jonathan: from new york city for our audience worldwide, i'm jonathan ferro. bloomberg "real yield" starts right now. the rally continues, driven by lower rates and signs the global economy is blossoming. inflows into u.s. great credit funds for an 11th week. shaping an unprecedented order book for saudi aramco's debut bond sale. we begin with the big issue. >> we are in a risk on environment. >> risk on within the income space. >> everything looks great in bonds. >> credit spreads are really tight. >> the fed is no longer your enemy.

>> the fed has called a truce on us bond investors. >> it is a support system. >> support for risk assets. >> it is allowing this reach for yield. >> reach for yield. >> reach for yield coming across all different asset classes. >> the market has maybe more upside. >> more juice that can be squeezed out. >> we think there is more room to run. jonathan: joining me is subadra rajappa, the head of u.s. rates strategy at societe generale, michael collins, senior portfolio manager, and bob miller. great to have you with me. let's talk about that support mechanism. low rates and why they can remain low for a whole lot longer. >> central banks want it that way. it is not just in the u.s. but globally, the ecb and the other global central banks are keen on , providing accommodation. if you listen to the fed speak this week, the feeling is that 2.5 is close to neutral, so they

are pretty much happy keeping rates where they are for an extended period of time, until they get an indication of moving policy either way. bob: i think the fed has pivoted in a very durable fashion and will not go back to last year's game plan. instead of following the methodology and trying to pin real neutral rates at some assumed level of neutral or tighter than neutral, they have clearly changed their reaction function to underwriting the expansion. they want the expansion to continue. they want to do something that most federal reserve's have been unable to do, achieve a soft landing. most feds, over the last three decades. i think they are dovish, will be dovish. they are sensitive to the low level of inflation. inflation is underwhelming. i think that lowers the bar to them easing, as opposed to a high bar with them tightening. michael: we are in the same camp, as you know.

we have been in this long low rates call for some time. -- for a long time. we said the 10-year would be 2.5% for the next decade. that feels really high. now we are saying maybe 2% will be the average 10 year for the next decade. that real rate is probably too high. i think the fed will continue, over time, to lower rates. our view is that does not cause wider spreads. that is not a risk of environment. lower rates begets tighter credit spreads over the long term. jonathan: let's decompose the treasury yield. we can see your chart on the screen right now. decompose the 10 year, nominal, break even, effective real yield. what does this tell you about where we are going? michael: nominal yield on top, 2.5%, comprised of two components. one is the real yield, the yellow line, which is the tips yield, and the 10-year real yield is 0.6%.

then, the blue line is the difference between the two, the inflation rate you need to justify the valuation of the other two. the inflation rate that is priced in is 2% for the next decade. 2% inflation seems high to us. we are in this lower, disinflationary world. you see that every day with the competition. even today, disney and netflix. now we are in this tit for tat competitive pricing environment. the real yield of 0.6 has the biggest room to fall and that will probably go to zero over time. jonathan: do you think i could go to zero? michael: i think a positive real funds rate, in the world we are in today, with so much demand for income, aging people, not enough bonds out there, why should they deserve a positive return over inflation for having a t-bill? subadra: i was thinking real yield this time around were higher than they were in 2016 and this year might be different than 2015.

but now, if you look at the chart of real yield, we are pretty much tracking the same decline, lower in real yield. the market is basically saying the prospects is lowering the expectation for growth over the longer run. that, to me, is troubling. the one thing i find interesting is, in the u.s., inflation expectations are still pretty high, close to 2%. compare that to europe. breakevens in the five-year in europe is at 1.35, very close to the lows over the last five years. to me, that divergence gives -- ads credibility to the fed, and probably less credibility to the ecb. jonathan: bob, your thoughts? bob: i think the inflation piece is important. last year, we had the unprecedented combination of significant fiscal policy in an economy that was at full employment. has not happened since the

mid-1960's. we didn't see any meaningful price impulse. we have had wage increases without passing through to prices. the structural nature of the economy is different today. price pressures are difficult to source. if you look at core services, that is the part of core inflation that is most sensitive to domestic slack. we have a very low unemployment capacityy high utilization, and core services has decelerated over the past six months. core services, if you take up -- out the pieces subject to declinedtors, it has 60-70 basis points year-over-year for the past six months. there is no upward pressure on prices. i think that is what is different at the fed. richard clarida joining the fed last year has started to move the narrative toward a greater sensitivity to inflation expectations and realized inflation. that tips the balance of their decision-making.

