jonathan: from new york city, i'm jonathan ferro. bloomberg "real yield" starts right now. ♪ jonathan: coming up, fresh trade tension providing even more fuel for the global bond market rally. 10-year treasury yields breaking down to new lows for the year. bund yields printing a new record. uncertainty leaving high-yield credit exposed. spreads widen, funds suffer. another week of outflows. we begin with a big issue, more fuel for the treasury market rally. >> the bond market rally right now is a risk off trade. >> massive flight to safety. >> the flight to risk-free assets and into bonds.

>> rushing into treasuries. >> the perfect storm in the treasury market. >> people are very nervous. >> people are coming around to the various factors and uncertainties. >> the combination of the safe haven demand of treasury plus the idea that growth is slowing. >> declining global growth. >> lackluster growth. >> trade tensions. >> rhetoric with china is not only back but escalating. >> new tariffs on mexico. >> mexico. >> the mexico exculpation escalation. >> this is a real problem. >> this is what the market is trying to do, recalibrating how much risk we should price in. jonathan: joining us now are our guests, great to see you guys. your thoughts on the big move we have seen in yields this week? >> it is interesting, we went from goldilocks to goldilocks, to goldilocks found the bear. i think it is a little overdone, the economy is slowing but still seems to be doing well. i think it's overdone. jonathan: i know everyone around

the table thinks it is overdone. michael, you definitely do. >> i do. the only way we can get above 2% is if the fed steps up and says we are concerned, we are thinking about cutting. we are not balanced anymore. we see no sign of that happening, so we are skeptical. >> it is not just about the fed cutting but the fed cutting several times. that is the bigger point. the likelihood the fed cuts several times in the current environment, let alone cutting at all, i think is very small. jonathan: the potential the yields can go lower, it's really nominal yields, it can go lower. if we compare treasuries to bunds, we have a positive real yield still in the u.s. we have a break lower in the last week, an aggressive break lower, but still positive. spoken to multiple people over the last week that thinks that white line can go to zero.

your thoughts? michael: doubtful. there's been a tremendous amount of skepticism about inflation over the last few weeks, months. if you look at 10-year breakevens in the u.s., we think they are too low. why should inflation be this low? if you think tariffs are bad, don't you think they are inflationary? you will probably see breaks tick up. we are skeptical about the real yield argument. krishna: i wouldn't say tariffs get us to an inflationary level. on a short-term basis, yes. longer-term, that is all about slowing growth. slowing growth leads to disinflation rather than inflation. i think that is the critical point. the difference between real yield in the u.s. and europe, i think, to some extent is warranted. our real growth is meaningfully higher than what the real growth is in europe. the likelihood it gets to zero, somehow i cannot square that circle.

>> i will echo what everyone else said but take it from the bottom-up perspective. when you look at what companies are reporting, we are not seeing a lot of inflationary pressure. conceptually, it's feasible. my gut feeling probably agrees with the panelists to say it will not happen. jonathan: in the global bond market, the story right now is the hunt for duration and a hunt for hedge. where do you go apart from treasuries? isn't that the argument of why you could see convergence there? we had a positive real year -- positive real yield. krishna: to some extent, it is flight to safety. to a larger extent, it is flight to duration. there is a bit of a dichotomy between the bond markets of the world and the stock market. if i had told you that we would be 5% away from the top, 10-year rates would be closer to 2%, you would have laughed me out of town. that is where we are. jonathan: if i told you 12 months ago that we would be pricing in three rate cuts over the next 12 months.

