jonathan: this is "bloomberg real yield." ♪ jonathan: coming up, a downside surprise on payrolls. may job numbers disappoint. the 10 year yield plunges to a new low. spreads just keep grinding tighter. we start with the big issue, the payrolls report injecting uncertainty into the fed's next move.

>> it is a weaker number on the market expected. >> it is disappointing. >> the overall trend is good. since inauguration day, the u6 rate is down 12%. we have brought back 12,000 people that were disappointed or underemployed. >> we have already begun to question the fed's rate have on inflation data. inflation is one side of it. now you have the labor market data disappointing little bit. it is not surprising that people are beginning to question whether the fed will go twice this year and three-time sector. >> the chair believes in job growth more than anything else. it is lower than the market expected perhaps, that she is going in june. >> june is on the table, 60% to 70%. november probably off the table. jonathan: what a lineup we have

for you. bob michele with jpmorgan. kathleen gafney at eaton vance. and michael collins at pgim. the message in treasuries, i want to start there. it is yields and spreads and the curve that is flat. whatever you look at, one day it is something, the other is 50. it just as flat. it says i don't buy the reflation story anymore. what is it saying to you? michael: markets are coming around to the view we have had. the fed is going to keep pushing the front end up, and the long and is pricing in the slower growth. that is coming through on the treasury curve. i would argue there is more room to run. i have a chart of 230 spreads

going back decades. typically that goes to zero. when they get to 2.5%, you will see yields around that level for the whole curve. jonathan: that 2.30, you think we can get flat? michael: if they keep tightening, insist on getting that 3%. but they had. i think that is too much. kathleen: i think they are definitely pricing in weakness. i think there is good demand in the economy. i think it is a misread. bob: i think there is so much money out there. central banks outside the u.s. are still printing money. there is $2 trillion a year that is being printed and coming into the bond market. jonathan: let's talk about how difficult it has been through

what is empty to be a treasury bear. bob: it has been tough. definitely. if you look at a couple things, central banks have been a bit more hawkish than anyone anticipated. you have the fed talking about taking down its balance sheet before the end of the year and commitd to more increases in the fed funds rate than anyone anticipated. yet the ecb talking about tapering their balance sheet. corporate earnings look great. the revenue recession of last year is gone. they look strong. there is a lot of good going on in the market. i think the term premium in the bond market is wrong. i agree with kathleen. there is a mountain of cash out there. it is being printed every month. jonathan: is there a message for the fed? michael: at the beginning of the year after the trump trade, the markets were pricing in a funds rate of 2.75.

today the markets are pricing in about 1.75, that is probably much closer to what is likely to be realized and closer to fair value. i think you're supposed to fade this rally a little bit because a lot of those lower rate hike expectations are being priced into the market. kathleen: i think the challenge for the markets is if you look at the short-term data, it says we should take a pause. when you look at what rates are pricing in over the next two years, it is only two and a half hikes, which is not enough for the economy. it is tough to be a bond bear. the risk with rates so low is there's a lot of downside left on the table. bob: don't listen to me. listen to -- who laid out a clear and precise passport fed tightening. when i look at maker initial

conditionshows, it st the fed has raised rates three times, and financial conditions have he's quite a bit. this suggests they are falling behind. they stopped qe because financial conditions had tightened. now that they are going the other way, they are more than off. kathleen: it is not tightening, it is just less accommodative. bob: they have miles to go. if i were the fed, go every other meeting until you get to 2%. wait there. jonathan: you said the signal is they are not going to do, look at to zen 30's, but you are saying maybe they are going to fast. michael: we are still short the project. they still have this 2% dot. it looks like they are adamant to rate hikes. some of these more dovish members are getting cold feet.

you look at the surprise index, that is rolling over heart. bob: at what point do they get cold feet? not a three quarters of a percent. maybe a year from now. michael: we should all hope they get to about one and a half to 2%. kathleen: my question is what are they tightening for? they seem to be tightening as a result of the labor market. what nobody is talking about is inflation. they don't think it exists. every day that goes by, we get more and more risk of inflation heating up. bob: they are tightening to normalize. surely a minus one -1.5% real rate is nowhere near normal. get to something that looks normal or at least neutral. then see what happens. she talked about the term premium, and she said it is the foreign money coming into the u.s. market.

