jon: from new york city, i am jonathan ferro with 30 minutes dedicated to fixed income. this is bloomberg "real yield." ♪ jon: coming up, solid payrolls growth shows there is still more room to run for america's labor markets. shots fired in the u.s.-china trade standoff, and trade-off brings one more use to flatten the curve. the flattest since 2007. we begin with a big issue another solid payrolls report. , >> this is a very solid solid report. >> that was pretty encouraging. >> very good jobs report, no

doubt about that. >> would look like it is bad news when the unemployment rate rose up. but if it goes up because people are quitting their jobs more and heading back into the labor force, it is a really, really strong market. >> all around good news story, at least for the near term. >> this won't change the fed to change course by itself. a few more reports in this direction, if we do see a wave of people coming back to the labor force, i would not expect that, but as it does seem to be the case, it could cause an adjustment in their thinking. >> the fed will hike at least once more. why not more than that? simply because wage growth is still sluggish. >> the fed is going to go another two times this year, but i wonder how they are going to go if the economy starts to bend down a little bit and the curve is close to the peak of where you will go. jon: joining me in new york city, iain stealey and krishna memani.

let's to me from london, begin with you. solid, solid, solid. it's all i heard this morning. is that what it is? krishna: it was across the krishna: it was across the board, reasonably good. good for risky assets, for sure. good growth in employment. telling us overall economic growth is even. -- is decent. wages are stable. everything is playing out according to plan from the fed perspective. everyone turned around and said they were solid. through the week, it was the least anticipated payrolls report i've seen so far in 2018. why do think that was? iain: when you look at the major issue, jobs in the u.s. are fine. everyone is focusing on tariffs, and that is what has been driving the market.

i would agree with what was said on the payroll report here at it is all it. it had a little bit of everything, good job growth, but the wages did not tick up. that probably means the fed does not need to go any quicker than what they are doing at the moment caret what we are seeing is risk assets have done really well. if you look at the paycheck of the economy this is a chart i , look at. you can look at the hours worked, the amount of people working, how much they get paid per hour, and this is growing at the same rate that we did before the crisis. saying this is a solid number in some ways is a little bit of an understatement. this is really on trend and a good number when it comes to job growth. krishna: the difference is this is happening at 3.5% unemployment rate as opposed to 5% or 7%. that is the most remarkable thing. the fed does not have to tighten.

maybe in 2019, they will be backing off. from the path that they are down. jon: it raises an important question. i remember moving to the united date that i was told get ready for payrolls growth to moderate. we are not going to be able to continuously print 200k, 200k. guess what we are doing? we are printing 200k. how is that possible? iain: a lot of slack in the market. the unemployment rate goes up and the participation rate goes up. it shows there is still slack which is why they are going very slowly compared to historical cycles, and we could see good prints going forward. >> 2019 is when we will see the end of hikes. one of the questions is when the , curve starts to get flatter,

because the federal reserve continues to hike even with , these good jobs numbers, you wind up getting fears of a recession. flat curves, two to four years, before tend to precede a recession. the question becomes how worried is the fed about that. you heard the minutes yesterday, the fed is looking at the curve. the fed is worried and they're looking at the curve. there is not much they can do about curve flattening except changing policies. jon: the consensus view for most people in the market and most people who sit around the table with me is to play the flatten her. i am not asking the question, how much juice is left to squeeze and how much upside is there in two-year yields. krishna: if it is as flat as it is, the amount of juice is sucked out. it is really very small. what that is telling you is that the fed will be forced into stopping unless they want to get into a recession. if it inverts further, recession

is coming down the pike because they are going down the path of policy tightening. jon: i've heard this argument, i do not see a federal reserve that is too worried. certainly they are looking at the yield curve but they were not stopping at 50 basis points, they are not stopping at 30. when do they stop? >> i think they will keep going for a while. when we look at what is going on in the economy it is a very , different environment to other cycles because you have the big amount of money coming into the market from the european central bank, the bank of japan -- that caps that premium. that is what has kept yields down. what will be interesting in the curve is the second half of the year. today, 30 basis points. role and carry which is so in horton, is a roundabout seven bits a quarter. you need that to be at 15 basis points for the flattener to make you money.

yet, we are in an environment where we will see all this quantity coming. will we still see them demand from law and bonds? i won't be sit apply -- i won't be surprised. jon: the federal reserve has not gone through neutral yet, yet we are having a conversation about the federal reserve having to top next year. why? krishna: this is a new world. the fed was trying desperately to get real rates up and the markets want no part of it. and i the structural issues we want to sweep under the carpet. they are not going away. i think this is going to be with us for a long time, real rates are not rising meaningfully. if they rise meaningfully, we will have a recession. they do not want that at all. jon: is in a new world? ira: it absolutely is a new world.

