jonathan: from the city of london, 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: italian populists proposing a bigger budget. battering the italian market. treasuries delivering a weeks of gains. yields left negative for european buyers. heading into q4, we are set for the biggest annual loss since 2008. we began with a big issue. populists battering the italian bond market. >> we had these rolling

existential crisis if the euro survives for years, and this is just one more stress point. >> 30%, which is a burden. they cannot be going even further. >> italy is a big economy in the european union. that should be a focus of concern. >> italy is still on a knife edge situation for me. >> this has been pressuring the markets for months it seems now. even if you get the budget problem out of the way now, it has been resolved. we will come back to this question in the next few months. >> there is something of a showdown that have to be followed through vis-a-vis the italian government and the european union. >> this is happening right as the ecb is dialing down qe. it is going from $30 million to $15 billion and then likely zero in january. we are wondering who is going to

be supporting italian debt going forward. jonathan: joining me is diana amoa, and scott thiel, plus coming to us from chicago is colin robertson. diana, talk about what is happening in italy. how big a risk is a budget deficit of 2.4% of gdp? diana: markets have been expecting something below 2%. the last few weeks we had numbers closer to 1.6%. 2% was really the top side the markets had been expecting. 2.4% is not a great number, particularly in the context were -- context where in the past they have been able to meet their one-year projections. this time they don't necessarily have the tailwind that they have historically had, and you have higher rates coming through as well. scott: it's important to take the number and context of the market.

italy had been meeting with investors to talk about this number in particular, but more generally the italian situation overall. they guided us to a number that was closer to below 2%. i think it's about the surprise that it now is for two-years. it is 2.4%. keeping in mind, if you look at the most pragmatic was 1.6% and the widest was 3%, it's somewhere in the middle. i think at the end of the day, it is important, but i think it's more about the expectations going into the announcement. jonathan: another set of expectations was the finance minister would be a moderating force. and quite rightly in many people's minds, he has failed to be the moderating force, if you look at the other side of the budget discussions. is there a moderating force in the italian government? is there one left? colin: i don't think there is one left. this did surprise me, the 2.4%

they came out. what we need to expect is more volatility with respect to italy. what i find somewhat encouraging today is the fact given this news, which was only a handful of basis points, 25 or so, that the 10-year moved up. in the context of what this was of 2.4% versus 1.9%, i found it a little bit encouraging and actually the spread versus bunds did not widen out as dramatically as i thought. for the near term, i have been presently surprised. jonathan: 25 basis points is always a welcome move. scott: the intraday volatility is gigantic. in the last hour and a half, they went up 1.5 points with no volume. it is important, there are a couple of things. there was no real contagion effect throughout the capital markets today. looking at italian senior

spreads, 15 wider, some spreads were 40 wider. south african cdf's were unchanged on the day. this has not been one of those events. it was kind of limited to italy. again, i think it is relatively a big move. if the italian bond market had taken out behind yields we saw at the end of august another 25 , basis point from here, we might start to see that contagion. jonathan: it is isolated to italy, which makes you wonder how mispriced bunds might be. -- ecbto ecb, tree commentary at the moment, they seem optimistic about the situation, the fundamentals of europe. you have got to believe the ecb's monetary policy stance will move in the other direction from where it is currently. you see that happening? diana: it is interesting to me. we talk about the contagion being limited. but you have to look at correlations. the euro-dollar still reacted.

the moves are marginal and other sectors that it doesn't mean we have not seen a slight repricing. it is something the ecb will be watching very closely. they have to deal with the italian headache. but they also have brexit around the corner. for them, the policy outlook is much more muddled by this outcome than if we had the 1.9% budget number we would have. jonathan: the market is drawing a distinction. do you think the risk is there that we could be on the path toward exploring redenomination risk in a eurozone country? colin: i don't really think we are at that point yet. i think we need to take it a couple more steps further to be a stress for the market. that type of redenomination risk, i don't think we are there. jonathan: if you look back at the financial crisis, the eurozone debt crisis, one hangover that is still here is investors are treating peripheral debt as if it is

credit and not sovereign debt. how much of a problem is that? colin: you end up having investors chasing the market both ways. if we look at a chart of non-european investors holding of italian bonds, they went way down as the market sold off suggesting people were stopping themselves out of positions in august so when the market starts rallying, no external invested -- investors own it and a half to chase it down. that is very much a credit. if you think about the way people trade credit and get stuck, investors think about it. it trades wider than south africa. it is definitely treated as a credit. the volatility is a function of the liquidity, which is terrible in the futures. i mean terrible. you have his credit-like environment for sure. jonathan: do you see this credit like environment changing anytime soon? the ecb has pretty much done all it can to insulate the eurozone from the redenomination risk.