jonathan: we started by talking about these mechanisms for broader risk assets. do you believe rates can remain in this environment, and can assets continue performing, or holding these levels? michael: if the fed is successful in extending the expansion and underwriting a soft landing from fiscally inspired 3% gdp rates a year ago, i think risk assets do well. jonathan: is that your base case? bob: yes. michael: i am worried that we are threading the needle. if your goldilocks growth environment is 2% to 4%, that is one thing, but it is really closer to 1.5% and 2%. you are playing with fire there. if it gets too low, to 1%, that is what we call the stall speed in the economy. then, bad things start to happen. if all of these over credits, the triple b part of the market, a quarter of the corporate bond market used to have leverage above, and now it is half. those were junk bonds back in

the day. jonathan: can we talk about pockets of complacency? we have this big order buildup -- order book buildup for the saudi aramco -- for saudi aramco. an order book is a gauge of demand, not necessarily a reflection of actual demand. to what degree earlier this week -- many people saw that this offer was going to be oversubscribed, therefore, had to upscale their orders, because they knew it would be scaled back. then, the thing snowballed. is that what happened this week? bob: it was delivered well from the primary underwriters. i'm not charlie the participants bought the bonds are as happy today as they were on monday or tuesday. i don't think, anything negative happening. it is just arguably people overpaid on a short-term time horizon. the capital structure looks attractive relative to other major energy complexes, but perhaps a bit rich. jonathan: the company carries no debt.

i wonder how you should value this. if you value this against the peers, you look at shell, exxon, we trade white of those names. it make sense from an investment grade perspective. essentially, this is a triple-a credit with no debt on the balance sheet. you can see why there would be appetite for the debt of saudi aramco. when we look at this from an em perspective, saudi arabia versus the sovereign curve, you get a different picture as to what the risk is associated with this credit. there is the aramco curve at the top there. shell and exxon at the bottom. chart andtch up the have a look at this from the em perspective, this is where the risk lies. why are we trading so tight to the sovereign? michael collins, in your view, are some maturities trading too tight to the sovereign? michael: em trades wide to investment grade for a reason. there is much more inherent volatility in data associated with it. you have to price it off the

sovereign. we saw the price going down. we bought some of the sovereign debt thinking if this is going to come in the sovereign will perform well. we generally try to avoid this. it looked really rich to us. the sovereign owns it. they can tax it, and they will in some cases, extract that entire $200 billion in earnings of ebitda as a tax, like they do in mexico. jonathan: do you think this was a sign of risk appetite going too far, or was this idiosyncratic? bob: i think it was more idiosyncratic. i think it was a new issuer, a lot of people wanted the name, interesting story. as i said before, people overpaid for it. jonathan: great to have you with us. coming up, the auction block. that conversation is up next. this is bloomberg "real yield." ♪

jonathan: i'm jonathan ferro. this is bloomberg "real yield." i want to head to the auction block in saudi arabia. we talked about the issue previously, aramco raising $12 billion in a bond market debut. the state owned energy giant drawing orders over 100 billion. at aallowed it to bill lower yield than the saudi government. in the u.s., the treasury selling 3, 10, and 30-year bonds this week. finally in europe, banko bpm bringing its first at1 offering to market.

it was getting over 600 million euros on bids. let's stick with europe. ecb president mario draghi emphasizing the balance of risk remains tilted to the downside. >> the growth outlook remains tilted to the downside on account of the persistence of uncertainties related to geopolitical factors, the threat of protectionist, and vulnerabilities in emerging markets. jonathan: still with me is subadra rajappa, michael collins, and bob miller. subadra, the financial repression trade is back. subadra: this is a classic financial repression trade. it is the ecb is going to keep monetary policy accommodative? we know they will be introducing it in september. the trade, you want to be in the peripheries. you want to be in btps.

spreadsseen btp narrowed dramatically. end of last year, 300 basis points, now between 200 to 250. look at greek debt, they are at their lowest level they have been in over a decade. to me, it is basically a signal, the ecb being a signal to take on risk. jonathan: is that right, bob miller? big move on the periphery, do you expect it to stay lower? bob: i think they grind lower. i don't think the ecb is in a position to increase interest rates or pursue anything other than accommodative monetary policy or a very long period of time. jonathan: for the periphery, it matters whether they start trading like stocks again. i caught up with your colleague who suggested maybe we are at an inflection point. he thinks they can start to trade like sovereigns. why does that make sense? bob: there are two things going

on. one is the technicals, the demand for yield, high quality sovereign debt in europe is tremendous, with bund yield stock at zero, probably forever. fundamentally, some of these countries are doing ok. we look at italy, they have a budget deficit over 2%. we are running close to 5% here. they look really austere over there as a block. they have a small deficit. the block is a strong, fiscal place. reaching a little on the margin in places like greece, spain, portugal makes sense to us. jonathan: it is the specter of redenomination risk that hangs over some of these currencies and offerings as well. with all due respect, the treasury does not have that. that is the problem with europe, which effectively makes a trade -- it trade like credit, not a sovereign. i'm wondering why this trait makes sense. bob: they should have a credit spread. if you cannot print your own currency, you have to have a credit spread.

we saw that in puerto rico. greece did effectively restructure. if you cannot print your own currency, you need to spread over bunds effectively. we are not saying it is going to go to zero or 10 or 20 or 30, where it has been in the past, because you have a lot of political risk. the question is what is the right spread? jonathan: what is the right spread? michael: for greece, probably tighter. they are going to continue to get upgraded. growing faster than expected, primary deficit is coming in. surplus is coming in better than expected. it is a proven credit, there are not that many proven credits in the world. jonathan: the use the word "forever" a little while ago about the german 10-year. do you see that? we use the word forever very loosely, but do you see it staying there for a long time? subadra: we do. we have a forecast for 11 basis points for the next year. we say it will be close to 04 at least next year, given the fact that the ecb will not do much.

