jonathan: from new york city for our audience worldwide, bloomberg real yield starts right now. ♪ coming up, inflation data coming in hotter. a dovish chair powell staying on message. treasury markets confusing just about everyone. we begin with the economy heating up. >> you are in the midst of getting hot inflation numbers. >> inflationary cpi number. >> cpi and pci print that were just insanely strong.

>> you are seeing it in retail sales figures. >> inflation is going to be running hotter. >> the demand picture is robust. >> we underestimated the level of inflation. >> what chairman powell has laid out. >> inflation will be transitory. >> allowed things to run as hot as they can for as long as they can. >> is the fed in agreement that inflation will be transitory? >> the federal reserve will be late to the party. jonathan: joining us now is our guests. let's start with the idea that this treasury market is confusing just about everybody. we have had hot cpi, ppi, hot retail sales. we have talked about this every day of the week. what is going on in this bond market? >> as you mention, hot cpi, hot

retail. we are seeing very little moves from the curve today. some steepening. it is the market not believing the fed and what they say they will do. powell has been consistent but the market is turning back to those dots and what they mean. if you look at where the hikes are priced, 2022, very little for 2023. that tells me the market thinks that they will have to go because of hot inflation but not because of hot growth. the story is not over. we will continue to see the reopening trade that we are seeing in retail sales. we don't think that story is over. it is just a matter of who will win the cat and mouse game

between the fed and the markets over the coming months. jonathan: what is your take? >> there are technicals involved here. just like we saw in march in the other direction, it seems there is the element of volume coming off driving some degree of the moves. the initial reaction from the june fomc, that seemed a little more reasonable. coming off of it, it feels like there are enough? question marks. the market seems to be dismissing a lot of the inflation print, more than retail numbers. it is a reopening dynamic playing out, but nothing to move the debates further on whether this is transitory or persistent? jonathan: your reaction, mark? >> those fundamentals are a very real shift in tone from the bed around inflation at the june fomc meeting. two, questions around the durability of growth and whether we are at peak growth or beyond.

and that has exacerbated in market. when we think about what is the real story here, it is the fed and the markets are questioning their commitment to an inflation overshoot, sustained inflation overshoot. that is what is pulling in the timing of the first few rate hikes. it is that shift in tone from the fed. in order for the fed to convince the market otherwise, we think they need to get taper out of the way, get that launched, so they can start talking about the timing of first rate hikes. two, they need to see evidence that some of these inflationary pressures are transitory. it sounds like they are a lot less confident in that, at least that they are seeing risks that it may not be as transitory as they originally thought.

as long as there are those questions, the fed will have a hard time being very dismissive of inflation. jonathan: let's pick up on point one on tapering. you know what happens next, the sequencing kicks in. how do they avoid that? mark: that is the challenge for them. what the market is hearing from them is that they are marching to taper. and they are. we think they will make the announcement at the end of the year, starting early next year, updates in january. but when the market here is that from the fed, they think tapering is tightening. the fed will have a difficult time convincing the market that is not the case. tapering is about moving away from extraordinarily easy policy, somewhat about stabilizing markets and making conditions very easy. tightening, raising rates, is

about sustained inflation in a tight labor market. the fed will try to convince the market that tapering is not tightening, but i think they need to get the tapering headache out of the way before they can begin to manage market expectations around the timing of the first lift off the pace thereafter. jonathan: noelle, what is your response to that? noelle: it is all about timing, getting growth in a good place where they can say, yes, we are confident that inflation is transitory. tapering announcement, they probably want to get that announced this year but don't want to start until q1 of next year. but the key is definitely timing , being persistent on your consistency, continuing to say we think inflation is transitory, it makes sense to

wait for the average inflation to pan out around 2%. jonathan: sri? sri: the fomc did feel like the market was coming to the view that the fed had moved on to how and when, rather than if and when over the debate of tapering. in the minutes, powell's commentary seems to suggest the debate has not moved forward as much it feels like there are not enough question marks around the dynamics or even the relation to the labor market. some of the prints around the long-term on a planet rate, etc., those are driving some degree of doubts around how quickly the fed would move. for us, the base case would be a september announcement where they will start talking about tapering and it is only until next year that they will start. but the range of outcomes around that has increased in recent weeks.

