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. rates and a, and heights on yields. emerging-market assets are facing down when of the worst quarters and almost three years. just 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 right now. >> we are the one strong island performing well, and the rest of global growth is slipping. within the u.s. 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. when you think about it you can him at health of the u.s., still very strong. the consumer remains strong. >> the u.s., ultimately, 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 pretty broadly and the u.s. high-yield bond market. even though people continue to say that the economics are solid. >> it depends. if this trade battle gets out of control, which i do not think it will -- i think there will be a resolution -- that if a mistake is made and you are playing a very high-stakes game right now, if a mistake is made that it will get very ugly for market. jonathan: joining me around the table is priya misra, head of

global rates strategy at td securities, bob miller from blackrock fixed income, and coming to us from texas, mark al qaeda, co-cio of howland capital management. thank you for joining us. talk about the concept of decoupling, whether the united states can do that and whether that is what we are seeing. --mark okada. >> 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. the 10 year german yield is up 30 basis points, that is great. the spread can only widen so much. i think the front end can somewhat decouple, because the u.s. economy is pretty strong, inflation is at target, the unemployment rate continues to decline, i think that is where we are seeing a continued flattening of the curve. i'm skeptical that the u.s. can continue to grow. i think we have had a significant sugar high from tax cuts and as that continues to fade, we will see growth

momentum to pick up. jonathan: one pocket of credit and fixed income that captures the story bob, is high-yield. you see this in em, asia, europe, versus the united states. high-yield is cracking pretty much everywhere. with the exception of u.s. high-yield. what does the chart look like as we go through the rest the year, bob? bob: it is important to look at the composition of the high-yield market. the higher quality, more rate sensitive, shorter duration part of the market has struggled this year more than the rate sensitive fixed income. the higher risk less rate sensitive 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 the growth sensitive hearts of the market, they do ok, much like the growth sensitive parts of the stock market do ok.

until we have a legitimate risk for decelerating growth. jonathan: that is a really good point. to build on that, mark okada, the duration story that bob wide-out out, and the other two story is issuance. we are seeing big issuance this week to the high-yield. and lastly, the cyclical backdrop has been supported. is the issuance story taking a bite out of high-yield? is that what you see, mark? mark: i think we certainly could see that. we could see an increase in issuance across the m&a spectrum that starts to heat up. remember, it takes time for these deals to come together. we had a big pause coming into february, so i think we will probably see some better issuance in the second half. given the technicals, we have had 33 weeks of outflows in how yields, and 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? leveraged loans or high-yield? bob: tricky question. the loan market has been a good place to hide. i think the front end, as you know, we think the front end of the yield curve in general offers a margin of safety now that it has an offered in the past. specifically 2.5% two-year notes that strikes us as reasonably fair. the loan market, we are definitely 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, an easier switch to be made, we think. 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 much of 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 took a look at spread versus turn of leverage, and surprisingly, even with the compression we have seen across leveraged loans, there are 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 has tightened a lot. and then, as bob mentioned, we've got the great dynamic that has been helpful, and will continue to be helpful. if you look at the expectations for a hike in september and december -- i think our call for four hikes this year's certainly in play.

as that continues, i see the relative dynamics to be fairly good. and lastly, 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. so i like loans versus high-yield, and i think they will continue with that. jonathan: there is a lot of demand for floating rate. maybe that sort of brings in bob's point, where we are seeing some of the underwriting standards deteriorate, because there were so much demand. again and again i am told that you are high on the cap structure, but you are only higher up on the cap structure if there's something below you. a lot of loans come into market. leveraged loans and actually don't have anything else 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 distributors had missed their numbers badly, they lost some key customers. those bonds went down 80 points in two months. the loans are down 40 points. so nothing is going to be immune

in the scale and size of this market, to the extent that you miss it or something bad happens. i think it is not a function of looking at leveraged loans versus high yields, again, it is a function of knowing what you own and what you don't own. this is the market where we have said over and over again that you need to be defensive. you need to pick your spots, try to avoid things like this, because when they do happen -- you are talking, these bonds and the loans were 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 is big story, but it is not the other one out there. we had toys "r" us in september, completely rolling over. we have the illusion things are kind of ok. bob, when you look at things at the moment, is this a market that is adequately pricing in risk? bob: we are definitely

experiencing a tightening of domestic financial conditions to my and it is going to continue, but it is highly unlikely that the feds are going to hold back anytime soon. they will likely meet expectations in september as others perhaps in december. but 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. i'm going to dig into this in a couple of minutes. priya: i was just going to add come i think that risk premium generally is rising. liquidity is not that great, that is the environment we are in. this is why, the point that was made, that you have to pick your spots, it becomes extremely important. because when we had cash leading zero, there was a rising tide that lifted every boat, and that is gone. i completely agree with bob. i think as the financial conditions are tightening, you have to be careful what you own. when everyone is rushing for the exit, it is not obvious that liquidity provide is out there. jonathan: priya misra along with

bob miller and mark okada from highland capital management. coming up, the auction block. they may be chewing on the world cup in russia, but the country posted the biggest bond miss since 2015. that conversation up next. this is "bloomberg real yield." ♪ ♪ jonathan: i'm jonathan ferro.