if anything, there is a potential -- the market is pricing in some amount of cuts for 2020, 30% probability. there is a nonzero probability that the market is thinking it might be easier monetary policy coming from the ecb by way of cuts in 2020. that means bond yields should remain close to zero. jonathan: is that within your base case? bob: i think europe has meaningful structural headwind. the european design does not allow for a meaningful, organic growth recovery without substantial policy support. the challenge around some of the things that we were talking about earlier, the credit spreads, is the binary nature of asset pricing. you have aggressive financial repression that forces, through regulatory channels and other channels, the yield lower, yet you have this relatively large

left tail. as you move toward it, the pricing moves aggressively. in 80% of the scenarios, spreads can grind tighter. in 5% to 10% of the scenarios, it's a real problem. jonathan: bob miller, great to have you with us, michael collins, subadra rajappa. let's get a check on treasuries. yields shaping up on the week as follows. five basis points on 2's and 10's. still ahead, the final spread, the week ahead containing a slew of fed speakers, as well as insight into the global consumer, retail sales in the u.s., and china. that is coming up next. this is bloomberg "real yield." ♪

jonathan: i'm jonathan ferro. this is bloomberg "real yield." it is time for the final spread. coming up over the next week, japan visiting the united states or trade talks. elsewhere, a ton of fed speak.

in china, industrial production and q1 gdp figures. in the u.s., we get the fed's beige book and retail sales for the month of march. last week, a holiday shortened week for many of you. final thoughts with bob miller, michael collins, subadra rajappa. bob, i want to talk about the chinese data that came out at the backend of this week. a lot of people looking at the export data saying it's an improvement, things are good. they look at credit, things are good. imports are still pretty soft. i would have thought, if credit growth and stimulus were starting to bite, that is where i would see it. bob: i think you will see it. the chinese have pulled a lot of different levers over the past six to nine months to provide some support or their economy. it may well be that support is domestically focused and not a a lot of the activity improvement spills out into the rest of the emerging-market complex, northern asian complex. that remains to be seen. it's critical that china

stabilizes in order for core europe to stabilize. europeans are particularly sensitive to the trade flows. the market wants to do the green shoots trade. people want to do this. i think it's probably the right trade. the deceleration in china was self-inflicted. it was intentional. they seem to be creating the scenario for a soft landing. i think that is the most likely outcome. the risk scenario, there's a much higher probability of disappointment in overshooting on every acceleration. jonathan: it is a trade the market is increasingly position -- positioned for. do you share that optimism about the bottoming out process as the year progresses, and maybe acceleration coming through in the back half of the year? michael: we are talking a lot and probability distributions. the base case is, if the stimulus does take hold, that

you get some stabilization, maybe modest improvement. but remember, the transmission mechanism for stimulus in china is a lot different than it was. maybe that is why you're not seeing a jump in imports. it used to be when they wanted to stimulate, we are going to import a bunch of commodities and iron ore from australia, we are going to build cities, build railroads. they are not doing that this time. they are trying to encourage lending and borrowing at the retail, small business level. that is a much stickier transmission mechanism. i am worried that it will be watered down, that this pickup will not be as robust as we have seen in the past and the data may be different than what we have seen. subadra: if you take a step back and look into coming into this year, i would say economists and strategists broadly underestimated the impact of the china slow down on broader global economies. that is why we have had the tremendous revisions coming from the imf in january, as well as this week. to me, it is too early to read

into the data that we've got this week and conclude that we are on the road to recovery. we still need to see clarity on the trade negotiations between the u.s. and china. we need to see consistent improvements in data coming out of china. i personally think there is the potential for more easing coming from the pboc over the coming months, based on how the data turns out. i think it is a little too early. jonathan: next week is another important week for the data specifically in china, and the u.s. as well. i want to wrap it up with a rapidfire round. three quick questions, three quick answers. first question, following off from that conversation, is the optimism for a second-half recovery in the global economy misplaced, yes or no? subadra: yes. michael: no. i think it will get a little better. bob: i think it gets better. jonathan: the low on the 10-year yield this year, negative nine basis points. have we seen the low for 2019, yes or no?

subadra: yes. michael: yes. bob: no. jonathan: cain and moore, attracting significant controversy around the federal reserve. do either of them get confirmed to the fed? subadra: no. michael: no. bob: yes. interesting. jonathan: subadra rajappa, michael collins, bob miller, great to catch up with you all. thank you for joining us. that does it for us. this was bloomberg "real yield." this is bloomberg tv. ♪

emily: i'm emily chang and this is "the best of bloomberg: technology." the house of mouse takes on netflix about we talk to ceo bob iger about how disney plus will reshape streaming. and can congress force change on the biggest players? we hear from mark warner. and softbank announces a new