jonathan: from new york city, i'm jonathan ferro. this is 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, treasuries gearing up for higher rates a , one-month t-bill breaking 2% and emerging-market central banks tighten policy, russia's the latest to hike rates. and 10 years since the lehman collapse. does the postcrisis market have a liquidity problem? is the story of divergence becomes a story of convergence. >> united states and the rest of the world. >> the u.s. and everything else.

>> in the u.s., we are not taking risk off quite yet. >> 2019 will be a year of convergence. >> 3% in the second half of next year of up to a half. >> are going to see convergence. >> u.s. economy is performing very well. >> convergence and earnings. >> the next couple of quarters look very strong. >> convergence between tech and the rest of the market. >> and you know what, the economy looks great. jonathan: a full house with me in new york. gershon distenfeld. subadra rajappa. and krishna memani. your thoughts on the convergence -divergence argument taking place right now. ms. rajappa: the divergence seems to have continued. my concern is if you listen to the ecb this week, they are

pretty much on hold for a good portion of next year, qe is anticipated to end sometime by the end of this year and what that really leaves them with is very accommodative policy. in contrast, you have the u.s. raising rates potentially four times over the next year, which makes it hard for the eastside -- the ecb to tighten monetary policy if the u.s. tries a slowdown for the later half of the year's divergence could stay on a little longer than we anticipated. mr. distenfeld: i agree. we are forecasting six times until the end of 2019. in the short-term, you are going to continue to see divergence. mr. memani: if the framework works out, convergence-divergence won't matter, all of this will go in the tank if the fed tightened six times and the ecb doesn't do anything because the dollar would strengthen to a level that

would be unsustainable for the global economy. at the end of the day, the conversation about divergence -convergence has to come down to economic fundamentals. the markets are diverging because economic fundamentals are diverging and until they start converging, there is not going to be respite. the real question for me is does this convergence that we are looking forward to, does it come about and more importantly, if that convergence comes through what? with u.s. growth slowing down of -- down or the rest of the world's growth speeding up? i think that's a very important question. jonathan: where do you answer that question? mr. memani: i think the likelihood that emerging markets and to some extent european growth is on the back of emerging market growth, the likelihood that emerging market growth accelerates in a meaningful way at this point , unlike 2015 and 2016, is very unlikely now. if there is going to be a

convergence, it will have to come from u.s. growth slowing down. we saw no evidence of that just yet, our hope is it will manifest itself. we will see. jonathan: one of the pain trades off of this convergence -divergence debate has been the spread between tens, germany, the united states, it's been wide, wide, wide. i spoke to bill gross earlier this year, who expected the spread to narrow. it has not worked out. do have any confidence that's going to narrow? ms. rajappa: i think ultimately the fiscal stimulus really caught a lot of markets, you have 4% gdp growth for the third quarter and we are tracking the second quarter and a 4% for the third quarter. that led to the strengthening of the dollar as well as higher treasury yields. treasury yields are 3% right now, and bund yields are still

stuck at 20 basis points. mr. distenfeld: in the short-term the story is the relative difference in economic outlooks. the u.s. is really strong and we might have a problem with the dollar rallying to the point where it is a problem for global growth, but that is not the main concern of the fed at the moment. if you look at the longer term, you look at deficits that continue to be a problem in the u.s., something we probably don't talk enough about, and running very loose fiscal policy at some point, the chickens are coming home to roost on that and the dollar might actually suffer as a result of that. in europe, we can argue about the exact timing, but you have to expect rates to go up in the long run. that's also unsustainable. 45 basis points on 10 year bond -- bund yields is not sustainable. jonathan: you touched on something we talked about earlier this week. do we really face a scenario, a risk-averse scenario where treasuries are the risk-free

assets that people been for in a drawdown and risk assets? do we really face that scenario? mr. distenfeld: we've been arguing forever that level matters. how much can we rally starting from 3%? we saw that, we got to 1.5% and that could happen in the short-term. it's much harder to see that the long term. but yes, in the short-term, when you have stress, people are going to go to safety. safety is going to be the dollar , and treasuries in the u.s. mr. memani: janet yellen said the fed should prepare themselves for a rerun of zero rates. that tells you all the policymakers are thinking. today, because of fiscal stimulus, everything looks hunky-dory in the u.s. and will probably grow at a rapid clip. a year from today, two years from today, if that scenario plays out and the fed tightens

six times in 2019, expecting u.s. growth to continue at this level is preposterous. it cannot sustain itself on the curve would be totally inverted and the dollar would be meaningfully stronger and you have a correction everywhere. in that environment where treasury rallies and rally in a meaningful way. mr. distenfeld: two more times this year. four times next year. i don't agree with that. policymakers also say the long-term average rate should be about 3%. another six times will take us to a little bit above that. that is not necessarily unsustainable. it might be a problem for the rest of the world, but the u.s. could continue to grow even if that kind of level. ms. rajappa: that's the fed raises twice this year and we go 2019, 2020.on in a framework very we are calling for slowdown in the second half of next year and 2020. maybe that gets pushed out a little bit but that's an eventuality and this is not just in our forecast. if you look at the fed forecast, they have a slowdown in growth