diana: i don't think that is going to change. i think as the ecb steps back from qe, it will become worse going forward. before you had them as a price in different higher of european debt. we no longer have that backstop. investors are left to support this market and need a factor in the fact that 2.4% might not be a disaster, that it is still a deterioration in credit. at what are you willing to take point the risk when there is no sign of fiscal consolidation on the horizon? jonathan: i'm guessing you don't like the price associated with the risk right now? diana: no. scott: the other function is the bund market. liquidity and risk free market has gone way down. the spread between the treasury market and the bund market has widened out dramatically. if you look at the liquidity in trading volumes in the bond market, they have gone way down as a qe program

has been winding down. i think there is a strange liquidity premium keeping the bund market in this lockdown that you described earlier. jonathan: scott thiel sticking with me, alongside diana amoa and colin robertson from northern trust asset management. coming up, the auction block. amid all the concerns on italy, the government is offering up some debt. this is "bloomberg real yield." ♪

♪ jonathan: i am jonathan ferro and this is "bloomberg real yield." i want to head to the auction block, we saw another big loan sale this week. credit suisse received so much demand for a $5 billion loan

that increased the final size by $400 million and is closing down the sales process a week early. it's financing kkr's leveraged buyout. mixed results. in the united states, despite the treasury auctioning off two and 5-year note offering the highest yields and a decade, buyers bought the two-year note that's at the weakest level since 2008. all those auctions were held before this week federal reserve decision, to raise rates once again. >> the fed it did not want to shock the market by making much of a change at all. >> things are great, they are booming. the fed is reacting to that. >> there is no sign the fed plans to pause. >> it is a recipe to move

quietly and judiciously and don't do anything radical in one way or the other. >> we expect we will see four rate hikes next year after another one at the end of this year, which is above what is being priced in. >> the federal open market committee will simply set policy and the best long-term interest of the country and of the economy. i think they will do their very best to ignore outside pressures. >> the economy has been doing quite well. i think that is because of the tax and regulatory reform. i think the fed's policy is about normalizing and getting back to normal is part of that, and i think markets will be working better as that continues and i hope it does. jonathan: still with me, diana amoa, scott thiel and colin robertson. colin, i want to begin with you. the federal reserve removing the word "accommodative." is it still an accommodative federal reserve? colin: yes, it is still in

accommodative federal reserve. i do think there are a number of important things going on here. the removal of accommodative puts investors more in a position, and i think this is the message chairman powell wanted to send, that the data is what is important. we know it is priced into the market and we know the expectations are for the fed numbers with respect to the dot plots. i find that intriguing. if you look at the dots, obviously there is a move priced in here in december and three more next year. that would put us at a position at the end of 2019 at 3/8th, and that seems high to me with respect to 10-year treasuries. another point quickly, when you look further out where the dot plots are measured, the expectation is we come to a terminal spot around 3%. even the 2021 dots are varied.

i think when the data comes through and we see inflation stuck at low levels and moderate paces of growth, the likelihood of one move this year and three next year is really overblown. i think each move they make, the next one will be that much tougher. jonathan: diana, what are your thoughts on that? you can take the dots and tell a story, but when you put them on screen into the spread between them all they are all over the , place. can you read anything into 2019 and 2020? diana: i think that is right. the fed has been hiking rates since 2015. economic expansion is long in the tooth. on top of that, we have the fiscal stimulus which my -- which might be potentially rolling over next year. there is a lot of uncertainty in the outlook beyond the next 12 months. that will introduce uncertainty in the dots. jonathan: the fed is not in the business of forecasting recessions or economic downturns. that would mean policy is in the wrong place.

do you see them needing to respond to a downturn in economic growth anytime soon? scott: no, i don't think so. i think they are in a happy place. pragmatic is the way i would describe their overall position and chairman powell's presentation. as the long-term rate gets above a more neutral rate, they will -- rate, there will be some reflection as to how far they want to push rates. but i think there on a preset course for the rest of this year for sure and into next year. it is interesting to note basically all real rates from the five-year through 30 year have converged to 1%. there is this concept the market is reflecting economic growth and accommodation is being withdrawn. it is interesting that the market is getting to that place. jonathan: how do you position the long end of the treasury curve at the moment? there have been huge appetites by the front end. when would you put duration back on and going further out on the treasury curve? scott: from a long-term for the

