jonathan: from new york city for our viewers worldwide, i am jonathan ferro, with 30 minutes dedicated to fixed income. this is bloomberg "real yield". ♪ coming up, a jobs report leaving the federal reserve on track to deliver more hikes this year. political risk in italy, reminding bond investors bet that it might not hate it when it is needed most. and, a tough week for a former bond king. the biggest drop in four years. we begin with our bloomberg jobs report. >> the numbers are strong. >> it is good news on all fronts. >> is a good, solid game in the labor market. i think there which number was

very important, good news on the which front as well. >> even though the wages are just above 2.5%, it is still not strong. right? inflation is bouncing around too. real wage growth is pretty mute. people are dipping into their savings to continue to spend, and that is worrisome. >> 2.7 percent, welcomed the news. still not 3.7% is sustained. we are still not seeing the real acceleration, broad-based acceleration in which growth than we would like to see out there. >> it is pretty much a scenario where the fed hawks think they can move forward once or twice. some say three times, i say june is the last. . i think as you get into next year, is the fed going to go three to four times this year in total, they are going to go three to four times.

how much they go next year, i think is the question. >> joining me around the table and new york, chief investment strategist at p jim fixed income, and above miller, head of u.s. multi sector fixed income strategy at blackrock. great to have you with me. bob kamal i would like to begin with you. it is very hard to find any weakness in this job report today. did you find any? bob: i am sure if you look hard enough, you can find something to be disappointed with, but it is a really solid report. the labor market is in a good place, and our judgment is that it will continue to grow, albeit not at the growth it has been going -- the pace it has been growing at the past two years, and which will go modestly higher. jon: people are trying to poke holes in the macro bank drop trade, things in europe that are happening. things in the united states look decent. this data seems to back that up. is that what you see? mary: you would not think of how yields as being a safe haven, but relative to other regions, there are holding up really well. jon: ccc's more so. >> ccc's more so. was again, the problem for high-yield has been rates.

so when we get a high job number like today, it certainly keeps us cautious on the duration side and kip says still liking the triple c and the single be part of the market. jon: in terms of rates, it has been a strange week where some people started to remove rate hikes for 2018. does it still make sense? robert: we saw in 2015 that when you have that crisis and the chinese currency was on the brink of devaluation, the fed basically moved to the sidelines. we saw that early this year in january, when there was stress in the market and there was a volatility spike. people began to price the fed out. that is correct of the market, to figure the fed may get dragged into this because italy is a big country. the european project is basically 20 years old, they

celebrate the 20th anniversary of the ecb, say could be a systemic shock. that makes sense. having said that, as soon as you get past the peak of that crisis, and you begin to go back to pricing the realities and fundamentals on the ground, they are good. john: the fundamentals are good, so why do we have this spread? we got used to this a couple years ago, but more recently things narrowed. now, to have blown out again, where you have this 100 basis point spread now, pretty much, in 2020. 2020 is ages away, but this gives you an indication that this market does not believe the federal reserve can go where it it is projecting it is going to go. where is blackrock bob: we think in between those lines? the fed is moving. as my colleague on the clip earlier said, we think it will move three to four times this year total. so, june and then september, and probably december. but we don't think there are going much above, at least for the time being, much above 2.5%. the market is priced for a 2.5% terminal rate. 2.60, something like that. the gap in the dots. the market is a probability -weighted pricing mechanism, so it includes probability of higher rates and lower rates. the long-term neutral rate in this country is under debate. there is a fiscal policy impulse that is just now kicking in and it is likely to impact growth

and inflation for the next several quarters. but in the overall medium-term, with the demographic trends and of the technological innovation impacting inflation, we don't think rates are going as high as the clock suggests. jonathan: do you agree? robert: i see them going higher. they are going to have the scope to continue. the economy is good, and they will continue. by agree that once they get to what they perceive to be neutral, the onus of proof will arise for continuing to raise rates. although in the u.s., people are thinking, you know, 2% are 3%, these are not high interest rates. but around the world, rates are low. after being as high as 65 basis points, we're down to 20. bones after being as high as 65 basis points, are down to 20,

--bunds. so we are really in a low interest rate world and i think they will get a signal to slow them down again once you get to the 2.5% area. john: we could talk about the negative curve again later. we can talk about that later. mary, this concept of the federal reserve gradually moving through neutral. moving through neutral, how key is it for the federal reserve to get to a place where it can move through neutral? and what would that mean for risk assets in the u.s., at a time where we've had very accommodative federal reserve policy? mary: it is certainly interesting. as we have seen the fed move toward high-yield, we have seen so far this year, a good amount of outflows from the asset class. that being said, spreads have

been fairly stable, but certainly as rates rise, some of the more levered issue is in our markets could see headwinds in terms of the cost of debt. pointed out the tension in the -- jonathan: i saw a piece from a professor on twitter. he pointed out the tension in the market. the federal reserve is talking about moving through neutral. the market does not really buy it. the markets is the federal reserve as very nervous about inverting the yield curve, and believes that if the fed ultimately was to go neutral, they will have to invert the curve to do it. can the federal reserve get away with getting through neutral without inverting the curve? bob: it is possible. i would think that one of the important factors that will influence that outcome, is out of their control, which is treasury issuance. how does the treasury manage the growing deficit financing needs that they have over the next several years? so far, they have not extended the duration of the weighted average maturity and probably unlikely to do so in the near term. but a shift in technicals could easily help the fed avoid an inverted curve, even if they are

