♪ jonathan: from new york city, i have jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ coming up, republicans take another step towards cutting taxes. corporations may have to wait until 2019 for 20%. cracks in credit. bonds fall the most since august. is there a message in the treasury market? the yield curve is in the flattest level in a decade. we begin with the big issue, junk-bond pain. >> high yields at the moment

anyway. >> is this a couple of isolated cases or the start of sending broader? it still seems more isolated. >> clearly the tax package will create winners and losers. >> tax reform has to happen. if it doesn't happen, it gets ugly. everything gets ugly very fast. >> it is no longer agreement for credit markets. it is more yellow. there are still some companies with decent fundamentals, but there is a lot of sectors or more sectors under pressure. >> you're not getting paid an awful lot. avenue -- as an investor yet to be careful. these days when the markets rollover it feels volatility needs to rise. >> my concern is what if the -- a goes to 260? that could be an genuine competitor to the credit market. that is where i think the bleed could be more systemic.

>> the 800 pound gorilla is whether or not this build of a corporate leverage which we have seen over the past few years is sustainable or does it lead to something less benign? jonathan: we have a full house in new york city today. joining me is henry peabody, subadra rajappa, and ashok bhatia. ashok, the situation in credit. we have seen this twice already this year. in the spring, again in august, and now as we approach the december and end of the year, will we see what we saw earlier in the year? ashok: i think this one is a little different. best guess is credit spreads are probably in for the year. there are two things a little different about this selloff. there are some fundamental deterioration, whether it is in some of the telethon names, retail names, pharmaceutical

names. there are some real disappointments. it will be hard to re-rate these credits. and tax reform -- we're seeing a house bill in the senate bill. these are creating winners and losers. some of the losers will be in things as varied as hospital bonds and the municipal market potentially, to cruise ship securities. we are starting to figure that out. as we focus on the winners and losers it will be something a little bit of an overhang. jonathan: henry, the same thing. it started out as a stock specific story. then at least through the sectors. sprint, the deal collapses. then it goes into the telecoms and it spreads in the health care. those were the leading declining sectors. is it sector-specific for you? business become an asset class problem? henry: i completely agree. there are some fundamental concerns. but from a valuation standpoint,

and that is the starting point of this, i think some of the wentrn really is that we into a negative correlation story and pile in the low volatility. as you start to get a whiff that equities are going to selloff with rates, it becomes of a question of our models and how we think about credit and risk and rates. that is what has happened. do we have a larger unwind? it is very possible, from some free stretch valuations. jonathan: did you see the valuation problem? subadra: this is an intended consequence of quantitative easing. in an environment where yields are low, and versus desk investors go out further and further to get returns. what happens is over time you start having this risk buildup in the system. the question is about risk versus reward. in a very simple term. to me, i feel like we might be

at a tipping point where the risks might outweigh the rewards. jonathan: we have been talking about that for a long time. i could ask any guest around the table, are you being compensated for the risk you are assuming in the market? they would say no but there is no alternative. you can say to people is that priced properly? they say no but they bought it anyway. why is it different now? ashok: take a little bit of a step back. we are in a synchronized growth environment. it is hard to see that changing. spreads may be tight. we may have a blip/ . does that mean we are about to have a 2008 experience? we don't think so. the drivers of a big default cycle in u.s. credit, they are not there right now. jonathan: something you said. the economy is doing well. i wonder if the credit is somewhat divorced from the

economy anyway given the way the rest of the market has been trading while the economy is recovering. look at europe. we were incredibly tight before this year, before the dana got better. we had a guest this week that said the taxes come through, as the economy gets better, as treasury yields back up, you will not have a good environment for credit. maybe the opposite. what the you say? >> it is a question of degree. say we have a 30-basis point in treasury yield and a widening of credit and we're sitting with the same u.s. growth environment, which is a reasonable hypothesis. we think we will see for demand. one of the big stories in credit has been the demand from japan, from overseas, from asia. our client race would view that as a backup and an interesting place to invest. assuming the economy is level, which is our guess.

henry: one of the things to think about is the mammoth flow and passive and index-based products. that is providing support for the tesla's and netflix's of the world. the question becomes, what happens when there is call on liquidity in the broad market? we see it extending in a private credit and private equity. that call on the quiddity will be the public markets. what happens then? you need to be caught isn't of the risk of those brought markets. jonathan: have you seen any of that this week? any evidence of selling of things that are the most liquid and things you can't sell? henry: that is what we have not been seen. it is fundamental-driven. watch for the cracks to spread into a more broad-based call on liquidity. so far it has not happened, but that is how these things get started. they don't start in the most obvious of fashions.

