♪ jonathan: from new york city, i'm jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, payrolls beat expectations, but wage growth leaves economists disappointed. municipal bond issuance explodes for a record month as investors try to get ahead of a tax bill. and wall street pushes back, the first full junk-bond deal of december. we start with the big issue, payrolls deliver, wage growth disappoints. >> this is a solid report. the topline number is spot on.

the data is pretty solid. >> we are starting to create jobs, but we are not creating enough decent jobs. >> wages are a little weak. 2.5% is moving in the right direction. >> this is another example of positive real growth where inflation remains tepid. >> what people haven't talked about is once again the employment to population rate went down with three percentage points below where we were in 2008, and that is why there is no wage growth. full employment is a long way away. there is lots of slack in the economy. >> i think there is some hidden labor out there. the participation rate is down significantly from where it was 4, 5, 6 years ago. we need to allow workers to keep more of what they earn, but more importantly, we need to be able to drive more wages to our hard-working citizens of this country. we very firmly believe tax reform will drive to wage

growth. jonathan: joining me in new york is oksana aronov alternative fixed income strategist from j.p. morgan asset management, richard clarida at tempo, and colin robertson from northern trust asset management. good to have you with me. rich, when will be break out of this story of decent momentum on payrolls for wage growth not doing much? richard: goldilocks has stayed at the party a long time. it is good, supportive for markets. rates are low. data is decent but surprising on the upside. inflation below target. you pointed out what is the plausible risk for the current scenario that we do get a pop in inflation above the market what -- above what the market expects. on that scenario, depending on how the fed reacts, to get some repricing. we are always from that. jonathan: no matter where it comes from, it informs the goldilocks story. growth is solid and stable, inflation is low, and it doesn't seem to be accelerating.

do you see a regime shift anytime soon? oksana: i think there are a lot of factors stacked on one side of the boat. meaning obviously economic data is all around positive on every front, whether you look at china or the u.s. or europe. this one missing piece, if the investors are waiting for the missing piece, inflation to accelerate, for the fed to accelerate, i think that is a precarious position to be in to not be prepared for that. one thing central banks are focused on is asset inflation. jonathan: is this going to change? is it like a cold spring or something that will creep up slowly? colin: i think it will creep up slowly. actually, i am more concerned with the fact inflation could be less than the market might think or investors may believe. jonathan: what will get us there is it like a cold spring or something that will creep up considering how we are already priced in the market? colin: i think it is a structural situation with inflation across the globe. if it is a situation where we continue to have employment report after employment report, groundhog day with inflation

expectations there but not coming to fruition, i think i'm more worried about the fed wanting to raise rates three times next year and inflation not supporting them. jonathan: what will happen to the yield curve? it's been a big story once again this week. early this week at one point, two's and ten's were going to test 50 basis points. what does this look like next year, this relentless flattening of the yield curve? can anything turn that around? richard: what i would say is i don't think the yield curve is all that much of a mystery. the slope right now is comparable to where it was in the last cycle. once you adjust for the decline of neutral rate. people talk about inverted curve. i agree, if we get an inverted curve, i start to worry, but i think if the fed gets the funds rate up and we get the data we are thinking we are likely to get, i don't see the curve inverting. where you get an inversion is if the fed overshoots neutral. if we get a big overshoot in

neutral, we will get an inversion. i think under the baseline i don't see it. jonathan: if we can stick with this chart, it's an example of where the pressure of the yield curve is coming from. it's coming with the two-year note pushing up much higher over the last 12 months. as you look at that break down, 10's have not done a lot. it has all been on the twos. what will that look like next year? oksana: let's think about why all the pressure on the 10's. potentially, investors view banks as inflation fighters. potentially people view the ecb as the easiest place in the world. that is creating demand for the longer end. what you should not be doing is inferring that bonds are telling us something we don't know, that the stock market doesn't know. i think you have to be realistic. the only thing the bonds are telegraphing is it is an artificially priced asset class. until the artificial demand is out of that part of the market,

