jonathan: from new york city, i'm jonathan ferro. bloomberg "real yield" starts right now. ♪ jonathan: coming up, trade tensions simmering. chinese state media signals a lack of interest in talks. investors turning increasingly cautious. high yield bond funds seeing the biggest outflows since december, leaving the treasury market prime for a rate cut with yield near 2019 lows. we begin with the big issue, the market looking for the fed to nail a soft landing. >> we think we will have a soft landing. >> pretty soft landing. >> a soft landing for the global economy. >> big central banks becoming notably easier.

>> easier monetary policy. >> i think they are in a good spot. >> the u.s. economy appears to be in pretty decent shape. >> what is the fed going to do in a different circumstance which because of the trade issues, actually the economy starts slowing down? >> the fed could start to cut rates. >> rate cuts. >> you will have a cut if trade talks break down. >> i have zero doubt in my mind that in that environment the fed is cutting rates. >> it depends on how the gross data comes out. jonathan: joining me to discuss is bob michele of jpmorgan, krishna memani of oppenheimer funds and james athey of aberdeen standard investments. it is what the markets are looking for. is it going to get it? james: a soft landing, i'm not so sure. history suggests, looking purely at the odds, it is quite unlikely. i think if you scratch a little further beneath the surface you find actually the circumstances

that we are likely to be facing in the next weeks, months, quarters, and beyond don't really compare that closely to the possibly two or three other occasions where we have been able to engineer a soft landing by easing rates previously in the midcycle. we are too late cycle and there are too many imbalances, too much of a weight off burden of debt, too many structural issues around the global economy really for me to believe that the fed can cut a couple of times and we can get back to everything is fine and don't need to worry. jonathan: you think we have engineered one. krishna: to some extent, the fed in 2018 effectively engineered a soft landing. tightening rates when growth was high and then pivoting down to a more easing policy. i think they have done that. whether that gets into a risk mode or not is an open question that we have to ask ourselves for the second half.

trade issues raises the issue. having said that, the fed has engineered a soft landing. jonathan: there is always the question asks, does the bond market know something the equity market does not know? that has not been the story of 2019. they are trading on the same thing. the fed has backed away, may even cut rates, yields have dropped aggressively. the market has been comfortable with that story. the real story is whether you think we have already engineered what krishna is talking about. bob: what a great time to be a bond. everyone loves you, you can do no wrong, you have no inflation. central banks have backed off of raising rates, running down the balance sheet. money is trapped on the sidelines. i think the fed has done it. they have full employment, inflation as they are now saying, close enough to the target. why not stop here and enjoy it? i'm not worried about credit. default rates are less than 1%. jonathan: is the market taking

it too far? where you see the yield curve out to seven years trading below the rate? is that the market taking things too far? bob: i don't think so. i think the market is genuinely distorted. as long as the central banks are sitting on these enormous balance sheets, the cash has to be invested somewhere. there is too much money domestically and internationally to get into the market. it will buy every backup. that is the new reality. jonathan: this is the chart that you have brought to us. it is fascinating. this is the 10-year rate, treasuries, bunds as well, minus the local policy rate. we have converged on the policy rate on the 10-year. why is this so critical, why is this so strong and important? bob: it tells you that any market where there is a steep curve, with the amount of intervention by central banks, money will flow into the long end of the market. we have seen that repeatedly. we have seen that out of asia, in particular where the relative steepness of the curve relative

to their curve is a signal to them to invest and hedge back to their base currency. jonathan: james, what do you think about that? i find it fascinating. james: it tells us we are running out of road i suppose. i agree with bob to the extent that financial markets have essentially been driven by almost entirely central-bank policy, liquidity provision, and the cost of money. the traditional connections we expect between asset classes and underlying economic fundamentals, things like . fundamentals, things like inflation, have been broken for many years now. the reality for me is that process has to continue seeing flow in order to continue working but it also is only as strong as the weakest link. if you start to look elsewhere, the saving glut that we know about coming from asia, a part of the reason you see treasury bond yields going so low, even in a period of relative economic strength, is a solution for

