♪ jonathan: for our viewers worldwide, i am jonathan ferro. this is "bloomberg real yield." ♪ jonathan: coming up, unemployment hits a 17 year low, the wage growth stalls, disappointing inflation bulls. jay powell is set to take the reins of the federal reserve. and how republicans believe a tax bill could add $1.5 trillion to the deficit over the next decade. we begin with a big issue. unemployment grinding lower, wage growth stalling out.

>> despite the summer being a little softer, we still think the economy is in good shape. >> economists would call it a robust economy with growth of 3% plus at least for the last two quarters, despite these rather disappointing employment numbers. i think we are past the crisis. >> we are still getting a lot of distortions out there, but the underlying economy is strong. what's worrisome is the decline in unemployment happened for the wrong reasons. we saw a pretty big drop in participation rates. this could be noise related to the hurricanes. >> the job number is noisy. still pretty good numbers in there. down to 4.1% unemployment. when you look at the u-6 number down 1.5% for the year, we are bringing a lot of people back into the workforce. >> wages are accelerating. i think that is important. we don't think wages are going to move beyond levels that economy tremendously high because of automation and technology. but it is real wage acceleration. so it just allows them -- we think they're going to go in december, two to three times next year, probably three times.

jonathan: joining me is matt hornbach, priya misra and nick gartside. i want to begin with you -- is there any signal in this jobs report at all? ms. misra: this whole pickup in wage inflation we saw last time, there was a handshake. even though the labor market is tightening, we are not seeing signs of wage inflation. this pressure on the fed to get -- to keep hiking, to get the funds rate close to the 275 level, that is what we're looking for. that is the signal it's giving the market that one or two more hikes. the fed has to follow and then see whether they have to keep going. jonathan: several elements have to fold into the payroll story. chair powell, how is he likely to look at these numbers? are they one or two hikes away from saying, we need to step back here? mr. gartside: no. are they one or two hikes away when you look at jay powell, the reality is he is a realist.

-- he is a realist. he's from the same mold as janet yellen. these labels of doves and hawks in a sense are not that helpful. what they are as realists, they look at the data. when you look at the data, in terms of economic growth, it is pretty robust. when you look at wages, let's be honest, a little disappointing. but there is real wage growth, so that puts the fed absolutely in play for december and probably three hikes next year. jonathan: do you take that side? mr. hornbach: i tend to agree with nick. although, next year will be an interesting one with the fed balance sheet starting to normalize more quickly. with respect to the 2.4% or 2.3% wage growth we are seeing, that's not out of the realm of what you would expect. you have productivity growth trending around 1% and 1.5% inflation.

that is going to give you wage growth somewhere right where we are. jonathan: growth rich and inflation poor seems to have been the story of the last couple of years. is there any reason that's going to change soon? ms. misra: i don't think so. i think you can get a little bit of pickup in inflation if these one-off factors go away. that 2% target the fed has, that's very elusive. you have technology that keeps that low. i would slightly disagree, the issue with powell is i think he's talked about short-term and long-term. i think the fed is going to see whether we can merge. if that doesn't happen, it may be a couple of pause, unless we get tax cuts. jonathan: if you look at where the federal reserve sees the long-term rate, and you plot that against the 30 year treasury yields, it's kind of putting a lid on where 30 year treasury yields go. we can bring up the chart. there it is, matt. is that something that just sticks stubbornly low, 30 year yields in the long-term rate

over the federal reserve the -- that just keeps coming lower? mr. gartside: absolutely. as long as the fed raises interest rates in an environment when we are 50 to 70 basis points below the inflation target, the yield curve will keep flattening. there is no reason why an investor needs to be worried about duration risks when you have a central bank pushing tighter policy in the face of low inflation by duration. jonathan: do you see the same thing, flat from the front end, because the two-year keeps selling off and the long end is just bid given what's happening with the inflation story? mr. gartside: when you look at the curve, it will continue to flatten for exactly the reasons that matt outlines. when you look at inflation, it's tricky to see that much significantly higher inflation long-term. what i would say, though, in the short run, watch the dollar. by the end of this year, we could well see the impact of the depreciation of the dollar. although the u.s. is a fairly closed economy, that's been a fairly decent move this year. all things being equal, that