-- long-term fundamental perspective, it is very consistent with a flat in flattening yield curve. that would suggest the yield curve should flatten on balance. in the near term, if we look at the amount, the fully priced in front of the market, the amount of tightening priced in already, it is hard to price in more than three or four rate hikes in a 12 month period. we are already there. think the longer term trend for a flatter yield curve is entrained. the shorter maturities offer a better value. jonathan: walk me through the why. scott: the five-year almost touched 3% this week. let's say you read 1.5% for very diversified corporate spreads where you add 3.5% from emerging markets. all of a sudden you are talking a yield of 4% or 5%. if you carry that high and you

have this idea that if the fed was to become more reflective, -- pace oface at monetary tightening, you potentially have a situation where you get to 20 to 25 basis point rally. that would give you some capital appreciation. jonathan: what do you think of that trade quickly? colin: i would agree with that trade. i would be willing to put money to work in the longer end of the curve. scott's point about the short end are spot on, but there is opportunity further out. just because of my view that it is a real possibility, in my opinion there are two more , hikes, not four expected to the end of next year. jonathan: guys, you are going to stick with me. colin robertson, diana amoa and scott thiel. in the markets this week, let's get a market check for you. tuesday, tends and 30's in the treasury market. they shape up as follows. you see the bid coming in on the back end of the 10's.

and the 30. just a mild one as we get a rally through the back end of this week. still ahead, the final spread and the week ahead featuring comments from jay powell, and the u.s. jobs report. this is "bloomberg real yield." ♪

♪ jonathan: i am jonathan ferro. this is "bloomberg real yield." it is time for the final spread. coming up in the next week, china's financial markets closed all week due to holidays. jay powell and theresa may speak. on friday, the jobs report just around the corner as we wrap up the end of september and the third quarter. still with me is diana amoa, scott thiel and colin robertson. let's start in london as we wrap up the quarter. this is a really interesting quarter for credit and an

interesting year for credit in the united states. ig investment grade underperforming. high-yield really outperforming. what you make of the dynamic in u.s. credit? scott: it is interesting to note if you look at the ratings structure and the high-yield market, the lower quality, the triple c's have compressed into double b's. the sub investment grade has really widened relative to i.g. it is the outperformance of the high-yield market that is noticeable and that obviously is consistent with positive economic activity, favorable financing rates, stock buybacks, etc. to me, that's an interesting divergence between high-yield part of the em market and the high-yield part of the high-yield market. jonathan: this is where you specialize in spend time looking at stuff. the third quarter has been brutal for emerging markets as people wake up to the idea it is not idiosyncratic and there is something broader happening here. what is your take from the third

quarter as we approach the end of a year and how you should eat positioning? diana: it's interesting to me and i think the point on what has been widening in em is key. most of the spread widening was in a few names, argentina, turkey, brazil, indonesia. thisnk where we are at point, argentina seems to be heading in the right direction with the imf coming on board and money coming through to the country sooner. turkey delivered despite a lot of skepticism. a lot of high-yield names that have been dragging em are looking better. we expect in this quarter to see some of that performance come through. jonathan: some of the local issues have been addressed but we have the macro problem for emerging markets. china has slowed high yields to the united states. rate hikes keep coming. can you be constructive on em right now? scott: we have had some high-yielders really implode. with some of the policy

responses in these countries, there has been a really big rally since the end of august in some markets. turkish two-year bonds, 11.5% yield to 5% yield. a big move. as investors are concerned about the backdrop and concerned about idiosyncratic risks, to some degree there is uncertainty that has been addressed. look at the fed's statement. the economy is chugging along. the chinese response to the tariff situation seems to have some sort of calming feeling. i think there are really some interesting opportunities in the higher yield. jonathan: when you do mention the hedges, the yield pickup is not there for treasury, whether europe or japan. how important is that aspect for the treasury market at the market to attract foreign buyers? colin: i don't think it is overly critical. i agree, there has definitely

been a shift in the valuations that make it more expensive. but evidenced by the fact of where long-term treasuries are at now, i think there are buyers that are happy buying treasuries and longer-term debt at these levels. it is important to have the buyers that could come in from overseas, but i don't think that is the driver and i think as the ecb winds down the qe, it will most likely be domestic buyers that are more critical to the treasury market in the u.s. versus outside. jonathan: really thoughtful stuff, guys. we are to end the show the way we always do, a rapid fire around. i asked three questions and you have to answer as quickly as possible. is the federal reserve is on course with another rate hike to close of the year? diana: yes. scott: yes. colin: yes. jonathan: unanimous. here is one. hold through the end

of the year. bunds or btp's? diana: btp's. scott: btp's. colin: i will take the bunds. junkhan: does chuck -- outperform investment-grade in the u.s.? diana: yes but double b's. i think investment-grade outperforms. colin: high-yield outperforms. jonathan: there you go, but a disagreement. thank you very much to diana amoa, scott thiel and colin robertson. that does it for us from london. we will be here from new york next time. this is bloomberg. ♪

yousef: the major stories driving headlines this week. president trump says opec is ripping off the world as the cartel snubs his demands to lower prices. iran feels the president's wrath. the u.s. leader says that iran is sowing chaos. the iranian president accuses america of economic terrorism. and the global trade war escalates as fresh tariffs come into effect on hundreds of billions of worth of goods. dollars ♪ yousef: opec sidestepped

president trump's demand for