jonathan: from new york city, i'm jonathan ferro. this is 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, wrapping up the first half with treasury bears closing gaps. emerging-market assets facing one of the worst quarters in almost three years. how safe is the new safety trade? investors flocking toward leveraged loans. we begin with a big issue. can u.s. markets decouple from the rest of the world? >> the u.s. looks like a better place to be than the rest of the world. >> we are like one strong island performing well, and the rest of

global growth is slipping. the economy continues to do well. it could be isolated as long as the shocks are not massive. >> we are looking at economy that is driven by the consumer. thinking about u.s. economic health, the consumer remain strong. >> the u.s. will not be able to decouple. it is part of the global economy. even president trump will work that out. >> you are starting to see weakening probably in the u.s. high-yield bond market, even though people continue to say that the economics are solid. >> if this trade battle gets out of control, which i do not think it well. i think there will be a resolution. but if a mistake is made, and you are playing very high-stakes right now -- if a mistake is made, then this is going to get ugly for markets. jonathan: joining me around the table is priya misra, head of global rates strategy at td securities, bob miller from

blackrock, and from texas, mark okada of highland capital management. talk about the concept of decoupling, whether the united states can do that and whether that is what we are seeing. priya: i think growth can somewhat decouple. equity markets don't really decouple. the long ends of the bonds don't decouple. global bond yields are declining. germany is at 30 basis points. the spread can only widen so much. i think the front end can't -- can somewhat decouple, because the u.s. economy is pretty strong, inflation is a target, underemployment rate continues to decline. i think that's why we will see a continued flattening of the curve. i'm skeptical that the u.s. can continue to grow. we had a significant sugar high from tax cuts. we do need for growth momentum to pick up.

jonathan: one pocket of credit and fixed income that captures the story is high yield. you see this in em, asia, europe, versus the united states. high-yield is cracking everywhere. what does this chart look like as we go through the rest of the year? bob: it is important to look at the composition of the high-yield market. the higher quality, more rate sensitive part of the market has struggled this year alongside more rate sensitive fixed income. the higher risk, triple c part of the market has done pretty well. returns between the quality and rate sensitivity of high-yield, our expectation is that that

probably continues in the second half of the year in growth sensitive parts of the market, they do ok, much like the growth sensitive parts of the stock market do ok into we have a legitimate risk of decelerating growth. jonathan: that is a really good point. to build on that, mark okada, the duration story that points out, the other is issuance. we are seeing big issuance this week to the high-yield. the cyclical backdroup has been supported. is the issuance story taking a bite out of high-yield? mark: i think we certainly could see that. we could see an increase in issuance across the m&a spectrum as it starts to heat up. it takes time for the deals to come together. we had a big pause in february. we will see better issuance in the second half. given the technicals, 33 weeks of outflows in high yields, that could lead to a bit of widening. jonathan: a conversation i have with a lot of people is the difference between high-yield and leveraged loans in the

united states. where is blackrock on the debate right now? bob: tricky question. the loan market has been a good place to hide. the front end, we think the front end of the yield curve in general offers a margin of safety now that it has not in the past, specifically 2.5% two-year notes seem fair. the loan market, we are witnessing a deterioration in underwriting standards throughout the market over the past quarter or so. relative to the high-yield market, i think that is a trickier trade. i would rather talk about what we are going to talk about next. which is em hard currency, and easier switch. relative to loans and/or high-yield. i don't have a strong opinion about the relative valuation of loans to high-yield at this juncture. jonathan: i know, mark, that you do. it has been your big trade in 2018, loans over high-yield. why does it still play out,

mark? mark: i think it is a function of the actual fundamentals and what you are getting paid for them. we looked at spread versus turn of leverage. surprisingly, even with the compression we have seen across leveraged loans, still 73 basis points wide to what you have seen in the high-yield market. from the fundamental standpoint, they are cheap, although it certainly tightened a lot. as bob mentioned, we've got the great dynamic that has been helpful, and will continue to be helpful. you look at the expectations for the hike in september and december. i think our call for four hikes this year is in play. as that continues, i see the relative dynamics to be fairly good. and technicals are going to be

good in this space. we don't have enough issuance. there is a lot of demand for the floating rate as people want to play defense. i like loans versus high-yield. jonathan: there is a lot of demand for floating rate. maybe that is why we have seen some of the underwriting standards deteriorate, because there is so much demand. again and again i am told that this is secure, hire up on the cap structure, you are only higher up on the cap structure if there is something below you. a lot of loans come into market. leverage loans that don't have anything below them. how difficult is it to dissect the market at the moment and pick the right things? mark: we have had a recent story here that is interesting. american tire just missed their numbers badly. they lost key customers. those bonds went down 80 points in two months. the loans are down 40 point. nothing is going to be immune in the scale and size of the