we should not be inferring anything about its forecasting powers. jonathan: let's be clear, the artificial demand is not coming out of the market anytime soon. oksana: it is going to peak around the midpoint of next year. somewhere between now and then, the market will have to reckon with that unless guidance changes dramatically. let's not forget, this is what -- the issue i have with the year. somewhere between now and then, the market will have to reckon bond price rationalistas and the people trying to come up with reasons for why bonds are priced rationally. we are getting increased treasury supply because the fed balance sheet is shrinking and we have a fed chair coming in who's talking less about their revision -- we are looking at bond price rationalistas and the strong economic growth and looking at central-bank concerns about inflation, asset inflation, and we are looking at a late cycle fiscal stimulus that is likely to go through. what is that going to do to the inflation expectations? jonathan: to her point, at the

start of that comment, it was about treasury issuance. now the treasury issuance story could be frontloaded at the front end and less along the back end. is that going to put more pressure on what the yield curve looks like? richard: i think it is a factor for the following reason. one big difference from the precrisis period is banks have to hold a lot of so-called high-quality liquid assets for strong economic growth and regulatory purposes. right now, the path of least resistance is to hold those excess reserves. as the fed drains those, there will be a demand for treasuries. some of that is essentially going to be absorbed under the current regime. but you are right.

deficits are projected to go up and there will be issuance hitting markets for the first time. the other thing i would like to point out, the fed's balance sheet reduction plan, which they began in october, is very bond market friendly. even though the balance sheet is shrinking, they are still buying treasuries and mortgages each month. it is really a year from now, according to the current plan, when it starts to roll off more rapidly jonathan: i want to get to what we will probably call the powell-draghi spread. it is two-year bunds versus two-year treasuries. earlier this week it was approaching 260 basis points. i keep asking the same thing over and over again, and then we go higher. how much oxygen is left up here? can we go much wider than where we are already at? 250-something on two-year bunds versus treasuries? colin: i think we can. we have a lot of things going on. i will bring up a chart if i can really quick. it is the world bond markets. if you take a look at it, you mentioned two-years. i have two-years here. this is just in the data range on the right-hand side over the last three months. if you take a look, everything is virtually near the low for the three-month period. as you mentioned also in the u.s., where we are seeing

pressure of the yield curve coming from the two-year side of the equation, in the u.s. that level is 181, at the high of the three-months. i think that will continue. i think unless there is a change to the growth trajectory and inflation expectations in europe, that the spread actually can widen further. jonathan: we have a question from a viewer. given the low supply dynamics, bunds are continuing to rally. how low can the 10-year bund yield go? i think unless there is a change to the growth trajectory and inflation expectations in europe, that the spread actually oksana: the most overpriced asset class in the world, possibly beaten by bitcoin. [laughter] jonathan: this is a bitcoin-free zone. oksana: that sounds good to me. in the short-term, the technicals can do whatever it is they will do. over the medium to longer term, neither the inflation data in europe -- nothing at the ecb is guiding lead us to believe that bunds have a tremendous amount

of rally here. i am looking at a screen here, a much simpler one in water one. you have $9 trillion in negative yielding securities of the world. this is potentially an interesting point in time to be short and get paid for being short, which none of the other people present here are sitting at the terminals right now have experience doing or ever faced this kind of reality. there is a differentiated thinking about opportunities. it is warranted. jonathan: how do we address this chart right now? how will this change dramatically anytime soon? this is staggering. historically, look at it. on the left side, it's unheard-of. richard: this would be my take on it. the u.s. two-year according to my baseline will continue to go up, not excessively but gradually under powell. meanwhile, the front end in eurozone is basically pegged out to at least midpoint of 2019. where it gets interesting is you will have a transition. draghi's term is up in november of 2019. it cannot be extended as in the

u.s. we cannot have draghi forever. there will be a post-draghi ecb. at that point, if the european economy is humming, the markets will start to romance a higher rate path in the eurozone. i think that is a 2019 story. i think for at least 2018, this chart can even be wider. jonathan: everyone is sticking with me. oksana aronov from jpmorgan, richard clarida and colin robertson. coming up, the auction block and potentially a record month for municipal bond issuance, and they are outperforming. that is next. this is "bloomberg real yield." ♪

