jonathan: from new york city, i am jonathan ferro, this is bloomberg real yield. coming up on the program, goldilocks growth. the status doesn't quite fit the optimism. the beginning of the end for the good times in credit. and looking ahead to chairman powell's first news conference, penciling in another rate hike. we begin with the big issue, is goldilocks just a fairytale? >> we are able to see these big increases in the labor force and

jobs growth without seeing a big push up in wages. at some point that ends, and when that starts to end, i think we will see a reaction in the bond market. >> inflation has got an enormous amount of inertia built in on the downside and on the upside, and it will move slowly on the upside. >> the fed is going to have to pick up the baton and say we are responsible for leaning against the economy so we don't get an inflation spiral going. and i think that is going to create complications, especially as the market has to start repricing for more and more rate increases. >> a little inflation is not so bad, but it is a pretty slippery slope. you can go to two and change to pretty fast. three jonathan: is the genie out of the bottle? >> not yet, but it is knocking. i'm thinking about coming out, and if i do, then what? jonathan: we have a full house here in new york city. joining me around the table is bob michael of j.p. morgan asset management. kathy jones, fixed chief income strategist, and doug people's,

cio at alliancebernstein. great to catch up with you. kathy, the issue with goldilocks. this week's data, retail software, it doesn't quite paint the picture that everything is ok in the u.s. economy. kathy: keep in mind first quarter is always a little soft, and we had a pretty good first quarter in terms of consumer spending, so i think what we are seeing is a normal retrenchment that you see, particularly a lot of credit card debt was run of -- up over the past couple of months. there is always a tendency to recoup. in general the economy still looks pretty good. job growth is good and that drives it. jonathan: bob, are things maybe not as brilliant as they seem? things seem ok, but are they as good as people expected them to be this year? bob: things are awesome right now. jonathan: walk me through why. bob: i love the current environment. look at capacity, look at small business optimism. it posted the second highest reading in history. the highest was september 1983, and that was during the reagan

reform years. you look at wage gains, they are starting to pick up. and you look at the central banks. they are basically being slow and gradual and normalizing at a glacial pace that we in the markets can easily absorb. jonathan: doug peebles? douglas: i think people are looking in the wrong place at inflation. we don't have much consumer price inflation or core pce. wherever the fed is. inflation is in asset prices. everybody thinks that is a great thing. if you define goldilocks as a buoyant economy, which i think i agree with bob, we not only have a buoyant economy in the u.s. -- we have a buoyant economy globally. we have very little pressures on consumer prices, but we do have asset prices that are quite robust. jonathan: bob? bob: but this is what is so great. the central banks see the asset price inflation also. why are we fighting this? why don't we embrace the ecb? they have got moderate growth, moderate inflation, they have got asset prices inflating, why change interest rates?

why not just leave it there and let us enjoy the asset price inflation until it spills over into the real economy and you see an inflation surge? douglas: how did that work for japan back in the late 1980's and 1990's? bob: they are still figuring it out. douglas: it did not work out. bob: yeah, but they have got the asset price inflation going on right now. they have optimal yield curve control. it is spilling through. jonathan: another single jgb 10 year that was up traded. tuesday it killed the market. bob: 0.0. the boj owns between 70% and 80% of jgb's. kathy: i think it's dangerous. i think it reaches a point where it is dangerous and the bubble pops. i think in some markets we are pretty close, but it is always the trouble, how do you time that? how high do the fed fund rates have to go to get that? i would argue we are not there yet because it is still below the rate of inflation and so we still have very easy conditions right now. jonathan: michael.

bob: i think the fed has a long way to go. projections come out. i think the dots will drift higher. they are behind the curve. kathy is right. it is a negative real yield. they are not interested in normalizing a volcker-esque pace. for us in the markets, that is just great. jonathan: so you guys all agree that things are great, fine. so what is it in the price? if i can bring in the short positions of treasuries, the consensus is get your short treasuries. if you put that against the yield, i'm wondering if the pain trade might be developing in the short-term here, bob. i borrowed this line from elon musk. is it stormy weather brewing? bob: where is it? we should have seen it by now. the short position has been built up for a month and a half. why are we 250, 260? it is because you have got the central banks continuing to run down their balance sheet, particularly the fed. so there is an incremental amount of selling that is going on. you have a lack of flows coming in overseas because the cross currency basis has shifted.