jonathan: i'm jonathan ferro. this is "bloomberg real yield." i want to head to the auction block now, where more than $240 billion of treasuries were offered this week. i want to focus on the $30 billion sale of seven-year know it's can mother had the lowest yield in three months, when they beat the cover ratio of 2.3, 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. the sale posted a bid-cover ratio which was the lowest in

almost a year. even with the yield on 5-year bond's, there are the highest in the eurozone. and 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. that is the worst result 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, which is basically -- fold the big long, book your trade, book your profit. i have seen a call from a morgan stanley, which effectively issued a 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. i am not sure if it is for a while. at 2.85, i think 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 great, personal consumption expenditures price index is at target, and i think the -- personal consumption expenditures price index is at target. 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 the moment we get above 3%, the 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 incredibly ahead of the curve on this. looking at the front and of the curve, a big push higher, and how things would rotate out of elsewhere in into the front and. have we seen the bulk of that play out yet? bob: no, we are actually 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. but the marginal dollar has started to become attracted in the front of the yield curve, which in short and businesses as well as the float into our funds, we're seeing it. jonathan: we were looking at charts during the commercial break and hopefully we can put one of them up. it is the performance of various asset classes in 2018 so far. you jumped on the one chart that pointed out, that 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 ones that are most sensitive to the withdrawal of very accommodative financial conditions in the u.s. specifically, but globally to some extent. the most duration-sensitive the highest quality assets, have actually suffer the most. some of those are trading -- i think there are two places where there is a reasonable margin of safety. one is at 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, the margin of safety. it probably will.

nonetheless, it is priced for it. you have a modest margin of safety. secondly, another topic from earlier, 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. right? that is a very unusual relationship, so it strikes me that there is some value there. you know, it is also in the crosshairs of trade wars, of china deceleration, of the u.s. tightening financial conditions. there are challenges, but it is

now priced to some degree for those 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. so many people come on this program and are still bullish on emerging markets. mark, where do you stand on things in a moment? mark: i think it is too early to call all safe, i think 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 refinancing risk on the bond market there. and to bob's point, it 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 everywhere you look, and this trade has been very popular. what i read and see for most people is they like em. they are still leaning into it, there are still seeing that it is cheap. to the extent that that is not the case, and we get more fundamental weakness in outflows, i think it is too early to call the all clear there. priya: as long as yield rates

keep rising, the u.s. 10 year yield rate is closer to 10%, that is a big headwind for em. the biggest macro for the next few months is how does european data improve? we were all waiting for the second quarter improvement in european rates, first quarter weakness was supposed to be easter, while, easter is long gone. we have not seen that improvement. if 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 she nailed u.s. yield rate this year. can you walk us through what you expect to see? priya: as the fed ended qe, the 10 year yield rates rose significantly as the fed continue to hike. but, i don't get the sense that productivity is picking up. so my sense of what equilibrium real rates the economy can actually handle, or risk assets can actually handle, that has not really changed. despite all the positive data. i think 10-year real rates will be kept around 1%. every time they get close to that point, i trade long. take it off at 60 basis points, that is how i have been trading at all year. 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. 2's, 10's and 30's shipping up as follows. 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 is coming up shortly. still ahead, the finals ride. -- the final spread. the week ahead featuring the mexican election and the payrolls report and of course, some 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 over the weekend. 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 markets closed on wednesday. plus, we will get the fed minutes, the u.s. jobs report and the scheduled start of u.s. tariffs on $34 billion of chinese goods. still with me, priya misra of td securities, bob miller from blackrock, mark okada of highland capital management, joining us in dallas, texas. good to have you with me. let's start with you, priya. a question i have asked through the week, is whether we have been through 30 basis points on the twos, tens and 10 years in treasuries, ever before. and not inverted. 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. my question essentially, army in the mid-1990's-type scenario, or army in the 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. because the fed is saying, look, we have to tighten, but they were not really changing the long-term rate. the other one is is global rates. they are still extremely low. draghi pulled out the impossible. he ended qe, and it was still extremely dovish. i would say that the forecast has that curve continue to zero. as the fed continues to hike but global growth doesn't really search. bob: the level of rates in the 1990's was considerably higher. i think that is important. the front end is most influenced by domestic purposes or domestic factors, but as priya mentioned earlier, the long end term structure, term premium, is very correlated. so the efforts of the ecb, boj, etc., to suppress yields and keep the structure very low has a gravitational pull on the long and here. so i think the curve is going to stay flatter longer than i originally thought, even though i think the front and offers a reasonable margin of safety

here. 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 in the foreign central banks. jonathan: i think that's a good point. i think the majority of our viewers would agree with that as well. marx, does that resonate with you too? 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. we certainly called the front end of the curve. so i would guess, i am sticking with the call. i am not sure that we continue to flatten, but certainly, i am getting more concerned. as we think about the trade dynamic, and what we are seeing from the global growth standpoint, the inability to decouple we mentioned, you have got to certainly get a little bit worried about that. however, long-term, i believe that we are normalizing across

the board from a monetary policy standpoint. and that means higher, higher. jonathan: i'm going to put you in the boxes and we are going to do the quick rapid fire round, where ask you some quick questions, and hopefully, you give me some decent answers. keep it very, very 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, bob, but you are on the spot now. come on. 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 going to be bearish for the payrolls report? if you don't get the presidential preview, are you bearish the payrolls report? priya: no. i think he has been told not to tweet, but no.

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, 6:00 p.m in london. this was "bloomberg real yield"" this is bloomberg tv. ♪

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