one of the things we have to ask ourselves is maybe we are not at neutral yet, maybe we are. there is no way to actually -- there are tons of different estimates, my estimate for the real rate might be 3%. two more hikes, we are there. that is not saying very much. but, other people might think it is 2%. which would mean they have already reached neutral and will be tightening. you look at things like the yield curve. one of the reasons term premium is so low is because we are nearing the real rate being met by the front end. as we do that, if the fed keeps on tightening effectively, they are tightening beyond the neutral rates. that is where policy mistake comes in. jon: what do you think of people who turn around and say the long end of the curve is capturing the global bond market story, the trade story is another excuse to demolish the curve even flatter? if i got rid of the trade story

today, just like that, where with the tenure yield be? krishna: the likelihood that it would be at 3.5% or 4% is not in the context. with or without trade, the key issue is there are structural issues facing the global economy. it is not just trade related pressures. inflation is not rising globally to a meaningful level. that is not something that is going that way. jon: if you think the federal reserve gets to a point where they need to slow down, what stops first? balance sheet unwind or rate hikes? krishna: balance sheets unwind because that is something they are already talking about to some extent. because of reserve problems. with all of these things they have created with new regulation, i do not think they have a pretty good idea of how reserves are being used and they are at a loss to explain. jon: what is the methodology to understand? what should be the appropriate

level of the balance sheet? how do you do the math on that? how do you know? are we just putting our finger in the sky, what is it meant to be? >> realistically, the only way you can know the balance sheet is when reserve demand picks up. this is why there have been discussions about that. what happens is there is this interest on excess reserves and that was set at the upper bound of the range that the fed is trying to set the fed funds rate, but spring, right after they'd started to unwind the balance sheet, you started seeing the effective rate the , actual traded fed funds rate creep higher and higher. because of that, they said this is a reserve problem. i do not think it is. i think there are other factors, but this is why others are talking about stopping the unwind. jon: great to have you with us. from bloomberg intelligence, sticking with me. coming up on the program, this week's treasury build sales suffer.

a mini massacre. we will explain. this is bloomberg "real yield." ♪

jon: i am jonathan ferro. this is bloomberg "real yield." i want to head to the auction block where there was a condensed treasuries schedule due to the holiday shortened week. the weekly auction of four-week bills for investors paid bids, treasuries also sold -- the $48 billion and three-month bills with a 2.62 ratio. the bit to cover ratio was the lowest in a decade. $15 billion was priced in june and making it the slowest issuance for that month since 2013. high-yield also posted the slowest quarter in eight years.

finally, in europe, corporate debt sales had the worst first cap in seven years. issuance of investment grade corporate bonds slumped 30%. this week, an interesting piece came highlighting the unfolding credit squeeze. in a note that his team roach, they said the following. over the last six months, we've compiled a long list of individual surprises to appear to be more than coincidental. when viewed alongside the decoupling of growth tightening half, u.s. financial conditions and repricing of risky assets, we have all the hallmarks of a slow motion credit crunch. still with me to discuss is ivory jersey krishna memani and , iain stealey. iain, what do you make of that? we are starting to see financial conditions tighten. a slow mo credit crunch?

iain: he is completely correct. we have seen this idiosyncratic events that have built up and they have hurt risk assets. we are seeing significant underperformance. i feel when we look in the u.s., we could well see q2 could print close to 6% of nominal gross number. that is still a good environment for credit and i believe areas for the high-yield market and very low issuance this year, there is the ability for that market to perform. i still think those spreads are attractive enough to the default rates are low. even if it is a slow-motion credit crunch, you have a lot of carry baked in. >> low insurance can be a positive or there is an argument to say we have so issuance right now because they can't come to market at the price they like. krishna: if iain likes the high-yield market, he must like the investment grade market. the contrast between the two markets in the u.s. is extraordinary.

jon: what do you make of that? krishna: investment-grade market is driven by issuance. rising rates and then a whole lot of issuance. high-yield where issuance was relatively low and not as rate sensitive defined more equities , and equities are ok, and that is a good thing. your point about emerging markets and tightening financial conditions and the non-us markets, that is real. that is something the fed may not care about. but i think by 2019, they will have no choice but to care about. i think that is where the transition will take lace. jon: whether the feedback loop is still sort of there, whether we can get a u.s. economy that responds to what is happening in european high-yield and in asian high-yield and whether there is feedback into u.s. credit. right now, on the screen, equity bonds rolling over. enthusiasm about the u.s. economy and u.s. high-yield being the place to be, does that