if in fact a short base were a big problem, i think we would see rates a lot lower. we have to accept that we have not seen rates lower. there is more selling is to come. jonathan: doug? douglas: i agree but the ecb is still doing 30 billion euro per month. i think that you see that impact on the bund market. right? every time the bund market wants to react to the data, all of a sudden the weight of 30 billion a month of the ecb weighs on it. the italian election is a perfect example. italian bond yields should be wider on the results of that election, and they are simply not. the notion of price insensitive buyers impacting markets has not gone away yet. bob: but the magnitude has declined. january of last year it was 167 billion a month of new money being printed coming into the government bond market. last month, less than 40 billion. so there is less of a backstop there. and by october, it turns into net contraction. doug: yeah, and i think in october, we will have to see what that actually means. bob: it is a bond market that

can support itself. douglas: exactly. jonathan: kathy do you see that , inflection point in october as something to worry about? kathy: i do think it is something to worry about because the fear of easy money is coming to an end. it is just doing it very slowly and gradually. as that happens, i am keeping an eye on the dollar because i think the currency market has been ahead of the other markets in this cycle and could signal, if we start to get a move up in the dollar, that could signal a further tightening of financial conditions. jonathan: do you see a catalyst for that? kathy: you know, i think based on real yields right now, it should be higher, but clearly we have supply problems in terms of the u.s. market, both in terms of deficits and trade imbalance, we have a lot of political uncertainty weighing on it as well. i would argue the dollar probably has got some room to move up from here. jonathan: another flashpoint has been a push higher in libor. if we can bring that up on the screen for our viewers. bob michael what is going on , here?

a lot of people scratching their heads, some people have decent explanations. what is yours? the liborok at overnight index swap basis. there are a number of things going on. one is there is a tremendous amount of issuance of treasury, 300 billion has put some weight on the market. you also have repatriation of foreign cash. a lot of the tech and pharma companies have cash overseas, they brought it back and liquidated short-term corporate, that put more pressure on the market. on top of that, you have cross currency swap basis shifting. so it's not as attractive for foreign investors to invest in the front end of the u.s. market. jonathan: kathy. kathy: yeah i would agree 100%. , i don't think it is particularly dangerous right now, not signaling that banks are having trouble funding themselves or anything else, but you know, in keeping an eye on it, and as libor goes up, it does drive cost up for a lot of lending in the united states. and that is a concern. jonathan: doug. douglas: i have total agreement. i would just caution one thing,

that oftentimes we tend to sort of discount that the price move does not matter at this time, and because we have ways to explain it away, and then all of a sudden you look back and you say we should have listened to the libor spread. jonathan: it is not just libor. you can look at commercial paper and short dated bills in america. there's something on the front and it is high-yield. and you wonder, we tried to have this conversation on this program over the last couple of weeks when does it compete for , capital in a significant way? doug: i think it is probably indicating that there is the notion that capital is wanted by the real economy, which it has not wanted for a long time, and so the financial markets will have to compete with that, and that shows up in price or yields. i think it is happening. bob: you look at three-month libor, 2.1%. suddenly, if you take a profit in an asset class, you have a place to put your money and generate a return. you are not your own anymore. it's creating competition. jonathan: kathy just finally.

kathy: i think you are seeing in the equity market, dividend payers are losing ground because people can stick with shorter duration much less risky asset , and get a similar yield to a dividend yield. jonathan: you are sticking with us. kathy, bob michael from j.p. morgan and doug peoples from alliance. coming up, the auction block. campbell soup offering this week, gives the corporate bond market some indigestion? coming up. this is "real yield." ♪

♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield." i want to head to the auction block now where russia's bond sale is defying its most recent diplomatic spat between the

united kingdom and the rest of the world. bids for europe on sale for russia were almost double the $4 billion on offer on the news that the 11-year note narrowing is -- is narrowing from initial guidance. in the u.s., another round of treasury offerings. $223 billion to be exact. we will highlight the average demand for 10-year note, fell to the lowest level since 2009. and over in the u.s., investment grade market, campbell soup sold $5.3 billion of bonds to fund its acquisition. the bonds did not narrow through execution and weakened after they were sold. still with me now, bob michael from j.p. morgan, kathy jones, and doug peebles. in the good old days, 12 months ago, you could narrow through execution. they would go into the secondary market and then continue to rally. that didn't happen with campbell soup. a lot of people use it as an example to say maybe it is the beginning of the end of the good times for investment grade credit. what is your view? douglas: i think it goes back to this discussion we had around the central banks. it is not an on-off switch, but they are slowing significantly.