moving about their version or their assumption of neutral. jonathan: as we close this segment, every friday, if you went on vacation in the last couple of months and only checked in on the market on a friday, he would think nothing would have happened at all over the last two weeks, for the two-year. and hardly much has happened on a 10-year either. this curve has suddenly stabilized in tight ranges. another we have had a pretty vicious week, but if you look at the two-year, every single friday over the last five fridays, it is around 2.50. what is the signal you take from that? robert: the underlying fundamentals of growth and inflation, despite everybody's anxiety, are pretty stable. it is a good environment and the fed has been largely on their game. but by historical standards, they are being very cautious. i think that is the ultimate

change your seeing, not the intraday, it is often quite muted. i will point out that treasuries are wide relative to the internals of the fed funds market. and in fact, the fed funds swaps beyond the 10 year point are already inverted, they are only at 2.5%. i think the focus may change as the fund rate gets higher, and people realize that those expectations are inverting. jon: let's continue the conversation. robert is sticking with me, and mary from hsbc global asset management as well as above miller from lack rock. coming up, the auction block. italy bringing some relief to markets following this week's meltdown and the nation's bonds. this is "bloomberg real yield." ♪

jonathan: i am jonathan ferro, this is "bloomberg real yield." to the auction block now, where italian bonds have gotten relief. the country sold 3.6 billion euros of five-year and 10 year debt, with an average yield substantially higher than last month. the nervousness around politics showed up across europe this week, including in poland, where they may scrap its only regular bond auction planned for june, leaving its calendar blank for the first time this year. and in european in corporates's, only 82 billion euros of bonds were sold across may, a decline of nearly 60% versus a year earlier. just a handful of investment grade issuers brave to debt markets this week, posting the slowest week for sales this year. still with me, are my three guests. bob, let's get your thoughts, the take away from europe this week. wow, the lack of liquidity of operating like this.

what lessons did we learned this week? bob: a couple of things. at a broad level, the markets are much less forgiving this year, relative to past years. you have mentioned thibefore on this show. this notion of the six-year aggressive monetary policy that provided a tailwind for all financial assets, that's changing. it is changing most in the u.s., but it is also changing globally. markets are less forgiving than they have been, and i don't think that will change anytime soon. specifically with respect to italy and the european situation. it highlights the degree to which that market is based upon very aggressive -- bond market valuations are primarily a function of very aggressive monetary policy intervention, unconventional policy pursuits. and one there is a question

about whether or not the central bank can or will continue to support aarket, the difference between fair value with intervention and fair value without intervention, is a really big number. jon: did you try to get involved in the price action? on tuesday, when we saw the market drop ridiculously low in italy? robert: there were definitely opportunities there. i think that as unstable as the situation in italy is, europe is really still on very strong footing. compared to 2012, they have taken phenomenal steps to really strengthen their system, and a lot of those countries are reaping the benefits. growth is strong.

the ecb is in a good place if they need it to support them. but the italians have in line. they have to stay with the program, that was definitely in doubt. but with other countries seeing their spreads widen, portugal, spain, there are absolutely opportunities, even in france. jonathan: liquidity totally evaporated in one of the biggest bond markets on the planet. what should the lesson be for anyone in high-yield? there has always been the sense that you can get out when you need to get out. but the fact of the matter is, when you need to get out most, you can't. do you apply the lessons we could've learned this week to your world, to high-yield? mary: to be honest, we think about it a lot. we saw that during the mini-energy crisis in high-yield a few years ago. and that is certainly not lost on us. it is something that we keep in mind, and all of our portfolios. jonathan: it was a difficult week as well for bill gross, the former bond king. having one of its worst days in its fund, since the inception of the last four years. i actually caught up with bill gross and asked him what went wrong this week in terms of the strategy. take a listen to what he had to

say. bill: our strategy basically, which was the basis of the question, has been a strategy that has been short german bunds and long u.s. treasuries. you know, the spread between the two is historically high. for instance, on on the 10 year, u.s. treasury versus the 10 year bond, it is 250 basis points. it has never been at that level. jonathan: that was bill gross. bob miller, if you are expecting that spread to narrow, and you want to do it by shorting bunds and going short u.s. treasuries, how do you do it? we have an incredibly distorted market. inflation south of 2%. can you short bunds? is it just a widow trade all over again? bob: you can short them for sure. whether you will reap a profit, is a very different question. i go back to their prior comment, to echo what you just said. german bunds do not trade at valuations that have anything to do with german economic fundamentals. the trajectory of growth or inflation, is a function of negative short-term interest