treasury yields that a problem for the global economy. if they are not borrowed and reinvested, they are a drag on economies. it is that process which ultimately requires us to keep feeding the machine. when we stop feeding the machine, we start facing up to the economic realities. they don't look so good. equities are priced to perfection. credit spreads are priced to something close to perfection. emerging market spreads priced close to perfection as well. i don't know what the triggers are but i know the vulnerabilities are numerous and everywhere. krishna: two takes on that. first, i think what this is telling us more than anything else is that this is a disinflationary trend in the world. two, i would rather see dispersion between 10-year rates and policy rates rather than the two on top of each other. that indicates an issue. having said that, the risk with respect to that is relatively modest. it is the level that matters.

the point that james is making is a point that everyone, every bear makes. which is, at some point, it is going to blow up. at some point, it is going to blow up, but if that happens five or 10 years from today, you would have missed out on the opportunity, as many have missed out over the last five years. the disinflationary trend makes whatever growth you have far more sustainable in the long run than a growth spurt and inflationary trend. i think that is what has been what is supporting the global economy, and i think that will support the global economy for the next five years. bob: but that is the problem. i, too, would like to see some dispersion of yields between official policy rates. i would like to see the 10-year at 4%. i'm just not going to get it. this is the reality we are in. what are we supposed to do? are you supposed to sit there and hope for something that will

not happen for maybe the next decade? i pulled up a chart on money market fund assets. this is the other thing that is alarming to me, not that we are dropping to 2%, but that we may go lower. money market fund assets are 3.1 trillion. they are normally about 2.5 trillion. money is piled up internationally, as james talked about, domestically. it was all so simple. the fed would stop raising rates toward the end of the year and you could invest higher. that is not happening. what do you do now? krishna: you are making the point that i've been making for the previous five years. in looking for the dispersion, i am not looking for the dispersion with 10-year rates being meaningfully higher. i would rather have that dispersion as being policy rates being somewhat lower than where they are. with the lack of inflation, for the fed to be on the verge of making a policy mistake, they came to their senses at the right time.

jonathan: james athey, weigh in. james: to some degree, krishna is saying, if we were to grow, it would be a mistake to worry about the potential for what happens when the growth stops. if you look at the drivers of growth globally, essentially what you are talking about is a bipolar world, where the u.s. acts as a consumer of last resort and china acts as the world producer of last resort, which means it is a demander in a lot of those inputs and processes. the u.s. economy has been driven essentially by falling unempolyment and credit growth. the chinese economy has been driven by fallen unemployment and credit growth. when those dynamics show signs of tiring, you have to wonder where is the next leg of growth. if you scratch beneath the surface of q1, you find the internals don't look good. domestic demand was 3% year after year. suddenly, that number looks very weak. it is only weak imports because of that weak demand that has

seen the headline number pop higher. if you look at china, when they stopped stimulating in the second half of last year, essentially, the economy stopped. those two dynamics concern me when we look to what is next. without it, we have to face up to some of those structural issues. jonathan: krishna, this cycle continues a whole lot longer. we have not reached the limits that james just painted? why five more years? krishna: five more years. do i know whether it is five or not? the point is, the end of the world that people were expecting in december did not materialize. the same way the end of the world that people are expecting in 2020, 2021 will not materialize. for two central reasons. one, inflation globally is low and will remain low. in that environment, fed policy and global central bank policy will remain supportive. chinese desire to maintain their

growth through credit growth is actually in place as well and will remain for an extended period of time. bob: i don't know about five years. i'm good for two. i would like to see what happens in the general election next year. you are right. expansions don't die of old age. australia is proof of that. jonathan: great to have you with me. you will be sticking with us. coming up on the program, the auction block. investors turning increasingly cautious. high yield bond funds, the biggest outflows since december. that conversation is next. this is bloomberg "real yield." ♪

jonathan: i'm jonathan ferro. this is bloomberg "real yield."