should add a little bit of inflation as we get into year-end. jonathan: it is an interesting point. i wonder how much it moves the dial. and another question i would ask is, for how long the federal reserve can go it alone? if you take the ecb's guidance so far, qe on autopilot through most of next year, maybe the whole of 2018, you are going to into 2019 with a deposit rate of -40 basis points and the federal reserve approaching 2% if their guidance is anything. how long can the fed go it alone? ms. misra: a little bit more, but when you are at zero real rate, but i would agree with everyone. the curve flattening makes sense from the inflation standpoint also from the global rate standpoint. if you have negative rates in the rest of the world, japan is not easing or not reducing their level of accommodation, if the ecb is not hiking until mid to late 2019. jonathan: the start of the year we were talking about tax plan that added to the deficit and reduce the inflation story and would boost treasury yields. i don't see it. why don't i see it? they have a house tax bill. they are saying $1.5 trillion

added to the deficit in the next decade. i don't see it in treasuries. why not? mr. hornbach: markets, especially investors who are thinking about the fed next year are not able to extrapolate the deficit increase we are expecting next year, which according to the jct, the scoring on this plan was released by the house would add about $170 billion to the deficit in calendar year 2018. that's not going to be that much of a pickup in treasury issuance. you look in 2019, you have a $220 billion increase in the deficit, 2020, another $200 billion plus. but again, what's happening in 2019 and 2020, that's way too far out on the calendar for the market to trade off of right now. jonathan: nick, is that

something you believe as well? the idea that, yes, treasuries, there may be more coming to the market. yes, we will add to the deficit. yes, the federal reserve will be pulling back as well, but it's too soon to price that in? mr. gartside: it's fairly too soon, but the reality is there's also a global phenomenon going on here, which is austerity is dead and other countries are likely to turn the fiscal taps on. all things being equal, when you look at markets, it could well be that they are still underestimating the potential for central-bank activity. not just in the u.s. but back to your earlier comments, in places like europe. there's a huge consensus that the ecb will never move rates again. the reality is when you look at europe, you have superstrong growth in europe. the risk is the ecb actually pulls forward the possibility of rate hikes. jonathan: nick, what was the bank of england doing hiking this week? mr. gartside: they did the right

thing in terms of hiking rates. when you look back, the cut post the referendum was clearly a policy mistake and the suggestion then was the u.k. would fall into recession. it absolutely has not fallen into recession. they've done exactly the right thing in raising interest rates. when you look forward, the risk again is that the banks are a lot more hawkish than anybody expects. jonathan: across the bloomberg, i want to ask of you -- what's the probability of them hiking in q1 next year? mr. gartside: over 50%. the data to watch is in the u.k., we get it a budget. we call it the autumn statement, it is in the next few weeks and the lesson from the election in the u.k. was that we are not tolerating austerity anymore. there will be a political reaction to that, which is to increase the deficit. you do a fiscal loosening, that's what gives the bank of england the excuse to hike rates in the first quarter. jonathan: it is great to have

you with me. matthew hornbach, priya misra, and nick gartside. coming up on this program, the auction block. argentina capitalizing on investor optimism towards its reform minded government. seems anyone can come to market from new york, this is "bloomberg real yield." ♪

♪ jonathan: from new york, i'm jonathan ferro. this is "bloomberg real yield." i want to head to the auction block now where we look at a comeback in argentina. the country sold $3.2 billion in international bonds. this comes just after argentina this summer sold $2.75 billion of 100 year debt. over in europe, october was a record month for high-yield

bonds with more than $62 billion in sales. corporate's have issued the equivalent of 18.9 billion euros, breaking the previous record. into france, a billion euro auction was met with the lowest ratio since january 2016 on the ratio for 30 years with the lowest since 2015. still with me is matthew hornbach, nick gartside, and priya misra. i want to take the opportunity to talk about europe. we talked about the ecb pulling back and we talked about the prospect of politics in europe reasserting itself in a much more negative way, and yet i see italy trading tighter to germany as the weeks progressed. i sit there scratching my head wondering why, so i'm going to ask you, why is italy trading tighter to germany, despite the kind of things everyone is talking about? political risk around the corner and the ecb pulling back. mr. gartside: the one thing investors do not talk about is economic risk.

