jonathan: from the city of london to our viewers worldwide, i'm jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." coming up, italian populists proposing a bigger budget, battering the italian bond market. treasuries delivering a week of gains, leading yields negative for european buyers. and heading into q4, with investment grade set for the biggest annual loss since 2008. we begin first with the big issue, populists battering the italian bond market. >> we have had these rolling existential crisis if the euro

survives for years now, and this is just one more stress point. >> public debt is at something like 130%, which is a burden. it cannot be going even further. >> of course, italy is a big economy in the european union and should be a focus of concern. >> italy is still on a knife edge situation from an economic point of view. >> this has clearly been something which has been pressuring the markets for months, it seems now. but even if you get the budget problem out of the way now, it has not been resolved. we'll come back to this question in the next few months. >> there is something of a showdown that has still got 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 billion to $15 billion and then likely zero in january. so we are all wondering who is going to be supporting italian debt going forward.

jonathan: joining me around the table here in london is diana amoa of jpmorgan, and scott thiel, deputy cio at blackrock. plus, coming to us from chicago is colin robertson, head of fixed-income at northern trust asset management. diana, i want to begin with you and talk about what is happening in italy. how big a risk is a budget deficit of 2.4% of gdp? diana: well, markets had been expecting something below 2%. i think the last few weeks we had numbers closer to 1.6%. 2% was really the top side the markets had been expecting. so 2.4% is actually not a great number, particularly in the context where in the past, they have been able to meet their one-year forward projections. this time around, they don't necessarily have the tailwind from growth that they have historically had, and you have higher rates coming through as well. jonathan: scott? scott: it's important to take the number in the context of market expectation. italy had been meeting with investors to talk about this

number in particular, but more generally the italian situation overall. and they had kind of guided us to a number that was closer to below 2%. the ecb target. so i think it's about the surprise that it now is, not only for one year, but for relevant,that is also that is 2.5%, 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. at the end of the day, i do not think -- it's 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 capital economics pointing out, and quite rightly in many people's minds, he would be that moderating force if you look at what has come out 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 didn't surprise me, the 2.4% that -- this did surprise

me, the 2.4% that came out. i think what we need to expect is more volatility with respect to italy. what i find somewhat encouraging, though, today is the fact given this news, which was only a handful of basis points, 25 or so, that the 10-year moved up. and in the context of what this was, of 2.4% versus 1.9%, i actually found it a little bit encouraging and actually the spread versus bunds did not widen out as dramatically as i thought it might have. so i have been, at least for the near term, pleasantly surprised. jonathan: scott, it you where we are in italy that 25 basis -- scott, it tells you where we are in italy that 25 basis points is always a welcome move. scott: the intraday volatility is gigantic. in the last hour and a half, 1.5 points with no volume. but i do think it is important, a couple of things. number one, there was no real contagion effect throughout the capital markets today. looking at italian senior spreads, were 15 wider. sub bank spreads were 40 wider.

south african cdf's were unchanged on the day. this has not been one of these kind of events -- what you just said, it was kind of limited to italy. but again, i think it is a relatively big move. i think that if the italian bond market had taken out the high yields that we saw at the end of august, another 25 basis points from here, we might start to see that contagion. thus far, we haven't. jonathan: it is isolated to italy, which makes you wonder how mispriced bunds might be. just listen to ecb commentary at the moment. they seem pretty optimistic about the situation, the economic fundamentals of europe. to put a bit into bunds at the moment, diana, you have got to believe the ecb's monetary policy stance will move from a different direction than where it is currently. do you see that happening? diana: it is interesting -- we talk about the contagion being limited, but you have to look at correlations. the euro-dollar still reacted. jonathan: that's a good point. diana: so the moves are marginal

in other sectors, but it does not mean we have not seen a slight repricing. and 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 he had the 1.9% budget number we would have. jonathan: at the moment, the market is drawing a distinction between supply risk and re-denomination risk. do you think the tail risk is there that we could be on the path for exploring re-denomination risk in a big european, eurozone country? colin: i don't really think we are at that point yet. it would be -- i think we need to take it a couple more steps further to be a stress for the market. so that type of re-denomination risk, i don't think we are there. jonathan: scott, at the moment, if you look back at the european financial crisis, the eurozone debt crisis, one hangover that is still here -- investors are treating peripheral debt as if it is credit and not sovereign debt. colin: 100%. jonathan: how much of a problem

is that? colin: you end up having investors chasing the market both ways. so if we look at a chart of non-european investors' holdings 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 investors own it and they have to buy it, and can kind of chase it down. that is very much a credit. if you think about the way people trade credit or emerging markets, they get stuck in that pattern. investors think about it. i mean, it trades wider than south africa, just to keep it in perspective. so they definitely treat it as a credit. the volatility is a function of the liquidity, which is terrible in the futures. i mean, terrible. you have this credit-like environment, for sure. jonathan: do you see this credit like environment changing around the periphery anytime soon? the ecb has pretty much done all it can to insulate the eurozone from re-denomination risk. but there is still the periphery

