♪ jonathan: from new york for our viewers worldwide, i'm jonathan ferro. with 30 minutes dedicated to fixed income, this is "bloomberg real yield." ♪ jonathan: coming up, a weather-impaired jobs report shows payrolls fall and wage growth surge. the short list for the next fed chair reaches the president's desk. warsh, yellen, cohn, and powell are all in the running. and the divide between madrid and barcelona continues to grow, sending spanish funds lower and much lower. we begin with a big issue, wage growth surging. robert stan on the fed's next move. >> this is confirmation we are getting real wage growth. >> 2.9% wage growth is the

headline. >> i think that is good for american workers. >> looking at the wage growth, and you are looking at the unemployment number, which is the bright news here. >> remember, janet yellen said in a healthy labor market wage growth is between 3% and 4%. so we are just about there. >> as long as wages begin to rise towards 3%, they certainly are. and i think the fed is a slamdunk in terms of raising rates in december. >> this confirms a story that has been permeating the market. the data is strong enough and the fed has said they will tighten, therefore december is pretty much in the bag. >> i think people will rightly interpret that the fed can move. they will go in december. we think two and three times next year. jonathan: joining me around the table and new york is oksana, from j.p. morgan asset management. george, head of american fixed-income strategies. plus coming to us from edinburgh, luke, senior

investment manager at aberdeen standard investments. i want to begin with payroll reports and just whip through the estimates and the numbers themselves. the estimate was 80,000. the number was -33. the unemployment rate grinded lower, 4.2%, but wage growth came in hot. 0.5% versus an estimate on 0.3% month on month. almost three percentage points on the year on year figure. george, it was a weather-impaired jobs report. we expected a headline number, but there was some excitement around wage growth. was that weather impaired too? george: there is a slight impact from the weather. there were also some calendar quirks boosting the number, but by and large it is heading in the right direction. the earlier comments you scrolled through, the markets have been waiting for this. i do think even if we get weaker growth numbers, wage pressures and general inflation is running higher, the fixed income market will get more defensive. jonathan: interested in a reaction in the market. treasury yields higher by four or five basis points.

we reversed that move. oksana, what do you make of the intraday activity around the jobs number itself? oksana: this is a strong jobs number. the unemployment rate lowest in 16 years. underemployment rate lowest in 10 years, participation rate is up, wage growth is up. there's no question about it. we have to stop interpreting good news as bad news and bad news as bad news. that is incessant. certainly treasuries at 2.4, that became an interesting buying opportunity for some participants out there. the question is, what is the pace at which the fed will move? the next move towards the end of the year seems to be in the bag at this point. what happens after that? and can this structurally untested market, which we will talk about hopefully more later, really handle that? jonathan: luke, let's talk about why the markets stopped trading on the wage growth figure. they got excited for about five minutes after the number dropped. luke: i think it's maybe to do

with the fact we saw it with the adp yesterday. the employment growth is still going on in the u.s., and everyone knows the nonfarm payroll difficulties versus the household difficulties. so we get a bit of volatility around the number. everybody sits back and thinks about it and we get back to normal again. yields will go higher over the long term, but for now i think people are just going to digest the weather report we had. jonathan: it is the weather report and not the jobs report. that is the take away for so many people. i want to get to the positioning story. oksana, you guys over at jpmorgan did your clients' survey. respondents showed a huge short position in treasuries. how critical is that to some of the price action we have seen on the screen? oksana: so, i actually want to take a bit of a different view on this, because you hear and read a lot about the short positions being supposedly the largest in a multiyear period. but let's debunk the myth here. where is all the money in fixed income?

it is in traditional, purely interest rate driven risk. trillions and trillions of dollars are on that side of the boat as yields continue to come down. people are getting paid less and less for that risk, but they can't get enough of it apparently. make no mistake about the fact that a lot of the price action within treasuries has been driven by central banks. the relationship between the increase in central bank balance sheets and what yields have done over the last 8, 9, 10 years is an almost one-for-one relationship. so this idea that these are these enormous buyers that will provide demand for when rates do start to firm up on top of normalization, i don't think it will hold up. jonathan: looking to what is happening with the nominal 10-year treasury yield, what has not been happening with and the term premium. george: as they described, it is kind of holding. it is anchoring down lower than fundamentals. as you can see, you look at the