as well in the coming years. in the forecast, they can't show you an actual slowdown or rate cut or recession, but that's kind of what the consensus seems to be, a slowdown in two years. jonathan: 2020, i keep hearing about 2020, on this program and other programs. where does 2020 come from? ms. rajappa: the way i look at it, we're already at the longest -- by the middle of next year, this is the longest business cycle. i'm not saying business cycle s die of old age, but you are starting to get to a point where you are reaching capacity and you are at full employment. the rates market especially is poised for protection. you are at 3% yield on the market is not poised to price in a rate cut yet. things can't just a that way for the foreseeable future. around 2020, something has to change. jonathan: it's a shallow recovery and it could go on a lot longer than people think. mr. memani: absolutely and that's our central theme. if -- it is 2020 because it's not 2019.

from a forecasting horizon standpoint, it's very convenient. that is the flip answer. the real answer is it is contingent on the fed tightening meaningfully, that's four or six or whatever we say the number is in 2019. if they do that, the likelihood that we get into a recession increases meaningfully for 2020. having said that, my expectation still is that this ends up being a much longer cycle than any of us has ever expected for one simple reason, which is inflation hasn't manifested itself in a meaningful way and until we see that, betting against the cycle has been a wrong bet. mr. distenfeld: it's already been a longer cycle than almost any other cycle, but it is -- but i think the flip answer is the real answer. in 2016, we were saying 17. once we realize we are hopeless at forecasting in the short-term, within go ok then we have some inside a year or two

from now. we see this in many phenomenon, the maturity walls or the high-yield debt comes up every time. look two or three years out. it's a natural thing. jonathan: your basic argument is this economy can tolerate ratesields, the higher that krishna thinks it can't tolerate. you think economy can tolerate higher yields and a much higher interest rate. mr. distenfeld: the real fear is i don't know for going to have a recession in 18 months or not. the scary thing is what if we start to see growth slow at the same time inflation is creeping up area what is the fed going to do? the feds have said they would rather err on the side of easing too much rather than on doing too much to keep economies going. you might have to err on doing too much to stall that growth so you don't have an inflation problem down the road. jonathan: you are all sticking with me. coming up, the auction block.

italian bonds under pressure as the new government looks to form a budget. this is "bloomberg real yield." ♪

♪ this is jonathan: "bloomberg real yield." month has this already topped $16 billion and has been absorbed well. $6 billion in for tranches for the biggest issuer of the week. elsewhere, the u.s. sold a combined $73 billion of 3, 10, and 30 years this week, the second largest such of --

largest batch of those. italy, auctions of 3, 7, and 30 year debt all drew weaker demand. the seven-year sale received bids worth 1.28 times the offer size. italy very much a topic of discussion at this week's ecb briefing, with mario draghi who expressed concerns over the country's new government. >> words have created some damage. interest rates have gone up for households and for firms. all of this hasn't created much spillover to other euro area countries. remained, at least so far, pretty much an italian episode. jonathan: still with me, my guests.

it looks like a bit of a snooze fest right now for the ecb. how do you think the policy path adjusts in the next 18 months? ms. rajappa: we had the ecb meeting this weekend and we didn't get a whole lot of specifics on what they are going to do on the policy fund that is new that we didn't already know. they're going to lower the pace of asset purchases in october and they are anticipated to end qe at the end of this year and normalize policy sometime in the middle of next year. they're basically telling you, yes, we are aware of what's happening in italy but it's not really a policy concern as of yet because the rest of europe seems to be doing quite well. jonathan: european credit is different. a stat came from your team the u.s. high-yield has outperformed global high-yield for the most since 2002. is that really true? >> it is not that big of a gap,

you're just talking about corporate debt. u.s. high-yield market has done better than almost anyone would have expected. the real underperformer has been emerging markets and we know that's a story name and last time i think we agreed upon that's probably where the real value is. you have to have a stomach for it because there is going to be some volatility, but that is really where the performances come and that's what value seems to be in the marketplace. jonathan: your argument seems to be diversify away from u.s. high-yield. is that right? mr. distenfeld: it might not be right in the next month or two but if you look or evaluations -- look at where valuations are and where we are in the cycle in the u.s., it makes sense pattern of that's convergence or divergence, in your language, in all likelihood you are going to see stuff outside the u.s. over the next 12 to 18 month outperform. jonathan: that is convergence. mr. memani: i'm glad to see him talk about getting away from high-yield. that is a nice change of pace. we continue to believe the best value in credit is really in emerging markets because they

have corrected in a meaningful, meaningful way. the spread between u.s. high-yield and emerging markets is probably the largest it has been in a long, long time. having said that, there's going to a lot of volatility and it's going to depend on the convergence working out the right way. jonathan: can we get more polarization within the em complex? mr. distenfeld: absolutely and that's important. you cannot just say all of em. is two completely different markets. for 75% of the country or so you haven't seen that. it hasn't done as well as but has on underperformed. you are talking about argentina and turkey into a lesser extent result in russia and they are , all things that have to happen, they are all policies that have to be put in place in the dollars were to be a big story. jonathan: give us a flavor of what you have been up to. mr. distenfeld: not a lot. we went into this year positioned with quite an bit in