the liquidity that has been available 12 months ago let's say is a different level now. again it is a dimmer. we don't expect to see lights out at any point in time, but markets are behaving today i think more normal than they were 12 months ago. namely, there is a name that comes up. there is a concession in the marketplace. it prices, it does not trade immediately stronger, but we are digesting it, and from the day after issuance until now, it is actually doing reasonably well. jonathan: kathy. kathy: there has been a lot of supply to absorb, a huge amount of supply to absorb, and you have the expectation of higher rates down the road. so a year ago, i'm not sure everyone believed rates would move up and be higher six months or 12 months from now. now if you are a buyer, you have to give some concession to discount the potential gain. jonathan: it's not dramatic, but it is certainly something you should take some time to look at and pay attention to.

do you see some fragility some , soft spots in investment grade? bob: no, i don't. i think the market got addicted to two massive flows into that market. one was asian cash coming in, when hedge backed yen in particular was attractive to the local market. that has dried up as the u.s. yield curve has flattened. and the second option a lot of , the offshore cash trapped on corporate balance sheets. of course with tax reform, this all gets repatriated. the market is trying to adjust to the absent of those two flows, which i think covered up a lot of deals. jonathan: we caught up with scott of guggenheim, the cio over there. this is what he thinks you should do with credit. scott: in fixed income, people should be dramatically upgrading the quality of their portfolios. you know it is time to get out , of high-yield. bank loans typically performed fairly well at this phase, but at some point you should be out of it. investment-grade corporate debt, i would get out of. jonathan: kathy jones, your

thoughts on that? kathy: well we are not , underweight, high-yield or investment grade, but we have been moving up in credit quality, and we have been for some time because spreads were so narrow and the premium you got for taking credit risk was low. i would agree to some extent. and the other problem is timing. you don't really know when the cycle turns until it turns rather abruptly. we think it is time to dial back the risk now. bob: i think when you look at bank loans, and in this market today, things that we worry about are liquidity and crowding. and i can't think of a better example of where we have double the risk than bank loans. you have a tremendous amount of people who own that asset class to frankly don't understand it very well. the second thing, the liquidity is not good in that market. in fact it is terrible. you get crowding and liquidity, that is what we would sell. jonathan: bob.

bob: i have been doing this 37 years. i don't remember a time when corporate america has had more financial flexibility. so i certainly would not be a seller of credit in here. i think the horizon looks pretty good. when you look at credit spreads, high-yield in particular, you can build a model. there is only one thing you have to get right. the expectation of default rising. and that is highly correlated to an approaching recession. if you don't see an approaching not going tou are see default rising, and you are not going to see a lot of pressure on the high-yield market. i would like to buy cheaper but i will take it at jonathan: 6.25. isn't that the point, if it is so good and corporate flexibility so great, the rough end of the deal is an investor hands? bob: in some transactions, maybe. but by and large, no. they have got this enormous tax windfall coming to them. it is not a one-time windfall, right. we get hung up on that. it is year after year after year. they do have a lot of flexibility. jonathan: doug. douglas: i think when you look at the average credit quality of the investment-grade market today, it is pretty darn low.

i am with bob, you want to clip your coupon as long as you can, i am also with kathy that it is hard to figure out when to worry about clipping the coupon. but when the time comes, i think the amount of ig issuance that falls into, you know the fallen , angels so to speak, it will dwarf anything we have seen. jonathan: we can bring up the leverage of investment grade, it has been picking up, in the data and in the numbers. nevermind the sentiment. we have seen it isn't it? , kathy: that is one of the biggest concerns. you have had a huge increase in leverage on corporate balance sheets. so again when the moment comes, , when that inflection point comes, when it is harder to service that debt or you know you are just not getting paid a lot to take the risk. jonathan: the leverage is picking up? bob: it is true. the leverage is picking up, but i would argue companies did the right thing last year when they built up that leverage. they access ultra low generational funding and return ed some of that to the shareholders. this is a new year, earnings estimates are up in the have

-- are going up. they have the financial flexibility, tax reform windfall and they will generate earnings to cover the leverage. jonathan: in terms of a big story this week, it goes to show investors can be terrible at timing toys "r" us. ,you bring up toys "r" us, and it is easy to say you can take , your point, and you can look back on things and explain them away perfectly. no one saw this coming in early september when this debt was trading close to par and then out of nowhere, bang. bob: i'm sorry. toys "r" us is new news. people have not been looking at brick-and-mortar stores. and talking about the threats. jonathan: we have doing it for years. why was it trading near par in early september? bob: i don't know. maybe it's the passive etf story. [laughter] douglas: i am with bob. jonathan: playing the -- [speaking simultaneously] jonathan: bob michael from j.p. morgan, kathy jones from charles schwab, doug peoples from alliancebernstein. i want to get a check on where the treasuries have been.