10 year rates. they typically track term premium. there has been a disconnect here. the fed is also raising short-term rates. rates are rising overall. we think that as the fed's balance sheet unwinds and ecb tapers, this flow that supported sovereign papers will go away. jonathan: concentration. you touched on it. i'm going to allow you to sort of elaborate on it. how much of a problem there may well be in the coming years? oksana: concentration is a really significant problem when you look at the concentration of interest rate risk and portfolios generally, and how that concentration is achieved. because in the retail market, for example -- not only in the retail market but in the institutional market as well, you do achieve it through ecs. they are meant to be liquid, but in the case of fixed income it's tied to an inherently illiquid instruments, a bond. what you see when you look at the largest etf's across all the sectors, the general aggregate, corporate, high yield, you have these etf's with 1000 different holders. when you look at the top 10,

they tend to control 30% to 50% of each one of those etf's. that should give everyone a pause when you consider the top five corporate bond etf's, for example, account for more than double the inventory the street is currently carrying. how is that going to work in terms of the dynamics around the possible reflation trade? jonathan: luke, your thoughts on that subject? luke: look, there has been a lot of money flowing into etf's. if you look at the fund flows, the majority of it, certainly much more than active money has been flowing into etf's. as an active fund manager i'm a little bit nervous about it and kind of a little bit happy about it. there are a lot of people who will get very upset as we go through what is likely to be two or three years of quite heavy volatility in yields and credit spreads as well. it actually should be in active money, not in passive money. now, i wish i didn't have to learn that lesson, but that is what they will have to go

through. jonathan: just thinking about the next couple of years -- luke is talking about a period of volatility. i'm looking at 2018. i'm wondering, how can we predict anything we don't know who is going to be running the federal reserve? we know the president has a short list, and it goes something like yellen, warsh, cohn, powell, and you can throw in taylor as well. is this a market ready for any one of those individuals? george: obviously with chairwoman yellen we would have continuity, so the markets could prepare for that. and even to some extent, powell would be viewed as a yellen proxy. but for the other two, we think kevin warsh would not necessarily be volatile by nature, but introducing new ideas around policy and how you interpret data. his views around the balance sheet, which was a big sticking issue on why he actually resigned, so this idea that the fed is on a cruise control balance sheet and unwind would

have to go faster because inflation would go up, so it does introduce volatility. jonathan: yes or no, if warsh has been nominated as fed chair, is that a foul on treasuries? oksana: there will be volatility in treasuries. treasuries will probably move up. i would just add there is a lot of conversation about which one will get the nod. i think if you look at it from the standpoint of who is most aligned with the administration's growth goals and deregulation agenda, i think kevin warsh has a strong case. jonathan: you think he does? oksana: i think he has a pretty strong case and that -- and that particular realm. are the markets pricing that in? not likely at this point. jonathan: oksana from jp morgan asset management staying with us and george and luke from aberdeen standard investments. up next on this program, the auction block. amid tension in spain, the country very much needed to get away from its bond offering this week. we will bring you the results. that's next. this is "bloomberg real yield." ♪ ♪

jonathan: i'm jonathan ferro. this is "bloomberg: real yield." i want to head to the auction block now, where we start with corporates and focus on a little bit more in energy. thanks to an offering this week from transocean energies and others, energy companies are returning to credit markets at the fastest pace in three years, with bankruptcies falling and oil stabilizing, and companies facing more than $70 billion of debt maturing in 2019. in sovereigns, abu dhabi's $10 billion sale following saudi arabia's $12.5 billion issue last week. the borrowing binge pushes sales from the middle east and north africa to a record $89 billion this year. and the big headliner of this

week was in spain. a sale of 3.2 billion, up 53 basis points. more than double that on last month's spanish sales of similar debt. sending demand to the highest level of interest in this maturity for months. still with us, oksana aronov and george, and luke hickmore joins us as well. luke, let's dig into europe very quickly. european politics is reasserting itself. this time it is spain and madrid and a divide opening up. i'm trying to gauge if that stays a spain story or does it bleed through the rest of the periphery as well? luke: i think it is a spain story through and through. you can start reading -- the other gips, as we used to call them, greece, italy, and portugal. i guess there's an outside risk if catalonia continues to cause problems. we have an italian election coming up probably early next year. that may spill over into that as