you can never see the catalyst for a negative move ahead of time and 10 point it. -- pinpoint it. your news about the economy is well taken, but what about saudi arabia? what about the risks in the middle east? there is a lot of risk in the market right now. we are not compensated for it. jonathan: something that struck me this week that i thought was different and it happened in thursday's session, equities soft, credit soft. german bund yields higher. did you figure out what was happening? subadra: it comes to the central banks and communication. comead a very dovish ecb out a few weeks ago at the meeting. the market overreacted. he saw a rally after the announced a tapering of assets. you had an official saying that the markets are very complacent. low in the hold, the start to

see the selloff in bunds. now we have an environment where the european union is going -- having its best growth in almost 20 years. it feels in that environment that yields are very low and they have to be repriced higher. jonathan: do you see more risk in high-yield or more risk in the suppose it risk-free asset like treasuries? ashok: i will pivot quickly. we see risk focused in certain i.t. sectors, focused and 70 interest rate sensitive double b high-yield segments. you don't want to over exaggerate these risks. the issue with the sovereign bonds issue is you have japan thinning 10-year bonds. european at negative. those are two big gravitational pulls. we get to 270? absolutely. is it a bigger story than that?

we don't see that right now. jonathan: everyone sticking with me. henry peabody, subadra rajappa and ashok bhatia. coming up, the auction block. last week tim cook opened the doors for the sale of the iphone x. this week he was selling aliens of bonds. high-grade issuers shrugging off market weakness. this is "bloomberg real yield." ♪

♪ jonathan: from new york city, i am jonathan ferro. this is "bloomberg real yield." the auction block now. muchgrade issuers very fall to the head. the iphone maker sold $7 billion of unsecured bonds in six

parts. the second-most active u.s. nonfinancial issuer of debt this year, just behind at&t. ups with a more than $5 billion offering. the company sold that across -- yielding one percentage point. u.s. treasury sold $23 billion of 10 year notes at 2.314%. the demand and the yield at the lowest levels since september. still with me is henry peabody, subadra rajappa and ashok bhatia . let's bring up the chart of the week. for many it is the chart of the year. many people thought it would get steeper. a lot flatter, the yield curve. take your place in looks something like this. a bounce over the last couple of days, but the trend is pretty clear. what is the signal, the message

that comes out of that chart? subadra: you have to look at the yield curve and context of the current market environment. you have technical factors like the treasuries refunding announcement last week. they will be focusing more on issuance. that puts pressure on the backend of the curve. a rallying on the backend. you also have some longer-term secular trends that are keeping bond yields at the long end of the curve in check. demographics is an important thing for considering. you also have the savings g lut, entremed is the man from overseas accounts. -- and tremendous demand from overseas accounts. at some point you will become a concern for the fed if it does get to be too flat. one, it will really hurt bank profitability. two, as an investor if you look

at the curve, you are not getting adequately compensated for taking risks. jonathan: you have this classic flattening. i wonder whether it is the message for the fed to slow down. does that have to be there takeaway? henry: i don't think so. in my guess the curve will probably end up shifting higher. that will be a source of volatility. one of the most underappreciated risks today is inflation's. . not ready to give up the supply and demand of labor will push prices higher. we expect things to happen sooner than they actually do. i think we probably see the move higher. your point about the curve, whether it is funds, two's, ten's, it does not move as if they think the fed is crediting rates. watch out. there is too much risk. there is too much capital trapped in the long end of the curve that has been reading for

yield through duration that is going to be in a bad spot. jonathan: what is the evidence? henry: i think what we see is we've had a history dating back since the 1970's, and beforehand, since the inception of the bloomberg government index. it has returned to something like 7% annually. that is supposed to be a risk i can free asset. you have those numbers that are put in a modern portfolio theory models. priceve qe, ldi, passive, insensitive buyers coming into the market that push prices to really ought not the long. when a bond is bought by virtue of its spot in the model, not for a total return opportunity, it says to me it is a little long in the tooth. jonathan: i feel it we have been talking about this for a while. i was having this discussion earlier on bloomberg tv about the cracks in credit.

then a headline dropped from the spanish treasury. they will issue 50-your debt next week. will the market so that up in a big way? many would say yes, it will. ashok: i think the remains demand for long-duration sovereign debt in this environment. it is global. it is probably related to what japanese and the european bond curve is occurring. we are thinking about it. the fed is hiking where inflation is at best unclear. that is sort of a big picture recipe for curve flattening. the curve is likely to change. we have potential to change next year the fed signals it reached the terminal point or inflation starts ticking higher and we believe the fed will accommodate it a little bit. those will be the signals for a more structural shift in the curve. your chart is a trend. it does not look like it is about to break. jonathan: would you can see the moves have taken something away from future growth?