change? iain: i do not think it does and i would disagree with the investment rate. there is a reason it has been selling off in the u.s. we have seen leverage ratios picking up. it has been classic late cycle behavior but we are not seeing that in the high-yield market. high-yield market leverage ratios is coming down following the energy crisis. there is a bit of a disconnect at that is why we have seen the underperformance. when we look at the rest of the world, the european market looks healthy to us on the investment-grade side, but you have got the elephant in the room. the ecb is going to stop buying corporate bonds at the end of the year. whereas the high-yield market in europe, it doesn't have that impact. they have not been buying high-yield ons. it now trades at a wider spread to the u.s., that has a good opportunity over the next six months. jon: what do you make of that? krishna: with respect to leverage, yes. the leverage of u.s. hybrid

market has gone up but that , coverage ratio is quite reasonable because of the high level of profitability. i disagree that reflects credit concerns in the market. it is a supply issue far more than anything else when you have a large m&a transactions coming into the system. market where flows into usual funds have been slow. the math is easy. jon: we are talking about a slow-motion credit crunch, the federal reserve, as we can debate, but -- let's assume they have. not by very much. my question, how are we going to get an ecb that can get away from negative rates when we are having a conversation right now about whether they moved by 10 basis points in september or december of next year? that is the debate right now, really? iain: first, they have to get rid of their quantitative easing program. slowly, they are reducing that. one of the ironies is if we wind

up with financial conditions continuing to tighten like they are, you wind up with a situation where the ecb cannot do anything except potentially reverse the quantitative easing program. how do you quantitatively tighten? how do you raise interest rates in an environment where you have it tightening so much? that is a big problem for central banks. that has been a problem for japan for so many years. when you reach the zero bound there's a limited number of , policy options that you have and the ecb may face the same options. krishna: ecb has even more challenging case from a cyclical standpoint. growth outlook is decent. we are talking about 5% or 6% of nominal growth, that in ecb terms is rolling over. it is a really big challenge, it may indeed be that the fed stops tightening at some point and the ecb does not get any opportunity to raise rates in this go around.

jon: great to have you with us, ira jersey from bloomberg intelligence. i want to get a check on where the market has in treasuries, , 2-10's. two year yield up by a mild two basis points. there is your curve flattening. down three on a 10 year yield. five on a 30 year. still ahead, the final spread. the week ahead featuring comments from mario draghi and the new numbers on u.s. inflation. much more in that. from new york, you are watching bloomberg "real yield." ♪

jon: i am jonathan ferro. this is bloomberg "real yield." it is time now for the final spread. coming up over the next week we , will hear from the ecb president mario draghi and get a new reading on u.s. inflation. plus, we have a rate decision in canada, u.s. bank earnings, and political meetings in europe including the one between president donald trump and the u.k. prime minister theresa may. still with me, ira jersey,

krishna memani, and iain stealey. just some final thoughts on the inflation story. everyone i've spoken to, you have been out front. saying, we will not get out -- inflation in any aggressive way at all. what do you see things going now? krishna: from a cyclical standpoint, we are going there and we may overshoot the 2% target. i wouldn't be surprised. the fed is being really smart and wise and basically making up stories to make sure they do not use the data point to tighten policy aggressively. that is the right thing to do from a policy standpoint. otherwise, they wind up with policy mistakes. >> it is not like the market is telling you there is going to be runaway inflation. you look at inflation breakevens and 10-year inflation breakevens, that is not runaway inflation. if you saw the breakeven curve of being very steep, that be

something to be concerned about where the fed would be fight -- i think more. the market is telling you that inflation is not really an issue. jon: do you have a better understanding under chair powell than you did under chair yellen? iain: i think it will be very similar. he will look at the data, analyze what is going on, and ultimately the view is that inflation is going to remain meek near-term. it could pick up because of a's effects. longer-term, the u.s. inflation is going to be low and that is going to be kept down by all of the cyclical structural impacts of low-cost providers, the amazon of this world, and low inflation globally. there is no inflation across europe. there is limited inflation across areas like japan and that is going to weigh down global inflation. they're going to monitor the data but they are not want to feel they have to go any quicker, i think they are going to look through those.

jon: the numbers are so good, that cannot be a problem. ira: it is not a problem. you can have real growth that is ok, low inflation. it is a goldilocks economy where you do not have runaway inflation and you do not have an employment problem. jon: it's time for the rapidfire round. you go into the boxes with short, sharp questions with quick answers. does the two tens curve inverts before the end of the year, yes or no? ira: ira no. krishna: no. iain: no. jon: have we seen the lowest unemployment curve of the cycle? ira: no. krishna: no. iain: no. jon: can the fed hike five more times without the ecb hiking once? ira: no. krishna: absolutely not. iain: i think they can. jon: raising some big questions. great to catch up with you.

ira jersey, krishna memani, and iain stealey joining us -- from new york city for audiences worldwide, that does it for us. we will see you. 6 p.m. in london from new york, , this is bloomberg "real yield." ♪

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