well. but right now, right here it is all about catalonia and spain. jonathan: i caught up with rick rieder from blackrock earlier. this is what he had to say on the spanish block. take a listen to this. >> away from this piece of news, spanish growth and employment data is arguably the best in europe. it has been heretofor the best -- heretofore the best story in europe. now you have a window that you can buy it a little cheaper. jonathan: are you a buyer? oksana: not a buyer. i'm astounded we still have spanish debt paying out. nobody wanted the stuff in double digits five or six years ago. frankly rick rieder's comments supports the fact that growth continues to accelerate, bonds should be reflecting that in terms of pricing and growth, inflation, etc. here is the power of artificial price setting by central banks. that's what they are capable of doing, keeping a lid on interest rate levels. jonathan: if you just look at where spreads have been

throughout the year so far or over the last 12 months, italy has blown out a lot wider than spain has. what you will see on the screen in just a moment is the basis point move over the years in terms of spread. what you will see is that italy has blown out 40 basis points. that is change, 40 basis points change over the last 12 months compared to what we have seen in spain. i just wonder, luke, to come back to you, whether italy is the real story and spain is just kind of the appetizer to what might be coming out of europe in the next 12 months? luke: i'm afraid it's an even bigger story than that. it is about credit markets, generally. do you really want to take a lot more risk in a market that is getting more and more asymmetric? the downside is getting bigger and bigger here. when you think about spain and italy and the peripheral market, generally you are loading up risk. right at this stage of the cycle, that is not somewhere i want to be. i want to be in companies i can understand where they are going. now, that means you are cautious about spanish companies all of a sudden, cautious about italian companies.

but that suits a more cautious style anyway. jonathan: george, if you're over in ecb hq in frankfurt and you are sitting at the top floor and you are mario draghi, what are you thinking about was happening in spain in the last week or so? george: you are thinking across european rates, and obviously there has been a heavy force in markets. to her point, i think there is definitely -- i think we have fallen into this trap of relative value comparisons. your chart showing a spread change, but the overall levels are low. if we are going to see growth -- he should be wanting to see rates rise for the right reasons. oksana: i would add one thing -- we are sitting here with u.s. cash about to hit 1.5%. why does anyone want to buy spain at 1.7%? jonathan: apparently they do, oksana, so why do you think they do? oksana: i think, again, it is the power of artificial price setting by the ecb. that is where most of that demand is coming from, that the ecb put. jonathan: how difficult will it be for the ecb to pull out?

let's pretend that we do not have ecb qe over the last week or so. what kind of move could we have seen in the bond market? how difficult will it be to take a step back? oksana: how difficult will it be for the ecb to take a step back? they are going to react to the economic picture on the ground. it continues to strengthen in europe and specifically, spain. spain has been one of the stronger areas. so if the fed continues on their trajectory, that will give the ecb some cover. the have certainly made -- that have certainly made comments that are very clear that they are headed in that direction. jonathan: luke, what options are on the table for the european central bankers as they change their quantitive easing policies? there seems to be two options they are debating. one is you can drop qe by $20 billion and extend for a shorter duration of time. or you can drop by a lot more and extend duration by a lot more. so qe can run longer but at a smaller rate or run at a bigger rate and have qe run shorter. given the politics, do you think

the weight of interest from the governing council might be to extend it as long as possible? luke: yeah, it's got to be, doesn't it? we've got catalonia now. we have italy coming up and we have austria still bubbling away. we have not even got a fully formed government in the netherlands yet. so i would think mario draghi would take his time right at this moment, but that does not mean he doesn't accelerate later. this is not a single two option game. there is nothing wrong with him getting into next year when things may have calmed down or accelerated. i tend to agree. take longer now, be cautious. don't get involved in every new issue. that makes a massive difference. jonathan: i think for a lot of people it is kind of scary. everyone is sticking with us. i want to get a market check on where treasuries have been this week. 2, 10, and 30. yields grinding a little bit