a really critical thing for italy was the upgrade. s&p upgraded italy last week. that was the first time in 22 years of the s&p had upgraded italy. therein lies the tale. when you look at european aggregate, it is probably the international economic success story now. and even a country like italy that's been afflicted by low growth has a much stronger growth trajectory now. that's what investors are focusing on, that means the spread to germany can contract another 25, if not 30 basis points. jonathan: what are your thoughts on what's happening with italian spreads? ms. misra: the ecb went so slow, they recalibrated. they are technically still not tapering, which implies they are not hiking at all in 2019. i worry about the italian election, some point the market is going to say political risk is hard to price in and maybe i want to step away from that. jonathan: matt, i see you

nodding your head, you agree with that? mr. hornbach: on the front end basis markets, and you look at the demand that coming from investors in japan, it actually pays to go into euros these days. from their perspective, rather than pay 200 basis points of spread to go into a treasury, you get paid to go buy europe. so, of course, absolutely agree. this is a carry trade, there's a lot of money out there. jonathan: i never thought i would hear you say people have gone long over a credit rating upgraded. i thought there was something we did 10 years ago with em, not with developed market countries like italy. what's going on? mr. gartside: when you look at a country like italy, you have to treat it like a credit, don't you? because it doesn't have its own central-bank. the other lesson is rating agencies typically lag. so it's a delayed reaction to much stronger growth when you

look at italy. jonathan: look at the situation in europe, nick. something that struck me is how difficult it is to push through your positive view of europe. if you push it through the fx market, we are still at pretty choppy levels with the ecb still hanging in with -40 basis point rate, if you push it through equities, it just refuses to expand. how do you push that through? that positive view on europe through the fixed income markets to really make money? mr. gartside: when you look at periphery, portugal, italy, spain, they are likely to contract relative to germany. the other one, a little controversial, european high-yield. some say that is the most misnamed fixed income sector, given that yields a massive 2%, but the reality is when you look at fundamentals in europe, there corporations were very robust and that spread and that yield is likely to contract lower and lower. what we saw in italy in terms of the upgrade you also see on the corporate side. many more upgrades then downgrades. jonathan: nick, something we have seen is 80 in one's. the performance is completely phenomenal. is there any more upside in that trade, as far as you're concerned? mr. gartside: a lot more upside. when you think of the macro side, you have a much better

economic picture. europe, probably for the second year running will outgrow the u.s. this year when you look at banks, they are still deleveraging, they are still adding capital. when you look a lot a lot of 81 bonds, the pain trade is as those yields go lower from here, not higher. jonathan: as i listen to this, the mood music around europe has changed dramatically. do you see the kind of reforms, the changes nick is outlining to justify the price action this year? ms. misra: i see extremely accommodative central banks

globally and that is creating this demand for yield. one other point, to nick's point, repatriation. a lot of money is invested in european fixed income that will potentially get repatriated back to the u.s. i wonder if you go dollar funding squeeze outside the u.s. that could affect european credit. i would just flag that as a risk. jonathan: let's talk about that, quickly. there's a lot of cash overseas and in some of those countries that invested in other credit or just fixed income or generally across europe and elsewhere. d.c. those companies meeting to exit those positions as they bring that money home? do you see it happening in impact on fixed income outside of the united states? mr. gartside: i mean, it shouldn't. when you think in aggregate, we still got massive buying from central banks. although the ecb taper starts next year, there will still be buying 30 billion euros worth month. you have a similar not for the bank of japan and in the european context, the tapering