market, to the extent that you miss numbers and something bad happens. think it is not a function of looking at leveraged loans versus high yields. it is a function of knowing when -- knowing what you own and don't. this is the market where we have said over and over again that you need to be defensive. you need to take your spot, and avoid things like this, because when they do happen -- the bonds and the loans were at a premium in the beginning of the year. you are down 80 and 40 points in both tranches. jonathan: you bring up an important single story. that's not the only one, we had toys "r" us in september, completely rolling over. we have the illusion things are kind of ok. would you look at things at the moment -- is this market adequately pricing in risk? bob: the market has -- we're definitely experiencing a tightening of domestic financial conditions, and it is going to continue. it is highly unlikely that the fed will pull back anytime soon. they will meet expectations in

september as well as perhaps in december. global financial conditions are tightening, and u.s. financial conditions are tightening. it will create eventually post-fiscal stimulus, growth pressure, and that is when you will see some of the cracks show up in more leveraged markets. jonathan: you sound a little more defensive. priya: i was just going to add risk premium generally is rising. we are in an environment where liquidity is not that great. this is why, the point that was meant that you have to pick your spot, it is extremely important. there was a rising tide that lifted every boat. that is gone. i completely agree with bob. i think as the financial conditions are tightening, you have to be careful what you own. everyone is rushing for the exit, it is not obvious that the liquidity provider is out there. jonathan: priya misra along with bob miller and mark okada. coming up, the auction block. they may be chewing on the world

cup in russia, the country posted the biggest bond miss since 2015. that conversation up next. this is "bloomberg real yield." ♪ ♪

jonathan: i'm jonathan ferro. this is "bloomberg real yield." we want to head to the auction block, where more than $240 billion of treasuries were offered this week. i want to focus on the $30 billion sale of seven-year notes, at the lowest yield in three months, with a ratio weaker than the last seven-year note sale. meanwhile, in italy, the country had its first auction of five and 10 year debt since the new

populist coalition took office. it was the lowest in a year, even with the yield on five-year bonds that are high on the eurozone. in russia, the country is on track for its biggest bond issuance in years. it sold half of the seven billion dollars it wanted to borrow this quarter. it is the worst results since 2015. still with me around the table, priya misra, bob miller, and joining us from dallas, texas, is mark okada. let's get to the story of treasuries so far this year. we have seen the call from goldman sachs. basically, fold the big long, book your trade, book your profit. you have seen the high on the u.s. 10-year. it takes me back to a question i will ask continuously, whether you think we have seen the high of the u.s. 10 year. priya: high for the next few months probably.

at 285 we are pricing in some of the risks. the u.s. economy is still pretty robust. when was the last time the fed chair said the economy was great? jonathan: it has been a while. priya: we have heard the economy is good. i think the fed will continue to hike. where i get nervous is when they go above neutral. 2% on the funds rate, financial conditions have not tightened that much. rates will continue to rise a little bit. i think money comes out of risk assets. into essentially treasuries. that's ultimately what cap's it. jonathan: we have seen that the instructor march are ready. you guys at blackrock have been ahead of the curve on this. the big push higher, and how things would rotate out of elsewhere and into the front end. have we seen the bulk of that play out yet? bob: we are in the early innings of the marginal unit of capital coming into the front end of the yield curve relative to where it

has been allocated over the past several years. the bulk of capital that sits in longer-duration assets, much of it is for regulatory purposes, and it is not going to switch into the front end. the marginal dollar has started to become attractive in the front end of the yield curve. in short and businesses as well as the flow into our funds. jonathan: we were looking at charts during the commercial break and hopefully we can put one of them up. performance of various asset classes in 2018 so far. you jumped on the one chart that pointed out it has been a duration story across much of the price action we have seen year to date. can you explain what we are seeing? bob: this goes back to the point we made at the beginning of the show, the assets that have performed the worst year-to-date, are the most sensitive to the withdrawal of very accommodative financial conditions in the u.s. specifically, but globally to some extent.

some of those are trading -- i think there are two places where there is the reasonable margin of safety. one is the front end of the treasury curve. you have an incremental 75 basis points of tightening priced into the front end of the curve. you have a margin and the fed may meet that expectation, it may not. it probably will. nonetheless, it is priced for it. you have a modest margin of safety. another is hard currency em. this stuff is down a lot. arguably, there is a margin of safety there that the hard currency spreads are above the high-yield spreads in the u.s. that is a very unusual relationship. it strikes me that there is value there. it is also in the crosshairs of trade worse, u.s. tightening financial conditions. there are challenges, but it is priced to some degree for the challenges. relative to a bunch of other

asset classes that really don't have meaningful margins of safety. jonathan: let's talk about emerging markets. i'm not sure we have seen capitulation yet. some leaning people come on the program and are -- summary people come on the program and are still bullish on emerging markets. where do you stand on things in the moment? mark: i think it is too early to call. if the dollar continues to get stronger, which is certainly something we did not call for the year, that will put a lot more pressure. you have a lot of emerging risk in the bond market there. i think bob is spot on that is repriced dramatically wider. it is a continuation of the theme about how technicals are driving fundamentals. there is an overpowering fundamental wherever you look. this trade has been very popular. what i read and see for most people is they like em. they are still leaning into it and still say it is cheap.

