♪ jonathan: from new york city, this is 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, the fed determines to keep hiking, sending two year treasury yields to 10 year highs. a booming leveraged loan market getting bigger, overtaking high-yield debt. and italian bonds ending the week on a better note. the eu striking a conciliatory tone. we begin with investors on edge. >> it is not a fantastic world out there. >> the market is vulnerable. >> you are seeing stocks and bonds act differently than they have in the past.

>> it is hard to be too optimistic at this point. >> investors got too complacent, they thought nothing could go wrong. >> the sugar high from the fiscal stimulus will absolutely fade. >> we fell in love wrongly with the notion of a synchronized to government in global growth. >> as long as credit is hanging in there, it looks like more of a technical equity correction. our thinking is we have not seen the top yet in this cycle. >> bonds are no longer that anchor to windward. if rates are moving up, that's a significant headwind that investors have not faced in decades. jonathan: joining me around the table is guy lebas, from janney montgomery scott, kathy jones, from the schwab center for financial research, and from illinois, matt freund, head of fixed income strategies at calamos investments. let's begin with you, kathy. there is an idea that has captured the attention of a lot

of people, the fed will keep going until something breaks. is that where this is going? kathy: that is what usually happens, so it is a realistic expectation. i would say we are already starting to see things maybe not break but crack a little bit. emerging markets have already come under a lot of pressure. eventually, if they continue to hike at a steady pace, we will see some other markets come under pressure. that being said, i'm not 100% convinced they will go as high on the fed funds rate as they are projecting. guy: not only are emerging markets cracking around the edges but you see some economic conditions also starting to be influenced by higher rates. my favorite example is auto sales deteriorating. we shifted the culture from a buying a $30,000 car to a $400 monthly payment. as rates have risen, financing costs have increased, so the appearance of inflation is a slow in sales. you see that at the edges.

what you have to keep in mind is we are seeing 2017 rate hikes influence auto sales today. we have not seen the effects of 2018. jonathan: should housing be a concern? guy: housing has become much more smaller as a portion of the u.s. economy. in the early 2000 it was driving 25% of economic growth. even two years ago, much smaller. i think 6%-10% of economic growth. slowdown will not be as broad. jonathan: the federal reserve is showing us that they are concerned more about financial stability. you can keep hiking because you are afraid of bubbles but then you can cause financial stability issues elsewhere in the economy. are they doing the right thing with this approach? matt: yes, they are absolutely doing the right thing today. the question is, will these actions will be right tomorrow. it really comes down to financial conditions in the neutral rate.

most people are talking about the neutral rate as if it is stable, but it is not. it's very hard to measure and it changes over time. it is our belief the neutral rate today has been raised temporarily by things like the stimulus bill with the new tax bill, what central banks are doing. the problem is, as the impacts fade, kathy got it right. as those impacts fade, the market will react differently to fed hikes in the future. we see a couple more hikes, two or three, but if those influences fade, we think the market will become much more concerned, even with the same type of hiking. jonathan: kathy, looking at the front end of the treasury curve, 2.90 on the 10 year. where you see this peaking? kathy: we are looking at a peak in short rates around the 3% area. we think the fed will get close to 3%. we see the curve flattening out.

now, 10 years above 3%, most of the rate hikes that we expect are already priced in, so i don't think we will see much lift at the longer end of the curve. jonathan: more steepening coming through the last few weeks, the trend is for a flatter curve, the spread between 2's and 10's. where do you see this going? guy: flatter. how long it takes is a different question. from roughly 100 basis points down to 30 basis points, 2/10 spread, the way that curve flattening trades work, there is a lot of profit in that. as we get to a flatter curve, and particularly higher rates, that flattening trade becomes a negative carry trade. so you tend to have fewer of the technical factors to drive rates flatter. it has to be more about concrete, measurable changes in economic conditions such as slowing inflation.

that really drives that last 30 basis points. jonathan: inflation has been absent in this treasury selloff. breakeven rates have not accelerated. you see in going the other way, kathy? kathy: going down? i think it will. it is very tough because the fed was under the 2% inflation target for so many years. i think they would love to see inflation above the target for a couple years to make sure it is symmetric. but i don't think that will happen. we are starting to see those numbers roll over on the inflation front. i am guessing this 2% is the upper end. jonathan: i'm wondering if the water is safe over in emerging markets to get back in. is it? matt: emerging markets are really hard to handicap today. i think the combination of the dollar, it is notoriously hard to forecast, and what we see with energy really is putting emerging markets in the spotlight. we think there are some emerging markets that we like very much.