we want to head to the auction block where u.s. companies are heading to the continent, europe, borrowing at the fastest rate in years. cheap funding cost lured them across the atlantic. fidelity national led the search in the so-called yankee issuance this year, issuing more than two thirds of its $8.2 billion offering in euros. risk off markets to the week. investors absorbing just shy of $30 billion worth of investment grade supply, including dow chemicals. a $2 billion multi-tranche offering. it was nearly five times covered. and the junk revival challenged by the biggest weekly outflows since december. six new deals coming to market, including barrett global. that $2 billion offering needed to be cut in half amid rising trade tensions. bob michele, krishna memani, and james athey is with us. your view on high-yield. no drama compared to what we saw at year end. how do things stack up at the moment? bob: pretty good to me. there is a bit of a binary

outcome here. if there is some sort of trade agreement or framework and it gets pushed off, the weight of money coming into a market with default rates below 1% pushes high-yield to the low 300 over credit spreads. over the next six months. certainly by year-end. if trade disintegrates and escalates, sure, high yield will widen out. i think it trades either side of 400. i think you get 375-425. i think it looks great. jonathan: what do you think of that, the prospect of tightening back up to over 300 again? james: to some degree, i agree with bob, in that it feels a little binary. i think possibly the news stories out there, the market dynamics out there that could shift things on to the downside are probably more numerous than just the trade debates. i look at commodity prices, oil prices. i think are those truly reflecting all the new information we have in terms of underlying supply and demand

dynamics notwithstanding the short-term disruptions and tensions we are seeing in the middle east? i'm not sure that is necessarily the case. we know the high-yield market is pretty heavily skewed toward energy names, we know there can be weakness there. to me, the more important, the more interesting dynamics are the psychology of markets, structure of markets, and the extent to which markets can cope in a calm and orderly fashion with potentially some of the drawdowns we may see in the near term from this escalating trade tension slowing growth, slowing manufacturing globally. we have seen horrific data in asia. i'm still cautious and concerned. i don't discount that bob may be right if we get good news. but i think the risks are more skewed to the downside. krishna: i think bob is right but 300 may be a little bit of a stretch. bob: i said low 300's.

krishna: fair enough. the point is, the underlying dynamic is setting up the right way. bob is right on that. decent growth, policy rates remain relatively low. 10-year rates remaining relatively low. equity markets stable, volatility over all remaining stable. things are going to be ok. but i think if there is a nuance to that, the likelihood of a trade deal is probably smaller in my judgment than what the market is expecting. therefore we may have to deal with maybe half a percent haircut to our growth expectations than we are today. that would be the one reason not to go all in. bob: you are a career credit guy. you know the only thing that matters is recession. as soon as you are on the verge of recession, you have to start pricing in much higher default and reprice the market. if you don't have imminent recession, every backup is a buying opportunity.

krishna: absolutely. high yield is a decent buy if you are looking for income. having said that, if you have to decide between equities and high-yield, i would go with equities. jonathan: would you really? krishna: yes. bob: you cannot like the bottom of the capital structure unless you look at top of the capital structure. krishna: you like the top of the capital structure for its fair value, but the bottom of the capital structure can go meaningfully higher. 325 basis points will not get you. james: i am not a top of the capital structure, bottom of the capital structure expert. i think the way that history has played this out, bob is right in the sense that this is a buying opportunity unless and until you can forecast a more self-fulfilling cycle of essentially defaults. that generally comes in a downturn. i'm concerned we have got less room to run on the u.s. economic road. i want to see the full second

quarter of data. but i get the feeling that we have started to see the best of some of these data points and things will not look so rosy in the next couple quarters. jonathan: what we have seen over the last week, outflows in high-yield, inflows of high grade. walk me through the appetite for u.s. credit from the foreign buyer. we are to the point where they are willing to be unhedged and come in and pick up the income. bob: what they look at is the yield they can get and the cost of the hedge back to their currency. it has pushed them into government bond markets with steeper yield curves, has pushed them into credit, it is one of the reasons, for example, they like european high-yield. they are at the point now where they have a lot of capital, have to get it invested. the cost of the hedge back to