that trades like credit. diana: i don't think that is going to change. i think if the ecb steps back from qe, it will become worse going forward. so before, you had the ecb as a pretty pricing different buyer of debt. we no longer have that backstop. investors are left to support this market need a factor in the fact that 2.4% might not be a disaster, but it is still a deterioration in credit. at which point are you willing to take 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. jonathan: scott? scott: i mean, obviously, the other function is the bund market. the liquidity in these risk free markets has gone way down. so one of the interesting things is the spread between the treasury market and the bund market has widened out dramatically. because bunds have basically been unchanged. more even now, today, obviously stronger. if you look at the liquidity in trading volumes, they have gone way down as a qe program has been winding down. so i also think there is a strange liquidity premium that is keeping the bund market

in this lockdown which you described earlier. ofathan: scott thiel black rock sticking with me, alongside diana amoa of jpmorgan, and colin robertson from northern trust asset management. coming up on the program, the auction block, amid all the concerns on italy, the government 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 now, where we saw another big loan sale this week. credit suisse received so much demand for a $5 billion loan that it increased the final size by $400 million and is closing

down the sales process a week early. the deal is helping to finance kkr's leveraged buyout. -- leveraged buyout of invision health care. in the united states, despite the treasury auctioning off two and five-year notes that offer the highest yields in a decade, buyers bought the two-year note, and offering's saw a bid to cover ratio that matched the weakest level since 2008. all those auctions were held before this week's federal reserves decision, where the central bank, of course, raised rates once again. >> the fed didn't really want to shock the markets by making much of a change at all. >> things are great right now, things are booming. the fed is reacting to that. >> there is more to run in this, assuming that the fed itself moves very, very gradually. >> there is no sign the fed plans to pause. >> it is really a recipe to move quietly and judiciously and don't do anything radical in one

way or the other. >> we actually 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 in the best long-term interest of the country and of the economy. and 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 reform, the regulatory reform. i think the fed's policy about normalizing, to get back to normal, is a part of that, and the markets will be working better as that continues and i hope it does. jonathan: still with me, diana amoa from jpmorgan asset management, scott thiel of blackrock, and colin robertson, from northern trust asset management. colin, i want to begin with you. the reserve removing that word "accommodative." is the federal reserve still an accommodative federal reserve? colin: yes, jonathan, it is

still an accommodative federal reserve. but i do think there are a number of important things going on here. the removal of "accommodative" i think puts investors in more of a position, and that's what chairman powell wanted to send the message of, that the data is what is important. i'm so we know it is priced into the market and we know what the expectations are for the fed members in respect to the dot plots. i find that intriguing, too. if you look at the dots, obviously there is a move priced in here in december and three more next year. and that would put us at a position at the end of 2019 at three and 1/8, and that seems high to me for the 10-year treasuries that are still trading at 3%. so one other point i want to make is when you look further out where the dot plots are measured, the expectation is we come to a terminal spot around 3%. but even the 2021 dots are very varied. and i do think that when the

data comes through and when we see inflation stuck at low levels and moderate paces of growth, i think the likelihood of one move this year and three next year is really overblown. and 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 look at the median dot to tell the story, but when you put the dots up on screen and see the spread between them all, they are all over the place. can you read anything into 2019 and 2020? diana: no, i think that is right. the fed has been hiking rates since 2015. this economic expansion is quite long in the tooth. on top of that, we have the fiscal stimulus which might potentially be rolling over next year. there is a lot of uncertainty in what the growth outlook beyond the next 12 months is like. and that will introduce uncertainty in the dots. jonathan: the federal reserve is not in the business of forecasting recessions or economic downturns. if they were, it would mean their policy is in the wrong place. for the federal reserve right now, do you see them needing to respond to a downturn in economic growth anytime soon? do you see that situation materializing? scott: no, i don't think so.

i mean, i think they are in a pretty happy place. "pragmatic" is the way i would describe their overall position and chairman powell's presentation. i think as the longer-term rate gets above 3%, or above a more neutral rate, they will be some -- there will be some reflection to how far they want to push rates. i think they are on a very preset course for the rest of this year for sure, and into next year. it is interesting to note that basically all real rates from the five-year to the 30 year have converged to 1%. so there is this concept the market is reflecting economic growth and accommodation is being withdrawn. so -- but it is interesting that the market is getting to that place. jonathan: talk to me about how you would position the long end of the treasury curve at the moment? there is a huge appetites by the front end. you have this great pickup of yield in the last 12 months. when would you consider putting duration back on and going further out on the treasury curve? scott: from a long-term for the mental perspective, you look at the closing of the u.s. asher gap -- upper gap

very consistent with a flat and flattening yield curve. that would suggest the yield curve should continue to flatten on balance. in the near-term, if we look at the fully priced-in front end of the market, the amount of tightening that is priced in already, it is hard to price in more than three or four rate hikes over a 12-month period. we are really right there. the front and actually looks attractive. that is not just from a carry perspective, but from a capital appreciation perspective. so i think the longer term trend for a flatter yield curve is still entrained. i think tactically, the shorter maturities offer a better value. jonathan: shorter maturity from a capital returns perspective, walk me through the why. scott: all right, so think about it -- the five-year almost touched 3% briefly this week. on, let's say, 1%, 1.5% for very high quality, very diversified corporate spreads or you add 3.5% from emerging markets, depending on your risk spectrum. all of a sudden, you are talking a 4% or 5% yield. if you carry that high and you