certainly mexico, latin america, and our emerging-market team is very positive on china, despite the slowing. that being said, we generally prefer emerging-market equities to emerging-market debt. jonathan: let's talk about the debt. china decelerating. kathy, pointed out in the past, 20% of the dollar e.m. index is chinese bonds. it's a big deal. kathy: it is a big deal. a huge change from where we were five or six years ago. given the lack of transparency, the slowdown in china, cracked down on excessive credit growth, it is really hard to get very positive on e.m. jonathan: deceleration, clearly it has been captured by the price. could it get worse, is this an opportunity? guy: i think we have gotten through the dramatic headlines of the e.m. breakdown, really in august. you cannot talk about this without bringing turkey up. what is remarkable about that

situation, though there were a great deal of worries, not a lot of evidence of contagion. those risks did not spread so dramatically with the exception of one or two other current account deficit issues. as a result, i have more confidence in the sector today than i did in august. you cannot deny the pricings are a good deal more attractive. on a relative value basis, e.m. debt, selective debt looks attractive. kathy: the spreads have widened somewhat, but not to the point where we would be really eager to jump in. i would rather see 400 over the spread and what we see today. jonathan: let's bring down the getting back into e.m. what are you looking at? guy: the sovereign sector is one that is more appealing. many of the political pressures in lat-am, i think a lot of

those concerns are overblown. on the margin, non-china southeast asia. jonathan: great to have you with us. you are going to stick with us. coming up on the program, the auction block. uber's first ever bond offering. demand was so strong it had to boost the size of the sale. that conversation on high yield and leveraged loans coming up. this is bloomberg. ♪

♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield." i want to head to the auction block, the u.s. treasury continues to swell its issuance. the $25 billion auction drawing

a yield of 2.17% with a bid to cover ratio of 3.13. amid the political turmoil, turkey attracted over $6 billion in bids in a sale of dollar bonds. the government offering a yield of 7.5%. in corporate, uber increased the size of its bond offering as orders swelled. it included $1.5 billion of eight-year notes and $500 million of five-years. still with me, guy lebas and kathy jones. matt freund is also here. matt, is this uber deal going to start looking a lot like that tesla deal from 12 months ago? matt: i don't think so. the uber deal, as you described, there is a large equity cushion below it. it was priced very well and placed very well.

we have seen the bonds outperform over the last couple of days. we think the uber story -- we like it from an equity side, and the risk reward, but there is a lot of solid and positive fundamentals there, especially on the shorter piece. jonathan: is another example the equity like attractiveness being captured in the debt market when it should not be? kathy: we are seeing people on the fixed income side take equity-like bets in the market, and that is usually a late cycle phenomenon. consider the duration of the bonds in the high-yield space. that is a fairly equity like investment. jonathan: i cannot tell you what will happen to uber in five years, eight years. 7.5%, 8%, does that get it done for you? guy: on a nominal basis, sure. looks great in today's market but i don't have familiarity with uber financials. in fact, it is a very narrow group that actually do.

kathy and i were talking about that during the break. i can't say with confidence. jonathan: high-yield press are about as tight as they are going to get? guy: i think so. late cycle, typically, buyers can expect a high probability of negative returns. at some point, this party ends. jonathan: high-yield u.s.? matt: we think we are clearly bouncing along the bottom. , a story thatu has not been told is how strong the fundamentals in the high-yield market are. the high-yield market today is approximately the same size it was three years ago. i think the other panelists are right, there has been some inappropriate risk making it into the market in the last couple months, but for the most part the underwriting discipline has been really solid. in fact, the problem is supply is down.

when you look at high-yield, we view it -- there is some concern about poor covenants, some underwriting standards getting stretched, but we are much more concerned about what is going on in the triple b space in the ig market, parts of the loan market, than we are in the high-yield market, where fundamentals are good. jonathan: you are pointing out supplies. jpmorgan pointing out that the supply of high yield on corporate is the smallest since 2009. of course, very different from 2018. the loan story, leveraged loans this week in the u.s., overtaking u.s. high-yield. that is where all the demand has been. huge demand in loans. have you been behind that demand? kathy: we have been in favor of a floating rate market on leveraged loans. we are concerned about the credit quality. particularly as things have gone forward over the last year. but it is where the demand is, everyone wants to be short duration, and they want yield.