something away from inflation expectations and of driven the long end lower? subadra: absolutely. you have an environment where inflation is relatively benign. an environment where the global stock of central bank holdings is very large, and has grown tremendously over the past two or three years. it really takes a volatility out of the system. that's wereironment volatility is low and returns are also low, do have this sort of flattening of the curve. jonathan: i'm thinking about how do we express this in the market? what is the actual trade? it has been really painful. if you don't want to do that, you see the market developing in the way you anticipate, what is the best way to anticipate that? i think it is still in positions of will benefit from continued curve flattening. it is the time to start thinking about shorter duration, fixed income yields.

we have the 10-year at 230. 125 is 230 against they funds rate. investors have to give up less income to come to a shorter duration strategy. i think that is a trend that will continue. the margin is how you react to what is going on. jonathan: these guys are sticking with me. henry peabody, subadra rajappa and ashok bhatia. let's get a check over bonds have been. treasury. yields up higher at the long end by about seven basis points. we have been watching -- talking about a flatter end curve. you end up with a steeper curve to finish the week. coming up, the final spread. the continuation of president trump's trip to asia. this is "bloomberg real yield." ♪

♪ from new york city, this is "bloomberg real yield." high-end jonathan ferro. time for the final spread. the president of united states continuing his first official trip to asia. a summit over in the philippines. u.s. economic data includes cpi and earnings from walmart as well. with me is henry peabody, subadra rajappa and ashok bhatia . subadra, earlier this year if the like the guys were all on the same page. some got together and portugal for the last be conference. they all cannot a little bit more hawkish than people expected. is is coordinated or sexist market chatter it doesn't count for much? subadra: i don't believe this is

coordinated. it will be a conference about communication and communication strategies. communication has been a struggle. if you look back at the last two decades, we have seen an evolution of the communication strategy of the fed, between greenspan, bernanke and yellen. the market tends to overreact sometimes the small things they say. we saw a large selloff after the taper tantrum in 2013 when ben bernanke spoken jackson hole. bund markettly the sold after medically after draghi's comments at sentra. i think you medication is more art than science, and that is something that needs a lot of work. jonathan: player the struggling to community so much? henry: i think there are a great number of constituencies looking for different messages. it is a challenging role. you are talking about markets

hanging on your every word. i frankly think they are not doing as awful a job as you might say. the yellen fed has done a good job. there are a lot of expectations about what the order of operations would be and they clarified that. that tells us the ecb is probably about a year or two behind the u.s. and that is why we are seeing this growth spurt and we will see two of the largest price insensitive buyers are government bonds walk away slowly from the market. it fits in with the bund move. it says to me watch out for rates. harp on that topic. jonathan: cap responsive will they be to the market moves we have seen in the last week? if credit continues to flatten. we had another deal today. canyon resource just called a deal -- pulled a deal. next week these guys take center stage, are the sensitive to was

happening in the debt market? ashok: i don't think so. these moves are still in the grand scheme a blip. they arethe ecb, doj, looking at the real economy at thinking about if these moves will filter into the real economy and slow growth. i think it is premature to have that view and the central banks will see that on a fed path for the hike in december. what has happened this week is not sufficient to change. henry: i completely agree. you take a long-term chart of spreads, it is really just a small hook at a low level. there are some sectors under it is genericher pricing or balance sheet issues in the telecoms. this isn't a widespread issue by the stretch of the imagination yet. it is also worth talking about leverage is extended. we are seeing the tail end of a credit cycle. now we can extend that with growth, but you see a deal like that being pulled and it is

something that is to be expected at some point in the cycle. there has been deal after deal come through. you have seen supply increased radically. one of the things we like to think about is how when bankers sell something they know there is demand for it. bankers are not in the business of having deals fall apart. we are just starting to see it. years whencouple of bankers can get deals done and that's when you want to buy it. jonathan: thank you for joining me. henry peabody, subadra rajappa and ashok bhatia. thank you very much. that does it for us from new york. we will see you next friday at 12:30 new york time. this is "bloomberg real yield." ♪

♪ >> it is 1:00 in washington, 6:00 in london. from bloomberg world headquarters, i'm david westin in today for david gura. shery: welcome to "bloomberg markets: balance of power."

david: here other top stories at this hour. the house is moving forward with a tax bill hoping for a vote next week. it will have to face up with a different version in the senate. on to vietnam. president trump continues his asia trip, meeting with his asian and pacific counterparts at the apec summit. china opens up. as president trump leaves beijing, the government decided to let the u.s. and other western companies buy majority stake in chinese banks. will u.s. banks want in? ♪ shery: it has been an intense week for tax reform and senate republican leaders debuted their own attempt at a massive tax reform yesterday. that sets up a showdown with the house over what