♪ jonathan: from new york city, i

am jonathan ferro. this is "bloomberg real yield." i want to head to the auction block now. the tax discussion in washington continues to reshape the money market. municipalities are rushing to sell tens of billions of dollars of securities before congress enacts legislation. december supply may eclipse the record for the month setback in 1985. next year's issuance is projected to fall. sales are strong in junk bonds. they usually tail off after thanksgiving. thanksgiving. not this year. november saw thousands of bonds double compared to last year. a little push back from investors. mcgraw-hill's $250 million pay in kind sale was pulled. buyers focused on the double-digit coupons in a market starved for yields. still with me, oksana aronov from jpmorgan, richard clarida from pimco, and colin robertson. so, the market does have some standards. oksana: the market does have standards after all, although you would not know it. i am looking at a screen right

now where you can see the bottom line item. that's a bb rated european utility issuer with a 1000-year maturity bond. jonathan: you told me about this and i had to double check it. is that really 3017? oksana: a whopping 2% yield. that is the power of quantitative easing globally. i want to bring up another interesting contestant. this is a bond from pressure, interesting contestant. this is a bond from pressure, double-b maturing next year. this one is yielding -39 basis points. jonathan: -39? oksana: -39 basis points. this one is a different issue. -39 basis points. jonathan: my question to you, is how does this make sense? why are we still doing this when the ecb is talking about pulling back, why are we still in the high-yield market? planning for capital returns and not for yield? does it make sense? colin: it makes sense to me.

the first thing i would say as i never thought i would say this. i think i would buy bitcoin versus the 1000-year. but i do think it makes sense. the central banks are going to reduce their accommodation slower than investors think. when i look at the high-yield market right now, overall with an option adjusted spread around 350 basis points, over the next year, that could give us a total return of 6%. i like the fact with respect to the picks, there is some discretion with the types of high-yield investors might buy. i still think it is a very positive market for the next 12 months. oksana: one thing to be aware of with respect to the high-yield market is it is structurally a different market than it was nine or 10 years ago, with etf's playing an enormous role. today, etf's comprise something like 4% to 5% of the market. it was essentially zero in 2007. what does that mean? you have very dramatic price discovery, prophecies or gaps up and down. that should inform a much more tactical approach to buying and selling.

we were extremely positive on the high-yield space in 2015 and 2016 when most people hated it. i was on the record saying ccc's will outperform, and they have. at this point in time, outside of some very selective pockets, in lower rated parts of the market, we are taking, reducing our exposure significantly. jonathan: how are you reducing your allocation to high-yield? the high-yield space in 2015 and 2016 when most people hated it. the question i keep answer, whether you have been compensated for the additional risk. on a total return basis, over the last year, picks outperformed all the high-yield. this year they have underperformed broader high-yield. you are not really being compensated on a total return basis to take the additional risk and go for the junkiest debt.

does this story accelerate that if you do take risks, you will not be compensated in the way you hoped you will be? oksana: that is the story generally whether you talk about interest rate risk or credit risk. you are not compensated for taking on additional risk. this becomes a part of the cycle where security selection matters tremendously. again, it is very specific to certain pockets. broadly, you are not compensated. double-b's are 200 spread. underperformed broader you are not compensated for the risks. selling it broadly and buying it very selectively, looking for floating rate structures and where we can find them, although that market is no bargain as well. definitely, i think there is no substitute for optionality. optionality means being hedged, so owning credit on a hedge. it means having liquid structures you don't need to be selling when come around. jonathan: we've had immense spread compression in credit markets, forcing people to places maybe they would not like to go.