-- quite a bit outside the u.s., and that underperformed. we added a little bit into it. we think argentina is particularly interesting and at the end of the day, their support from the imf, you have two-year local bonds yielding 60% and the odds of that outperforming over the next couple of years is very, very high. mr. memani: emerging markets is the best value, if you buy anything at the margin, that's where you look at value. let's be clear about one thing , that is emerging markets, not just dollar denominated debt, it is local currency. local currency has underperformed u.s. markets in a meaningful way across the board. there is a tremendous amount of value there. jonathan: guys, you're going to stick with me. in the markets, a check on where bonds have been this year, too's, tens, 30's. yields higher at the front end by seven basis points.

cycle highs on a two-year, 2% on a one-month bill in the treasury market. have a think about that, up 4% basis -- up for basis points on the 10. still ahead, the final spread of the week from the bank of japan , and the the 10th anniversary through the weekend of the collapse of lehman brothers. this is bloomberg real yield. ♪

♪ jonathan: i'm jonathan ferro , this is "bloomberg real yield." coming up this week, we have the 10 year anniversary of the collapse of lehman brothers, plus a summit in korea and decision from the bank of japan cannot and economic data in the united states and across europe as well. with me to discuss is gershon distenfeld, subadra rajappa and krishna memani. 10 years looking back, i want to look forward a little bit and think about post crisis, how this market has changed.

a lot of people point to a illiquidity and what should be a very liquid market. has liquidity changed in the treasury market? ms. rajappa: you really see any change in liquidities, still looks like a very liquid market. where things are fundamentally changes on the regulatory side. dealers like ourselves have to subject to leverage issue requirements that constrain our balance sheets. we are less willing to warehouse treasuries like we used to in the past. to a littleleading bit of illiquidity in the market. jonathan: people point to that sleepy day in october 2014 when treasuries have this huge move out of nowhere and a lot of people think about that moment and think about what could happen on a really, really bad day when money floods into treasuries. what does october 2014 mean to

you and can you really tied back to the regulatory regime can post crisis? mr. distenfeld: that is an important factor. equal amounte an of buyer and sellers, but the walmart bonds and the sellers might be wireless. there's often that ten-year treasury bonds, there's a buyer and seller. there's certainly much more matching of orders, but that does expose the market to if you get one-sided trade one way or the other, you could see very sharp movements. mr. memani: the picture for liquidity really comes through in off the run treasuries than a -- then it does on the run treasuries and then the picture has certainly deteriorated. whether that's a bad thing for the markets, i'm not so sure. why should we be making really liquid markets on every security? how does that help us? having said that, i think the

point about the corporate market is a good one, and innovation in the corporate market from a liquidity standpoint isn't the dealers and anything of that sort. it's really that etf's. etf's are providing countercyclical liquidity that you would not normally get because of the aggregation of the risk, you can get speculators to take the other side of all corporate investors looking to dump corporate bonds. corporate investors go one way. they are buying all of them or they are selling all of them. normally because of the disaggregation, people have a challenge. with availability of etf's, that has helped in a significant way. jonathan: a final word on that , a shift to passive. mr. distenfeld: a lot of credit etf's are not really passive. they do have sampling, they can't buy every single bond in the market. the second thing is it's helping from a liquidity perspective it's been a disaster for investors. particularly high-yield. you look at hyg, j and k, they

have woefully underperformed actively managed high-yield funds and there's this perception that going passive beats active and that may be true in segments of the equity market, but it's the exact opposite. spend more than 10 years since the things that come to be an d 85% of actively managed funds net of fees have beaten these things. jonathan: really good final point. i will take the opportunity to ask you quick final questions. get ready. do treasuries keep their risk mitigating characters six in the next downturn? mr. distenfeld: yes. ms. rajappa: yes. mr. memani: absolutely. jonathan: have we seen this cycle wide on treasuries versus bunds? on the 10 year maturity. mr. distenfeld: not even close. ms. rajappa: no. mr. memani: not close, but we're getting there. jonathan: i did this just for you, this final question is for you and you don't have to play

if you want to, subadra. i'm giving you time to do it. u.s. high yield or leveraged loans? mr. distenfeld: high. u.s. high-yield by a wide margin. ms. rajappa: pass. mr. memani: leveraged loans. jonathan: we will do that another time. subadra rajappa, gershon distenfeld and krishna memani. that does it for us, we will see you next friday at 1:00 p.m. new york time, 6:00 p.m. in london. for our audience worldwide, this was "bloomberg real yield." this is bloomberg tv. ♪

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yousef: you're watching "best of bloomberg daybreak: middle east." the major stories driving headlines. currencies synced to a 17 month low and asian stocks suffer a losing streak as trade tensions and monetary policy fears weigh on investors. central banks from agents get a bank of egypt gets a reprieve as inflation rises at the slowest pace since may. and, whether middle east could see the next oil rush for premium brands. ♪ yousef: bloomberg sources said saudi arabia's oil front was