jonathan: here we are at 1.30 the 10-year. people are asking the question, have we already seen a peak in yields, not only for the year, but for the cycle? >> i think we have seen the peak in rates probably for the cycle. there could be another twin peak later on -- twin peak later on, but that is one of the underpinnings for the secular rate. jonathan: we may have seen a peak. hsbc also alluding to that on bloomberg surveillance. i wonder, mark, your response to that. it already feels so early, but for some people this cycle is moving at light speed. maybe we have seen a peak in yields and in the yield curve as well.

mark: i will take the other side of it. we don't think we have seen the peak quite yet. we think we will see another twin peak, potentially higher than what we saw in q1. the reason for that, we believe inflation is truly transitory. it will take time for the data to prove that out. as that happens, that will allow the fed to recommit, establish they want to overshoot on inflation and grow. we think the inflation data will be supportive of that. the fed will be able to generate more upside inflation risk in the market's mind, and also better expectations for growth. supporting that view is you have a savings rate that is elevated, in all likelihood, more fiscal stimulus that is supportive of growth and productivity. in that backdrop, we think you'll see rates move higher. the trick is it probably will not happen until the fed can convince the market that they

will not tighten too soon, choke off the recovery and any notion of more sustained, longer run inflationary pressures. jonathan: that is a difficult trick to pull off right now. sri, your thoughts on what side of the trade you would be on? people talking about the potential of a peak already in the cycle. what side are you on? sri: i will take the side of my reit's colleague. -- rates colleague. their target is to percent by next year. it is premature to say the levels have peaked for the cycle. definitely not in that camp. jonathan: final word, noelle. every single cycle we have more debt, our tolerance for things diminishes. why wouldn't this be it? noelle: every cycle we are also

looking at unemployment that is falling, and we are looking at an economy that is on the other cited reopening, and we are not there yet. we don't have the data to support a peak being behind us. that is why we are still calling for weeks to increase. jonathan: there we go. .there we go. seemingly on the same page on this one. that conversation is up next. this is bloomberg. ♪

jonathan: live from new york

city, i'm jonathan ferro. this is bloomberg's "real yield." the big banks helping the charge for high-grade debt issuance this week. morgan stanley and bank of america pushing new issues close to $30 billion. delta offering to buy back up to $1 billion of high cost bonds issued over the pandemic. private equity offerings leading a resurgence in u.s. high-yield issuance, with a five-day total on track to top $6 billion. let's bring in the team. we spent the past 15 minutes talking about rates, yields at 1.30. real yield deeply negative. we are talking about road being choked off, you look at credit, and you wonder if anything is happening at all. what is going on? sri: clearly, it's been fairly range bound.

there is a lot more going on in the rates markets, but it feels to us there is sufficient liquidity across the board, whether you are talking to the investor community, issuers, banks, there is a lot of liquid in the surplus. that is being reflected in the market, seeing the funneling of this cash and liquidity coming in. some of the biggest beneficiaries out there are the sponsors of the private equity space. one of the things that we are tracking is the amount of traditionalist coming in, but more so in the loan space, rather than the high-yield bond market. a lot of it is refinancing related, so it will be good to see some that issuance. that is the dynamic they are watching closely. jonathan: noelle, alone's market is your world, what do you see? noelle: demand has been great

this year, returns come in strong for loans. there reopening is benefiting loans well. still relative value place relative to high-yield, ig. i wanted to make one comment on the ccc's and high-yield, they are not performing as they have. issuance has been quite robust and high-yield, and a lot of the cash is taking profits in ccc's, moving to the primary issuance. that is something to keep in mind. in the high-yield space, we tend to focus in the higher quality ratings amongst high-yield. jonathan: ccc's, the bottom end of the credit quality spectrum, is that a crack in credit, something to be concerned about? sri: not really but i agree with what she mentioned. valuations got to an extent where we were concerned about how complacent investors were around the behavior of the asset class. as we have spoken about before,

the ccc pocket does well early in a cycle. at the current level of valuations and prices, it is difficult to engineer meaningful outperformance in the ccc's. we have also transition to up in quality buyers in the high-yield space around april and may. that is maybe a bit too early but we are sticking with the call. it makes sense to play more defense at this part of the cycle. jonathan: nothing too dramatic here. we caught up with the st. louis fed president jim bullard this week. michael mckee talk to him about tapering and said the decision was made in the context of an emergency, facing the potential of a depression. he had one concern, we don't want to rock the markets too much. i am paraphrasing, but that was basically it. mark, when you hear what your peers have to say, there is nothing to worry about, get on with it. mark: liquidity is abundant, and