rates set by the ecb, and overwhelming intervention through large-scale asset purchase programs. yes, there are running less now than they were a year ago and are expected to taper toward zero. our expectation is the ecb will have a very difficult time exiting large-scale asset purchase programs over the next three to six months, even though they may very well dial it down going into 2019. but those markets, they are not free to trade based upon economic fundamentals. so it makes very challenging a relative value trade against a market that is less influenced by the central bank intervention. jonathan: robert, your thoughts on that, the idea that we might have a widow maker all over again. but it is not japanese, that this time it is german. robert: the problem is that the ecb is in the market, but there is a huge captive buyer base that has the top end of the treasury market. they can look at all these different markets on a hedged basis, and when they're looking

at jgbs at a five basis point yield, in germany, bunds are up .5%, there is a decent amount of carry and small amount of negative supply. so, these things are like a gold commodity. so, to go and short them, is honestly very dangerous, despite the fact that by some measures, yields are low and they look expensive. jon: that spread got. down to about 320, 2 years. bunds versus treasuries, can it stay that wide? i spend so much time asking that question. do you think it can stay that wide? robert: the chances of it going wider are going to be like 50-50. the fed will be marching along, presumably another 150 basis points. two years are going to have to go with a lot of that movement. by the same token, the ecb is probably going to be stuck trying to get to zero for two years. so that spread is going to be under pressure. all the while, germany will find

a slight surplus. there's absolutely no supply, and on the treasury side of it, a massive amount of treasury issuance. jonathan: it is a pretty crude way of capturing the transatlantic divide. the european economy versus the u.s. economy. but there are not many better ways to do it than comparing -- just comparing where bunds are and treasuries are. does by american ring true to you at the moment? is that where people should adding exposure? mary: a feels like for now, yes. the u.s. high has held in quite welcome as a mentioned. the european high-yield has been underweight this year and we have been long for some time on european high-yields. earlier this week, as it widened on italy, we did take some of that protection off, because as you mentioned, away from italy, european fundamentals still look pretty healthy. with that said, for the u.s., we're not jumping up and down about high-yield and certainly recognize that if things were to

get worse in europe, we could see spreads widen, but for now, it still feels like we are pretty insulated. jonathan: thank you for my guests for sticking with me. next up on the program, we will bring you a market share for where bunds have been this week. twos, tents, and 30 yields. believe it or not, after the week we have had, down just one basis point. on the 10 year note, we are down by about four basis points. just south of 2.9 0%. still ahead on the program, the final spread. the week ahead as trade tensions spread. this is "bloomberg real yield". ♪

>> timeout for the final spread. trade will be front and center once again. wilbur ross this weekend, the

european mission president speaks in brussels. leaders at the g7 summit in quebec. plus, tesla holds its annual shareholder meeting. i am sure we will find time for that next week. still with me, robert, mary, and bob. rob, going into next week, there may be some concerns after that stellar payroll report that we will have to start thinking about the fed going forward five times this year. what is the message to not fear the fed this year and beyond? robert: one is bond side and the other is that this is a less liquid, later cycle environment. so at this point of the cycle, typically the fed is moving, but the long-term yields are stabilized and the higher fixed income products tend to perform very well. at the same time, your equity volatility tends to go up, and progress in the market tends to

slow down. we are not looking for a recession, but as you get closer, the risk will be rising. the pessimism is not the way to go in terms of the long-term fixed income. we are not at 1.5% on the 10-year note. we are pushing 3%, and i think that is a big number these days. jonathan: how do we know where we are in the cycle? i keep hearing a lot of people talking about late cycle. what is late cycle to the team at blackrock at the moment? bob: late cycle is a really challenging debate. economically, with unemployment rates below the natural level of unemployment, that would suggest that we are later in the cycle. it as we also know based upon history, that does not change

until something disrupts it and it is subject to change a lot. financial markets strike us as reasonable valuations in fixed income, likely to get a little cheaper. but not by a lot. risk assets are kind of reasonably valued, but the growth trajectory is the harder question. piling on fiscal policy at full employment is not exactly the prescription we would have suggested. it creates -- we think it creates a larger risk of kind of a boom-bust scenario where things look good for the next several quarters, then the lack of organic replacement demands could create this operation risked their we had is a tricky environment. but the fixed income market is reasonably priced for the balance of outcomes. jon: i want to wrap things up with tricky questions. the rapidfire round. three questions, three short answers to close out the show. the first one being, and italian election before year end? yes or no? robert: no. mary: yes. bob: no. jonathan: long btp's or long spain through year-end? 10 year maturity? long btp's or long spain through year-end? robert? robert: i like them both. spain is a much easier call. mary: spain. bob: can i short them both? jonathan: there we go. the trump twitter account, is it the new leading payroll

indicator for payroll friday next month? yes or no? robert: no. i bet on volatility, so no. mary: hopefully not. bob: no. jonathan: you guys wanted to avoid that. they got their pr standing in the corner. great to catch up with you. robert, mary, bob. that does it for me from new york. that does it for us. we will see you next friday at 1:00 p.m. new york, 6:00 p.m. london. for our viewers worldwide. this was "bloomberg real yield." this is bloomberg tv. ♪

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