jonathan: let's talk about the global inflation story. last time you were on the program, you brought up chinese ppi. it is not just inflation in the u.s. that started to bleed, in china we started to roll over of it. does that mean that 2017 seems to have peaked? bob: it doesn't make it more difficult to be a treasury bear. everything coming out of the central banks tells you that over the next year they are going to withdraw accommodation. we are debating the speed of it. that is a secular change. i think china has done a great job. i will take the other side of that they have a very complex array of problems to deal with. they have done it well. they tackled the banking system. they tackled what they needed to do with infrastructure.

they are targeting a reasonable level of growth. not above 10%, but 6%, that is a good level. jonathan: you say it is stupid to buy a 10 year, but 30's at 1.52, is that too steep? bob: absolutely. the fed says they are going to begin balance sheet reduction. that supports the market having to deal with. the traditional metrics we have looked at, when the fed raises rates, the curve flats. we have never had to build in, what happens when they control the long end of the curve? michael: i totally agree with that. this will not be a normal cycle. in the past cycles, they had one tool. now they have to. i don't think you will see the curve get flat as a pancake. kathleen: my only concern is

that the supply at the long end is shrinking. i don't think there's going to be as much havoc in the market because there is less to buy. bob: it depends on what balance sheet runoff they have. in 2018 and 2019, they have 200 billion in treasuries that mature. having something that is transparent and steps up. if they get to 10 billion or 20 billion treasuries and mortgages per month, we can absorb that. jonathan: final question for you michael collins, are the numbers today an opportunity to sell down holdings? michael: yes. we're going to cut down a little bit. maybe they don't hit 1.75 to but that is much closer to fair value in our mind.

jonathan: coming up next on the program, it is the auction block as high yields dry out and spreads get tighter. you are watching "bloomberg real yield." ♪

jonathan: the calendar flips over from may to june this week, and it was the slowest may for the market since 2012 with 47 deals, which follows the slowest april since 2009. the spread between high yields,

bonds, and treasuries is expected to tighten. currently that is about 360 basis points. as investors search for yield, the company managed to increase its offering from one billion, offering five-year notes with a coupon. want to bring back bob michele, kathleen gaffney, and michael collins. kathleen, let's use that hurts offering as a catalyst. how difficult is it to get adequately compensated? kathleen: you are not adequately compensated no matter where you look. it is tough and high-yield. jonathan: let's use the car rental company as an example.

they have a capacity issue. they have an issue around the price of their vehicles. a lot of people are looking at the company and same there are problems in the subprime auto debt, and problems with these companies. michael: there are two problems with the credit markets and high-yield markets, one is these cracks we are seeing on the credit side. auto companies have finance arms. we are seeing auto sales and production rollover. you are seeing problems in rental companies, big problems in retail, and some signs the lodging sector is being hit by technological change. you have fundamental supply, and you have valuation problems. one third of the bonds in the high-yield market have spread under 200 basis points. i don't think we've ever seen that. bob: i think everyone is being a little too greedy on t high-yield market.

i think a spread of 360 basis points with default rate coming down, we had the accident in energy, and default rates only got to 12%. we are headed to 1% by the end of the year. 360 basis points compensate you for that. i would like to buy high-yield at 8% to 10%, but i cannot. if i don't buy it, someone else is going to come in. as long as defaults don't go up, i am ok. jonathan: what about specific cracks in high-yield? bob: there are some. you have to understand what has happened in the auto industry. there were no purchases of autos in 2007, 2008, 2009, and that pent-up demand got seated in 2012 through 2014. you are seeing some delicacies and losses going up as a normal curve would. in that market like a lot of credit markets, you cannot buy

it at the spread you might like, but you are getting 35% credit enhancement. jonathan: this is a chart we can pull up. you look at inventories for every car sold, outside of recessionary periods we are at highs or off of highs we haven't seen since the 1980's. kathleen: why buy a new car? there is no need. there is less demand because of technology for cars. it doesn't mean there is weak demand in the economy. jonathan: let's talk about demand in the debt market. auto loans or heartz or carprime companies? kathleen: i am concerned about the health of the auto companies. i would stay away. that doesn't mean you cannot find good opportunities in credit or high-yield if you

brought in your horizon. corporate are a good example. michael: that 360 spread on the high-yield market is a little misleading. a lot of the cable companies, health care companies, consumer companies, gaming companies have those really tight spreads. if you want to get that average yield, you have to do a barbell and take a chance, and hopefully you are really smart or really lucky and add value. jonathan: going through the notes of individual portfolios, what stood out for me is your cash allocation. about 15% is really high. kathleen: it has been higher. jonathan: justify it for me. kathleen: there is little to buy if you are a value investor looking for long term. credit spreads are two tight. i worry about the bond math.