it will get even larger in the couple months ahead, due to ongoing fed qe, the decline of the treasuries. cash balances there will be about a trillion by the end of october, assuming that resolution. this dynamic of very easy financial conditions is likely going to persist, barring some type of significant external shock and growth. in this context, with incredibly easy financial conditions, it makes a lot of sense for the fed to march down that path to taper. you are right, the way they arrive at the $120 billion a month in treasuries and mortgage purchases was almost by experiment. they initially needed to do a lot to stabilize the market and then withdrew to the point where they believed the markets could function on their own. but is that the right amount for

them to be adding into the market today? i don't know. it makes a lot of sense when you think about how easy financial conditions are, how well credit is. the fed will dial back and they will likely follow market expectations, which have them starting to taper early next year. jonathan: i want to build on this question of financial conditions, whether this credit market is now just totally divorced from the underlying economy? i ask that question to wells fargo earlier today. >> i don't think we have a cycle anymore. the fed determines if we are on a secular path of low growth around the very low rates. jonathan: let me repeat that, i don't think we have a cycle anymore. the fed has determined we are on a secular path of low growth around a low range of yields. when you hear that, what are you thinking? sri: i see where she is coming

from. this has become an environment, there is a very protracted period of time, regardless of what the cycles of risk are, there is still the backstop provided by the fed. that is leading to the psychodynamics not being there anymore. at least for that reason i would like to believe that we are still, there is still an element of a cycle. it may play out in a more sporadic fashion, but it does give you some degree of guidance, guard rails around what is the portion of the cycle you are in, how do you position your portfolios? early in the cycle, coming out of recession, or if the recession risk is priced in lower, that means you want to play on these compression fees. given where we are now, regardless of whether it is a

cycle or not, we would say this is an environment that is more mid to late cycle and we want to be more defensive in terms of how you allocate credit. jonathan: noelle, final word? noelle: this is exactly why the rates market is so confused relative to the credit market. the credit market is looking at fundamentals. fundamentals are telling us defaults are expected to be lower. company fundamentals are improving. earnings are so far really robust, expected to be robust coming into the coming weeks. it doesn't make sense for the market to start pricing for what the rates market is telling us. jonathan: more still to come. coming up on the program, the final spread, the week ahead featuring an ecb rate conference, an announcement from christine lagarde.

this is bloomberg. ♪

jonathan: live from new york city, i'm jonathan ferro. this is bloomberg's "real yield." time for the final spread, the week ahead. monday, prime minister boris johnson set to lift covid restrictions on the u.k. tuesday, u.s. housing starts, and another billionaire heading to space. thursday, ecb rate decision, news conference with christine lagarde. friday, u.s. and u.k. pmi data. final word with our guests. mark, a lot of ink will be wasted on the ecb next week. when we are talking about tapering, i want to talk about the size of balance sheets. they are huge at the central banks and will remain that way for a long time. what will be important for the next several years? mark: you are right, central

bank balance sheets are large and they are not done growing yet although the pace will slow. but we will focus on in particular is the amount of cash available, liquidity in the banking system. right now in the u.s., certainly, it is too much. we heard that in bank earnings. some are trying to manage the size of their deposits, they don't want additional inflows, and they are try to push out a way either to other banks or other parts of the fed's balance sheet, maine and the overnight repo facility. this is the environment that we will be in for a very long time, likely years. the new york fed asked market participants when you think we will start to shrink our balance sheets, not until 2025. this environment is not going away. jonathan: i mentioned the ecb.

let's get to the rapidfire around. ecb on thursday. do you watch the presser or take an early weekend? noelle? noelle: for me, the presser because i'm in the u.s.. sri: politically right answer, presser. mark: they are not going to say that much. jonathan: it has been fantastic to catch up. full coverage that you must watch here on bloomberg tv. for our audience worldwide, this was real yield. this is bloomberg. ♪

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mark: i'm mark crumpton with bloomberg first word news. in cuba, the communist

government is promising it will learn from the rare mass protests that occurred last weekend. authorities will temporarily ease restrictions on food and medicine imports. thousands of people took to the streets to demand freedom and food. cuba's economy shrank 11% last year. one week from the opening ceremonies of the summer olympics, the governor of tokyo says she sees the virus-delayed event becoming in her words a beacon of hope. covid-19 infection numbers in tokyo this week reach highs not seen for months, but she says japan is ready. >> we are preparing whatever the circumstance is. and the success of the games is largely created by the excitement from the athletes. mark: canadian prime minister justin trudeau says his company will welcome fully vaccinated

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