their base currency is not what it used to be, so they are willing to take dollar unhedged. krishna: there are some people who will take dollar unhedged, but the majority of large institutional buyers would probably look at it on a fully hedged basis. on that front, the reverse yankees are telling you where things are from a valuation standpoint. the dearth of supply in europe, and i think demand for credit in europe, relative to what you can get on a hedged basis out of the u.s. i think is probably -- jonathan: i'm hearing more people signal appetite for european high-yield credit. is that the right approach? krishna: yes, i think european high-yield, depending on the sector is perhaps cheaper, than what it is in the u.s. valuations are certainly better. the direction of the economy -- and this will create a lot of ruckus here -- the direction of the economy in europe is probably better than the u.s. the u.s. is going down. europe is increasing marginally, but improving rather than deteriorating.

jonathan: why did you save this for now? we are up against the clock. we have to come back and talk about this. james cannot wait to weigh in. let's get a market check. yields heading south down six basis points on the 2-year. just off the lows of 2019. still ahead, the final spread and the week ahead, including a slew of fed speak, including chairman powell. that is next. this is bloomberg. ♪

jonathan: i'm jonathan ferro. this is bloomberg "real yield." it is time for the final spread coming up over the next week, a busy one. monday, kicking off in japan with first-quarter gdp. tuesday, mark carney testifies about his may inflation report. wednesday, the fomc releasing minutes from its latest meeting, plus plenty of fed speak. bob michele, krishna memani, and

james athey itching to weigh in on the eurozone call. james: this is the least ugly contest at the moment. we have had lots of cyclical strength, decent reasons why that's been able to occur. when unemployment stops falling, you need changes in behavior to get consumption patterns keeping up with where they were. for the u.s., i don't see anything that tells me it's about to fall off a cliff. trade tensions is a huge current, trade deficit account country. this will not hurt the u.s. too much. when i look at the eurozone, it's a different story. it has essentially been excessive eurozone support. fiscal stimulus at the margin more recently. realistically, it's been trade, exports. specifically exports which start first and foremost in china. if you see trade tensions and domestic policy choices in china, which are beginning to slow things at the margin, the

eurozone manufacturing industry stops dead. when that percolates through the system, there is really not a lot left. domestic demand with a few notable exceptions, has not been sufficient, given the current size of the economy. i think the eurozone has some serious challenges to face up to. bob: i'm not worried about europe. you have to go back to monetary policy is excessively accommodative. we thought they would be raising rates and running down the balance sheet. they are not. they are backstopping the bond markets. by the way, brexit is not much of a concern. companies have spent the last three years preparing for a hard brexit. jonathan: very good point. time for rapidfire round. three quick questions. china front and center. on the currency, will china engineer, tolerate, or constrain u.n. weakness? bob: tolerate. krishna: tolerate. james: constrain.

jonathan: venture back into high-yield or hideout in investment grade? bob: high-yield. krishna: high-yield. james: buy duration. [laughter] jonathan: have we seen the high for the 10-year yield in 2019? yes or no? bob: yes. krishna: absolutely. james: absolutely. jonathan: great to catch up with you. what a conversation. james athey, bob michele, krishna memani. we will see you next friday at 1:00 p.m. new york time. this is bloomberg tv. ♪

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♪ >> coming up, the stories that shaped the week in business around the world. trade tensions take center stage as tariffs escalate. headlines and markets moving every which way. >> they are trying to do it in a way that says tit for tat. >> it speaks to how deep the gulf is becoming between the countries. >> it's impossible to trade and invest on the back of what trump says. >> data from china shows economy losing steam. conflict the rep in the middle east. >> tensions are rising in the region. >> earnings reports add details to the global picture. >> a very good set of