two-year going higher by two basis points, down five on the 10 year down eight on a 30 year. , some curve flattening once again in the treasury market. still ahead on this program, it is the final spread, the week ahead featuring rate decisions from the federal reserve and the bank of england. this is "bloomberg real yield." ♪

♪ jonathan: i'm jonathan ferro. this is "bloomberg real yield," and it is time now for the final spread. coming up over the next week, it is a big week to come with federal reserve chair jay powell's first rate decision and news conference since being elected. fed chair, plus you have a decision from the bank of england, a new governor of the bank of china, and another potential u.s. government shutdown that not many of you will be paying attention to. still with me bob michael from j.p. morgan, kathy jones from charles schwab and doug peoples from alliancebernstein. kathy do we assume that the , federal reserve next week

grants from three, otherwise cointreau? kathy: you need four dots to move to get the median to move up. i think it is doable. i think it is possible assuming , that powell is one of them, i think we could see the dots grind up a little bit. jonathan: doug? doug: i think we are going to certainly see some sort of entering higher in the dots very they should be moving higher, but i think the real story is the market is coming up to meet the dots. it has been a long time since we have that in place. jonathan: without much encouragement either. it just kind of happened. bob, incredibly enthusiastic in the last 25 minutes, but isn't -- as a central bank or, isn't it most prudent to have optionality as a central banker and leave the upside risk of a four rate hike move further into the year and just leave it at three? bob: i think they will leave it for hikes this year. three we are interested in the longer term dots. where is the two and three quarters moving to? is it getting back to three or maybe even a bit higher?

jonathan: is there a catalyst for that to shift up? bob: i think so. i think the -- there is pretty good growth and the labor market looks pretty tight. why not start to get back up to a level that looks more rational on the historical perspective? jonathan: if the federal reserve started to guide higher for longer-term rates, how would the market react? kathy: it is something we talk a lot about, but i don't think the general public talks a lot about this. jonathan: i don't think they talk about this. kathy: i don't think they do, but if you start to see the terminal rate move up, i think it would catch a lot of people's attention. 10-year yields tend to peak with the fed funds rate, at the peak of the fed funds rate, so we see the terminal rate move up. we could expect bond yields to move up as well. jonathan: is there a reason for terminal race to shift higher instead of dropping it? douglas: not necessarily. if you look at what potential growth is in the u.s. economy, it has not changed much and productivity is what productivity is. jonathan: isn't that the point, here, bob?

the long-term production potential of the economy isn't improving that much? you might get a short-term boost from a fiscal stimulus plan, but longer-term, what is the story? bob: i think longer-term you can expect some shift. i think you are at a generational transition. the baby boomers are moving out. we are passing that on to millennials. you have to plan for that. we are coming into more of a technology-based economy. at sometimes you are going to reach capacity there. and when i look at the dots, i don't know how forecastable they have been. it strikes me that they have been pretty coincident to the rate of growth as a is unfolding in front of the fed. jonathan: we will begin with a quick question with some short yes or no answers if possible. does the fed signal four or stick with three? bob: three. kathy: four. douglas: four. jonathan: have 10-year treasury yields peaked for 2018? bob? bob: not even close. kathy: no.

bob: no. jonathan: have we seen the bottom for credit spreads this year? have we seen the bottom for credit spreads this year in ig? yes or no? bob. bob: spreads are going tighter. jonathan: they're always going tighter for you. kathy. kathy: yes, we have seen the low. douglas: pretty close to the low. jonathan: great to have you with this, fantastic program with us. thank you for joining us, bob michael from j.p. morgan, kathy jones from charles schwab, doug peoples from alliancebernstein. from new york, that does it for us. we will see you next friday at 11:30 a.m. new york time. 3:30 p.m. london. this is "bloomberg real yield." ♪

♪ haidi: more turmoil in dumpedton, the u.s. has and coming dialogue from china. betty: a new head of the pboc will succeed the 15 year veteran. boss, will make the new same as the old boss. wins and a landslide and is russia's longest serving leader since stalin. betty: the g20 with trade tension at the top of the agenda. live in windows are is.