as it gets late in the cycle you think about late cycle behavior. i'm thinking more about illiquidity and where they may be should not be? richard: that has been the focus at pimco for several years. a lot of good news is priced in. we think investors, especially in fixed income, should have a keen eye on liquidity. to be frank, use rallies and spread tightening to adjust the portfolios out of less liquid positions. as new money comes in, have a higher fraction of it in cash, absolutely. jonathan: you guys are sticking with me. oksana aronov from jpmorgan, richard clarida from pimco, and colin robertson. we want to get a check on where the market has been this week. it looks a little something like this. yields up at the front end by two basis points. the u.s. 30-year. up a single point at some very marginal corporate flattening if

you account for those things right there. compared to the last few weeks, price action pretty muted. still ahead, the final spread for the week ahead featuring rate decisions for the federal reserve, the ecb, and the bank of england. that is next. this is "bloomberg real yield." ♪

♪ jonathan: from new york city for our audience worldwide, i'm jonathan ferro. this is "bloomberg real yield." time for the final spread. coming up over the next week it will be pretty busy. u.s. tax talks. bitcoin futures. we begin and end our bitcoin conversation. you have talks in washington, three key central bank decisions and an eu summit. a brexit breakthrough came this week. a lot of things to look out for over the next week. around the table, oksana aronov, richard clarida, and colin

robertson. rich, as you look across the three central bank decisions, if you had a focus on one, which is the most important? richard: you have to focus on the fed. the fed will actually do something. unless we get hit by a meteor, the fed will be hiking rates next week. even powell in his hearing signaled his desire to do that. it is fully priced in. we will have janet yellen's presumably last press conference. we will get a new edition of the dots. in terms of the ecb and the bank of england, draghi laid out the game plan at a prior meeting. i think it will be little news in this meeting. the bank of england, no decision but we will see if there is any dissent. jonathan: do you just assume the news conference after the next news conference is the same but with jay powell there instead of janet yellen? oksana: i think because everyone assumes that is going to be the case that powell will be a continuation of yellen. i think it could happen very quickly, or she will step down as soon as he is approved. very likely he will be at the january meeting. he may be viewed as a dove and a

continuation of yellen, but he is very outspoken on deregulation. that can have some ramifications for the market that are not necessarily being priced in right now. jonathan: colin, yellen 2.0 or different this time? colin: i think it is 2.0. i think that clearly some decisions could be different. the fact powell came in and was very similar in conversation with respect to how yellen spoke to the markets, no change or shift yet with the expectation that has been sent out that they would like to raise rates three times next year, i think that is basically how the first quarter will look. i think the real issue for me and where we can have something with respect to the market that could change the course of the fed, is if as we talked about

yields today, if the 10-year rate continues to contract, powell will have a real issue saying to the markets if they want to raise rates three times in 2018. jonathan: let's get to it. shall we wrap up the program? time for the rapid fire round. the three of you go into your boxes, and i ask a series of questions. we keep the answers really short. first question, as we going to 2018 and everyone looks at a flattening treasury yield curve, will we get an inversion at some point next year on the treasury curve? inversion next year, yes or no? oksana: no. richard: no. colin: no. jonathan: that is easy. oksana: boring. jonathan: that is easy. credit and high-yield. picks or broader high-yield? through next year, total return, which will get the most outperformance? oksana: broader high-yield, but you have to be selective. richard: agreed. colin: broader high-yield. jonathan: next one. as we look to next week with the central banks on deck, put the fed to one side and think about this.

who hikes next, the ecb or the boe? oksana: the boe. richard: the boe. colin: ecb. jonathan: there we go. we have a market. oksana aronov from jpmorgan, thank you very much. richard clarida and colin robertson. and of course, pimco the official sponsor of "bloomberg real yield." from new york city, that does it for us. we will see you next friday at 12:30 new york time. this was "bloomberg real yield." this is bloomberg tv. ♪

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