to the extent that that is not the case can we get more fundamental weakness and outflows, i think it is too early to call the all clear there. priya: as long as real rates keep rising, ust near real rates closer to 1%, it is a big headwind for em. the biggest macro for the next few months is how does european data improve? first quarter weakness was supposed to be easter. easter is long gone. we have not seen that improvement. if that doesn't happen and the dollar continues to strengthen, why put money in em? jonathan: i mentioned to someone that you were coming in the program, and they said that priya misra nailed this this year. priya: as the fed ended qe, the rates most significantly. i don't get the sense that productivity is picking up. my sense of what equilibrium real rates that the economy can handle, or risk assets can handle, has not really changed, despite all of the positive data. i think 10-year real rates will be cap around 1%.

every time they get close to that point, i trade long. jonathan: priya misra great to have you with us. alongside robert miller from blackrock and mark okada of highland capital management. let's get a market check on treasuries. yields lower on the two-year by about two basis points. the 10 year coming in six. the 30 year coming eight. the shape of the curve a little flatter. that conversation coming up shortly. the final spread. the week ahead featuring the mexican election and the payrolls report and of course, fireworks in the united states of america. this is "bloomberg real yield." ♪ jonathan: i'm jonathan ferro.

this is "bloomberg real yield." it is time for the final spread. coming up over the next week, mexico will be holding its presidential election. it will be a shortened trading week in the united states due to the fourth of july holiday with an early close of trading on tuesday and market close on wednesday. we will get fed minutes, the u.s. jobs report and the scheduled start of u.s. tariffs on $34 billion of chinese goods. so with me, priya misra of td securities, bob miller from blackrock, mark okada of highland securities in dallas, -- highland capital management in dallas, texas. good to have you with me. you, priya.iwtwith a question i have asked through the week, whether we have been through 30 basis points ever before and not inverted, and the response i got was that we did. it was in the mid-1990's where we breached that level of 30 basis points and then came back, and the cycle continued. are we in a mid-1990's-type scenario, or late 1990's-type scenario looking at the treasury curve? priya: two things to that.

we are not seeing a pickup in productivity. if the fed continues to hike and goes above neutral, that curve will continue to flatten and invert. the fed is saying, we have to tighten, but they are not changing the long-term rate. the other one is is global rates. dovish. extremely draghi pulled out the impossible. i would say that the forecast has that curve continue to zero. as the fed continues to hike but global growth doesn't really budge. bob: the level of rates in the 1990's was considerably higher. that is important. the front end is most influenced by domestic purposes. or domestic factors. as priya mentioned earlier, the long end term structure, term premium, is very correlated. the efforts of the ecb, boj, etc., to suppress real yields and keep the structure very low has a gravitational pull. the curve is going to stay flatter than i originally thought, even though i think the

front end offers a regional safety. i'm not sure that the 30-basis point curve today is sending a signal sent in the mid-1990's at a different rate structure with much less activism. jonathan: i think that's a good point. i think the majority of our viewers would agree with that as well. does that resonate with you? mark: i give myself the grade for calls of the year coming into january, this is an area where i give myself b or b-, because we did not think the curve what flatten this way. i am sticking with the call. i'm not sure that we continue to flatten. i'm getting more concerned. as we think about the tray dynamic and what we are seeing from the global growth standpoint, the inability to decouple we mentioned, you have got to be a little bit worried about that. however, long-term, i believe that we are normalizing across

the board from a monetary policy standpoint. that means higher. jonathan: i'm going to put you in the boxes and we are going to do the rapidfire round. i will ask you some quick questions. hopefully you will give me decent answers. keep it short. have we seen the high of the u.s. 10-year yield for 2018? priya: yes. bob: no. mark: no. jonathan: leveraged loans or u.s. high-yield into year-end? priya: leveraged loans. jonathan: i know you didn't want to answer this. you are on the spot now. bob: loans. mark: loans, they're both right. jonathan: come on. [laughter] jonathan: 7:21 next friday ahead of payrolls, if there isn't a presidential tweet, are you run -- going to be bearish for the payrolls report?

priya: no. i think he has been told not to tweet. bob: no. mark: same. jonathan: guys, where's the fun with this? [laughter] it has been great to catch up with you. that does it for us. we will see you at 1:00 p.m. next friday new york time. this was "bloomberg real yield"" this is bloomberg tv. ♪

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