is likely to happen in government. so you still have that huge buyer of corporate bonds in europe represented by the ecb. jonathan: is the pain trade still to short bunds? mr. hornbach: yields are going to continue to creep lower over time. i don't a lot of weight into the idea that the 30 year bull market and treasuries is over. and we for that quite a bit. we have heard it on shows such as yours. we just do not see that happening. jonathan: i do not say it. matt hornbach sticking back away from that sticking with me. nick gartside and priya misra, great have you with us. bonds, choose 10's, 30's, four basis points moves higher on a two-year and four basis points moves higher on a two-year and 810 basis point move lower on the 30 year. that's a flatter yield curve, a much flatter yield curve over the week so far. big moves still ahead, the final spread, the week ahead featuring

president donald trump's to asia and much more as well. from new york, this is "bloomberg real yield." ♪

♪ jonathan: from new york city, ♪ jonathan: from new york city, for our viewers worldwide i'm jonathan ferro. this is "bloomberg real yield." it is time for the final spread. coming up over the next week, the president of united states, donald trump, makes his first official trip to asia, meeting with various government leaders, including japan's shinzo abe and china's leader xi jinping. we will hear from mario draghi. global ceos as well as bloomberg's year ahead summit. brexit negotiation talks continue as well. matt hornbach from morgan stanley still with us and priya misra in new york as well. and nick gartside joins us out of london. i was surprised by how much the yield curve has flattened this week. priya, we talked about it before

we went to commercial. we have come in a tremendous amount on 230 and a lot of people are saying it's a crowded trade. your thoughts on where they are going over the next couple of months. ms. misra: i think the fed is telling you they still plan to continue to raise rates while the rest of the world global bond rates sustained low. that is keeping the long end relatively anchored. i think you can flatten. the one additional piece of information we got from treasury this week was they are still thinking about the long ends, but they are not that excited. as a taxpayer, it's not the right thing to issue in the very long end. i think if all the issuance is going to come in the front end, and even if we get tax reform i don't think it's a big statement the front end faces issuance. mr. hornbach: what the treasury told us this week really changes the dynamic around tax reform. over the past month or so, the yield curve steepened on increased optimism about tax reform. but that was because people thought they were going to have to finance it with tens and 30's

and a 50 year. treasury told us this week that it's unlikely to be the case. ultimately now, optimism over tax reform, as that builds into the marketplace is more of a flattener, not a steepener. jonathan: just thinking about the longer-term issuance, it struck me as odd that we were told by treasury we didn't think -- they didn't think there was much demand for longer-term maturities. i could pick out a whole list of options we've had this year that signal terrific demand for duration. where do think we are getting at with that? mr. gartside: when you look in the european context, we have got european countries that a hundred years ago didn't exist now issuing 100 year bonds. so there is a definite geographic split here. when you look in europe and particularly in the u.k. there's this appetite for longer dated bonds. and in this sense, the longer the better. jonathan: priya, was it about demand fundamentally?

that people did want to buy it, or was it something else? ms. misra: i think it is demand. you don't have pension regulations like they do in europe or canada. there is no reason for a pension fund here to be extending out in duration. if they were to start issuing, and i think for treasuries, it is not going to be a one-off issuance. it's every quarter we would have to deal with a new 50 year. with vol, that convexity is not valued. maybe volatility picks up, but i think it's a demand issue right now. jonathan: we wrap up the program and the week with a rapidfire question round. short answers, if possible. powell plus a tax plan equals a flatter or steeper yield curve through 2018? flatter or steeper? mr. hornbach: flatter. ms. misra: flatter. mr. gartside: flatter. jonathan: treasuries range bound or 3% within a year? mr. hornbach: range bound. ms. misra: range bound. mr. gartside: range bound. jonathan: is carney still

an unreliable boyfriend? yes or no? mr. hornbach: no comments. ms. misra: i think not. jonathan: come on, nick. mr. gartside: he is an unreliable boyfriend. the surprise is he hikes more than is expected. jonathan: great to have you with me. matt hornback, priya misra, and nick gartside. as always, thank you for your time. from new york, that does it for us. we will see you next friday at 12:30 in new york, 5:30 in london. don't miss us. from new york for our audience worldwide, this has been "bloomberg real yield." ♪ retail.

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