the fundamentals are good, and it has paid to be there a long time, but i don't want to be the last one at the party. bob: every asset class has suffered from valuation fatigue. everyone would like to buy cheaper. valuations have been stretched by a lot of metrics. yet the money keeps pouring in. maybe we are supposed to blame the fed and central banks in aggregate. maybe they are supposed to step up the reduction in their size of their aggregate balance sheet. until that ends, you will feel the pain. the money is being printed. it is going to be exported to us in the u.s. we are painfully going to have to invested in asset classes where we have valuation. kathleen: you can reach out more broadly. 15% is not a high cash position, i have been as high as 5%. bob: where are you reaching out? kathleen: currency and in corporate's.

technology, globalization, the challenge to get growth going. there's a lot of upside in the yen. markets are nervous because of attention issues. bob: that is a quantum increase in risk. you are predicated on the developed markets being somewhat robust. we talked about china slowing down and the central banks not only to the. kathleen: you are talking about the perception of risk. i would argue that em corporate and reform potential in em countries is a much better risk to take them the rate risk with 10 year treasuries. bob: i like local emerging markets. jonathan: that is not a confession. bob: you are still statistically cheap from where they were back when the taper tantrum started. i like the government bonds.

i like more liquidity there. i like that they have a high real yield. jonathan: looking at the bloomberg barclays, talk about the sleep at night buffer you might have or not at all. kathleen: no. not at all when you look at breakevens. i have a chart here that looks at the u.s. agg equal weighted for duration. we are at a nice cushion. today in the lower right you see we are at 42 basis points. if we get an increase in interest rates, you are wiping out that total return potential. that is where i get very nervous about staying too late in credit. jonathan: you are all staying with us. bob michael, kathleen gaffney, michael collins. yields grinding lower by two basis points on the two-year. 2.81% is the latter curve no matter where you look at it in the treasury market.

still ahead, the final spread. the ecb and u.k. heading to the polls. this is "bloomberg real yield." ♪

♪ jonathan: this is "bloomberg real yield." it is time for the final spread. over the next week, right decisions from the ecb, australia, and india. the big event in the u k, the election. june 8 is busy. the u.k. election, the ecb, and director comey is testifying as well. join me as bob michele, kathleen gaffney, and michael collins. what are you looking for? michael: we are going to start

talking about tapering purchases of bonds. the fed is talking about reducing the size of mount sheet, and the ecb is talking about reducing purchases. look at the data out of europe, spain, italy, greece moving ahead. europe is outgrowing the u.s. right now. kathleen: i completely agree. europe is going to become the focus. there is a lot of youthfulness coming out of your. we have inflation there. jonathan: i want to go to the rapidfire around. one word answers from each of you. do we had 2% on the tenure before we had 2.5%? bob: 2.5% kathleen: 2%. michael: i wish it was 2%. jonathan: high hee or cash? bob: high-yield. kathleen: cash.

michael: high-yield. jonathan: are you long euro or long sterling next week? bob: sterling. kathleen: euro. michael: i will take the other side and go with the sterling. jonathan: it has been great to have you with us on the program. kathleen gaffney, michael collins, and bob michele. that does it. we will see you next friday with special coverage of the u.k. election and the ecb decision taking place next friday. this is "bloomberg real yield." ♪

♪ mr. buffett: i said, "what do i do with this money?" he said, "investing it is about assigning the right use for the money." i did not want to go to college. my dad wanted me to go to college. i had $175,000. i thought that was all i would need to live the rest of my life. david: did you ever run into that guy again? mr. buffett: he needs protection now. david: when you had your first annual meeting, how many showed up at that? mr. buffett: we had about 12. you have to count my aunt katie and a couple of friends. david: any advice to a young investor who would like to emulate you? >> would you fix your tie, please? david: most people would not recognize me if my tie was not fixed. let's leave it this way. all ri