have this idea that if the fed were to become more reflective about the pace of monetary policy tightening, you could potentially have a situation where you get a 20 to 25 basis point rally as a result, and that would give you some capital appreciation. jonathan: colin, what do you think of that trade, just quickly? colin: i would agree with that trade. per your question, jonathan, i also would be willing to put money to work in the longer end of the curve. scott's points about the short end are spot on, but there is opportunity further out the curve as well just because my view, it's a real possibility in my opinion there are two more hikes, not four that would be expected through the end of next year. jonathan: you will stick with me. colin robertson from morgan trust diana amoa and scott , thiel. in the markets this week, let's get a market check for you. two's, tens, and 30's. in the treasury market, we shape up as follows on the two-year. you see the bid coming in on the back end of the tens and the 30's. just a marginal, mild as we get

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

jonathan: i am jonathan ferro. this is "bloomberg real yield." it is time now for the final spread. coming up over the next week, china's financial markets closed all week due to the holidays. plus, fed chair jay powell and u.k. prime minister theresa may -- u.k. prime minister minister theresa may speak. on friday, it is here already -- the jobs report just around the corner as we wrap up the end of september and the third quarter. still the three from -- still with me from jpmorgan asset management is diana amoa, scott thiel of blackrock, and colin robertson from northern trust as it management joining us out -- asset management joining us out of chicago. 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 really underperforming. high-yield, really outperforming. what do you make of the dynamic of the u.s. credit? scott: it is interesting to note if you look at the ratings structure and the high-yield market, what has happened is the lower quality, the ccc's have compressed dramatically into bb's. in emerging markets, the high-yield or sub investment-grade has really widened relative to i.g. and so what is happening is it is really the outperformance of the high-yield market that is notable, that is obviously consistent with positive economic activity, still favorable financing rates, stock buybacks, etc. but i think to me, that is the most surprising divergence between the high-yield part of the em market and the high-yield em market. jonathan: let's talk about em, diana. this is where you specialize and 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 the year and how you should be positioning? diana: it is interesting

actually. i think the point on what has been widening in em is key. most of the widening of the spread we saw was in a few idiosyncratic names. argentina, turkey, brazil, indonesia. i think now, where we are at this point is, we are at a point where 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 they wouldn't come through. so a lot of high-yield names are actually looking a little bit better. and we expect in this quarter to see some of that under-performance in em come through. jonathan: scott, some of the local issues have been addressed but we still have the macro problem for emerging markets. china slowdown, high yields to the united states on treasuries, the rate hikes keep coming. can you be constructive on em right now? scott: i think you can, and those comments are spot on. the reality is we have had some high-yielders really implode. but with some of the policy responses in these countries,

we have seen a big -- there has been a really big rally since the end of august in some markets. turkish two-year bonds in dollars, 11.5% yield to 5% yield. pretty big move. but as investors were concerned about the backdrop and concerned about idiosyncratic risk -- and the idiosyncratic risk, 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 kind of calming feeling. and so i do think it is an attractive market, but there are really some interesting opportunities in the higher yielders. jonathan: colin, i want to talk to you about whether the treasury market is attractive to the foreign buyer. when you mention the fx hedges, the yield pickup is not there for treasuries, whether in europe or japan for that matter. how critical do you think that aspect is for the treasury market at the market to attract foreign buyers? colin: sure. i don't think it is overly critical. i agree with you, jonathan. there has definitely been a shift in the valuations that

make it more expensive. but evidenced by the fact where long-term treasuries are right now, i think there are pivotal -- incremental buyers that are happy buying treasuries and longer-term debt at these levels. it's important to have the buyers that could come in from overseas, but i don't think that is the driver and i even 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 going to end the show the way we always end the show with a rapidfire around. i get to ask three quick questions and you answer as quickly as possible. i'm going to start start with an easy one. is the federal reserve is on course to a fourth rate hike to close out the year? just a simple yes or no. diana: yes. scott: yes. colin: yes. jonathan: unanimous. here is one for you. 2018, buy or hold through the end of the year. 10-year bunds or btp's?

diana: btp's. scott: btp's. colin: i will take the bunds. jonathan: just quickly, does junk outperform investment grade through year end in the u.s., yes or no? diana: yes, but bb's. scott: i think investment-grade outperforms. colin: high-yield outperforms. jonathan: there you go, a bit of disagreement. we make a market at the end. to catch up with you all. 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. ♪

♪ alix: $100 oil. analysts warn of an oil price spike. total says it could happen. how to play triple digit crude. the golden merger. mark bristow is leading the new company. how other gold makers will compete. how one oil company is trying to change the energy mix in a world where wind and solar gain market shares. we speak to eldar saetre. ♪