a lot of deals are just not making sense. jonathan: i understand why people are buying into this market because the returns have been so good. as my colleagues point out, it is the junkiest part of high-yield loans that have generated some of the best returns. guy: that is what you would expect on a fundamental basis. really my concern in that sector is twofold. number one is the way in which it's being sold to some retail investors. that sounds an awful lot like -- it sounds awful lot like about what we heard in 2006, 2007. the second piece that concerns me is the growth in this market means, on average, credit quality has been deteriorating, so in the next downturn, it's likely to be more severe. if we are selling these and structuring these, lending on, this sector did well

fundamentally during the global financial crisis, we are structuring the sector to the last problem, not to the next one. jonathan: that is the view of a lot of people. recovery rates were so good last time around relative to the other things, is it going to be different? matt: i wish i could disagree with the panelists. i think they are right, when you talk about broad sectors, broad parts to the market, we think that if investors are not paying attention to the risks, they'll be disappointed. what i push back to is that we are really finding select opportunities in high-yield and loans and in ig credit. while i would not say all loans are cheap, or all high-yield is cheap, i think there are still some really attractive opportunities that we are taking advantage of. it is making sure you are being well paid for the risks you are taking.

that is great for active management. jonathan: let's talk about that. in investment grade, there are some areas that have been attractive. what have you been looking at, what have you been picking up? matt: within the investment grade part of the market, we were really looking to go up in quality. we do like bbb's. the conagra deal we thought was attractively priced. energy names were beaten up, in mlp's energy service has a long way to go. for the most part, the pickup that you are getting over higher-quality corporates, cmbs, is now getting tighten up where we are looking for things to go up in the ig space specifically. kathy: i would agree with matt on that. up in quality is where you need to go in credit this year, up in liquidity. if you look at the leveraged

loan area, liquidity is a concern. bigger issues, up in quality, we think you can earn the coupon and probably have a decent return. but nothing to write home about. jonathan: kathy jones sticking with me alongside guy lebas and matt freund. let's get a market check on bonds. to's tens, 30 year treasury. the picture looks like this. up another six basis points on the u.s. two-year note. stable on the 10-year. 3.20. 2.91 is the yield on the two-year note. still ahead, the final spread and the week ahead, featuring a rate decision from mario draghi and the ecb. that is next. this is bloomberg "real yield." ♪

♪ jonathan: this is bloomberg "real yield." time for the final spread. coming up over the next week, a really busy week of earnings and central-bank rate decisions. the ecb and the bank of canada

with their announcements as the fed has a release and bank earnings, and u.s. gdp. to wrap up the program is guy lebas, kathy jones, and matt freund. kathy, let's begin with you. ecb, what are you looking for? kathy: not much, don't expect them to do anything. they have pretty much already signaled what they will do for the next year. the big issue they face with italy is how they address the situation because the bond market is so huge. jonathan: the italian bond market is all over the place. 30, 40 basis points intraday. guy: yes. wide range. there is some risk it expands more systemically. if we look at what happened in may and early june, there was a pretty quick bid once we had about 3.80. it doesn't seem like that is evolving now.

jonathan: matt, what are your thoughts on the italian bond market? matt: what i would point to is these things are great news, there is a lot of noise, lots of competing political narratives there. it generally takes more time for decisions to be made. i would say we are going through a lot of posturing, but the final decisions, which way these things will fall, that is still a couple quarters away. i think we will have more volatility, but i think at the end of the day, saner heads will prevail and we will find a workable solution. jonathan: if we get to around 3.50 at the close of trade this week, do you like the italian 10-year? matt: you know, our foundation is making sure that we are being well paid for the risks we are taking. the only thing you can say about it at 3.50 is it is more

attractive at three or 2.50. we are expecting more volatility, we think there are some better places, especially for dollars centric investors to go, but again expect more volatility in the weeks and months ahead. jonathan: guy, you want to talk about the canada rate decision next week. guy: this morning, we had some weakness in canadian cpi, which is at odds with an economy driven by commodity exports. the strength we have seen in oil prices. it is surprising. so i have a question for the bank of canada. how do they handle deteriorating inflation data in the face of potentially stronger growth's from the commodities exports? jonathan: how do you think they manage that? guy: i don't know, i want to find out. jonathan: you must have a forecast. guy: i have not had the opportunity to revisit the outlook since this morning. jonathan: let's wrap up with some quick final questions. the rapid fire round. one word answers if possible. buy and hold for six months,

what gives you the highest return? you can either buy uber or tesla debt of a similar maturity. guy: uber. kathy: uber. matt: uber. jonathan: a consensus on uber. u.s. high-yield or u.s. leverage loans, where is the performance over the next six months? guy: leveraged loans. kathy: high-yield. matt: high-yield. jonathan: let's wrap it up with this one. the u.s. 10-year or the italian 10-year for the next six months, if you had to buy and hold one of them? kathy is trying to figure this one out. which one? guy: currency hedged italian 10-year. jonathan: oh come on. no currency hedge. guy: nominal italian. kathy: u.s. treasuries.

matt: i agree with kathy, u.s. treasuries. jonathan: great to catch up with you all. guy lebas, kathy jones, and matt freund. from new york city for our audience worldwide, that does it for us. 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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