higher. up two basis points on the two-year. up three on a 30-year as well. still ahead, the final spread. the big week ahead, featuring u.s. bank earnings and details on their fixed income trading groups. that is one thing to watch next week. this is "bloomberg: real yield." ♪ ♪

jonathan: this is "bloomberg: real yield." i'm jonathan ferro. let's get you an update on what's coming up next week. coming up over the next week, we wait to see what will happen in catalan with the parliament on monday. we will have minutes from the fomc. the imf world bank meeting and u.s. economic data, including cpi and retail sales. plus, the president donald trump may give a speech regarding his decision on the iranian nuclear deal. the president of the united states, of course, made waves in the bond market when he said

puerto rico's debt should be wiped out. i want to bring back oksana, george, and luke. i can put the general obligation bond of puerto rico on the screen and you can see the the damage those comments did to a bond that has already been absolutely battered. we dropped into the low 30's. i believe we trade at about $.38 on the dollar. george, we are now having this ugly conversation about this debt for a while, the recovery rate. how do you look at a situation in puerto rico and work out the recovery rate of a bond like that? george: we don't really look at the muni side of things, but i do think there are concerns around recoveries. as much as is true for the situation, but in general across the muni markets, people are concerned about potential obligations and long-term liabilities. jonathan: oksana?

oksana: you have got people leaving the region now. if you think about a geo, and about the fact is usually supported by the taxing power of the local authorities, that taxing power must be getting reduced by the minute if you don't have people in the region. but bringing it back to sort of portfolios, puerto rico has been a favorite of high-yield investors for quite some time. what we have said -- we generally stayed away from very risky, high-yield areas of the muni market. the reason has been this is an interesting illustration. when you are in that part of the market, you are dependent on a couple of players for liquidity. and this is an extreme illustration of this, and there is no liquidity in a position and that is the general problem with a high-yield market. jonathan: in terms of wiping out the debt, it was the first time since the inauguration larry summers agreed with the president. he said i agree with the president of the united states. the debt needs to be wiped out. luke, i want to think about how you are thinking about the situation right now. some reporting of bloomberg.

a population the size of connecticut, the economy the size of the nebraska, with a bigger debt load for any state except for new york, california, and massachusetts. it's a tough, tough situation. and how do you address it? how do you restructure the problems in puerto rico? luke: and even if you deal with the $73 billion in debt, how do you deal with the $50 billion in pension deficit in the background as well? this will rumble on for a long time. 40% of these general obligation bonds are owned by you and me and people individually around the usa. i haven't got any, to be fair. the triple tax benefit is really attractive to people. so who do you want to punish? it's not the big banks donald trump was talking about. it's your normal pensioners, the savers you will punish. so it's an intractable position. i honestly don't know how you get out of it. it doesn't feel like the u.s. treasury can take this

obligation on. jonathan: it does not look like it at all. we will wrap things up and get to the rapidfire round, where we put together the last 25 minutes of the program and look ahead to the next week as well. guys, one question, short answers if you can. have we seen the 2017 lows for the 10 year yield, yes or no? oksana: yes. george: yes. luke: yes. jonathan: there we go. next fed chair, pick one. yellen, warsh, cohen, or powell. oksana: warsh. george: warsh. george: warsh. luke: kevin warsh. jonathan: i'm surprised at the consensus around kevin warsh here. ok guys, final question. this one will be fun and difficult, because you have to pick one of these. catalonia or spain with a similar maturity. i'm going to pick out 2020. i could tell you the spread is about 300 basis points. which one do you hold through 2020? catalonia or spain?

oksana: not touching that one. [laughter] george: i'm off-line on that one, too. jonathan: luke, you have to give me one. luke: you would have to go with spain. jonathan: there we go, we really appreciate your time. oksana staying out of trouble alongside george and luke hickmore at aberdeen standard investments. from new york, that does it for us. we will see you next friday at 12:00 new york time, 5:00 p.m. in london. until next time, have a great weekend. this is "bloomberg real yield." ♪ .. ..

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