of the protectionism around the world, stronger dollar. none of these things will be constructive for e.m. at these prices particularly. when i hear, as was said, that there is still positive sentiment around e.m., i struggle to understand what kind of price appreciation you can get from a better pricing of 290 basis points over treasuries? fundamentals are strong in many parts of the market, we don't argue with that. it is just hard to understand where that price appreciation will come from as the fed continues to tighten and do all the things it is doing, and protectionism continues to roll around the world. my final point on that, we have

not yet seen technicals really hurt that part of the market. we have not seen a significant amount of outflows. technicals can do very bad things to the market, as we learned with high-yield in 2015 and 2016. fundamentals were limited to the energy part of the market but everything fell out of bed. that has not happened yet. krishna: when we say we like e.m., it is e.m. fx and local rates, not credit spreads. just to be clear. jonathan: to wrap things up, a quick three questions. really short answers if you can. you know how this works. first question, have we seen the tight of the year in u.s. investment grade? jim: no. oksana: no. krishna: no. jonathan: have we seen the wide bunds?year jim: no. oksana: no. krishna: no.

jonathan: world cup winner. e.m. or dm? jim: not the united states. oksana: do i really have to? jonathan: indulge me. oksana: i will go with the e.m.. krishna: e.m. jonathan: trying to ask americans about football. jim keenan, krishna memani, oksana aronov. i'm not doing that again. that does it for us from new york. we will see you next friday at 1:00 p.m. new york time. this was "bloomberg real yield." this is bloomberg tv. ♪

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♪ manus: you're watching "best of bloomberg daybreak: middle east." the major stories driving the headlines from the region this week. opec on a knife edge, speculation about output cuts swirled as ministers gathered for the crucial meeting in vienna. welcome to the club. saudi arabia wins the coveted emerging markets status from msci, billions of dollars are now set to flow into the kingdom. trade tensions kick up another notch as president trump threatens to slap tariffs on a further $200 billion worth of chinese goods. first up, as opec ministers