krishna: i would push you out of town. jonathan: richard clarida weighing in. this is what he had to say. >> we are attuned to potential risks in the outlook. if we saw a downside risk to the outlook, then that would be a factor that could call for more accommodative policy. that is definitely something in the risk management area that we would think about. jonathan: i don't know if we are clutching at straws, but some thought that comments were the window opening slowly toward the idea of a rate cut. your thoughts on that? to me, that is a very incremental move if that is the story. lale: i am in the same boat with you. i agree. he also emphasized data. data does not suggest that. unless they would fall to the whims of what is happening in the equity markets -- we are just down 5%. let's take this into perspective. just 5%. jonathan: jpmorgan out today. looking for a rate cut in

september and december. this is not the first time we have seen a decent spread between what the market is looking for and what the fed is implying through the communication. we have seen this kind of spread before. what i'm trying to get my head around is what is the catalyst for reconciliation in the next several months, is a better data -- is it better data or does the fed drag us there? krishna: it is better data. we will see the economy is not slowing down to the level it needs to slow down for the fed to come up with a rate cut in 2019. if that is not the case, if that is what his call is, that's a different situation. our expectation is second half is better despite all the talk of tariffs on a global basis. therefore, we probably don't get that rate cut. >> more data out of china. pmi back in contraction territory. there is so much hope through 2019 in risk assets with the second-half recovery. there is some real doubts around the second-half recovery. rightly so? michael: probably not.

i think the second-half recovery could be there. pboc has more latitude to become more accommodative. it can cushion the blow. the data might be sketchy but it has the firepower to do it. lale: i think in simplistic terms, the economy is slowing. that just means lower valuations, wider spreads. it does not mean recession, put your money under the mattress. a month ago, everybody out here was saying goldilocks, goldilocks, goldilocks. this flip-flopping is a little ridiculous. jonathan: is it a breakout into a new regime, or return to the same old story? lale: i think it is the same story. yes, the tariff story is incremental in information, but we need to see what happens. we have not seen it in the economic data and what we hear from the companies. no need to rush to a conclusion and make grand conclusions that we are about to enter a recession or new regime. jonathan: so much anxiety out there.

last week, we had a soft pmi manufacturing in the u.s., just enough to shake the confidence that the u.s. economy will be resilient to global weakness. next week, what are you looking for? krishna: weaker numbers. second quarter, if you look at any data point, second quarter will be weaker because it is payback for the first quarter. inventory liquidation and things like that. but the real story is the second half of the year. there is lots of stimulus from the tax cuts and spending package that will come through in 2019. the economy entered 2019 with enough momentum, as we saw in the first quarter numbers. that momentum carries us through the week data in the second quarter of this year, and things get better in the second half. jonathan: where is that stimulus coming from? most people assume it fades. krishna: all the spending they had planned in the budget deal, the tax cuts, the actual spending did not take place in 2018. it was planned for and a lot is coming in 2019.

jonathan: let me put you all on the spot. you all seem to take the view that the market overall has aggregate pricing. where do you fall? what would you be looking at? michael: front end. futures pricing crazy. that is this year. krishna: i think i would say the 10-year. it is probably the safer ratio trade. however, you cannot eat sharp ratios. lale: 10-year. jonathan: great to have you all with us. up next, the auction block. junk investors fleeing as spreads hit a 15-week high. that conversation is coming 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 and begin in japan. the nation's first publicly yen-denominated bond is redefining the phrase high-yield by being sold below a 1% yield. in the u.s., the treasury struggling to get off of its seven-year debt auction. the notes received the weakest amount in three years and were sold with a 1.9 basis point tail. finally, cracks forming in the u.s. corporate market. the industrial company flex that holds a triple b minus rating paid a 35 basis point concession in order to bring its $450 million of 10-year notes to market. that is where we begin the segment, cracks in credit. pimco ringing the alarm. >> we have probably the riskiest

credit market we have ever had. it is true when you look at both the size of it, the duration of it, and the quality aspects of it. there is a big vulnerability there. jonathan: my guests are still with us. krishna, your view on that call? krishna: if he is talking about potential liquidity issues in the market or where the credit markets will underperform, i can see why he would say that. having said that, i think there's a bit of inconsistency between their views on the credit market and their views on the economy. they are not expecting recession for three to five years. if that's the case, the credit market may be risky. likelihood the risk will manifest it self in prices probably doesn't happen. jonathan: after spending some time with him, i think the view is that three to five years of mild recession, but perhaps the view that we are approaching the

mid- 2000's. this is where things start to build. is there any push back to that view from your side of things? krishna: the pushback would be, it is the same argument we make all the time. i would rather buy treasuries at 4%. treasuries are not going to be at 4%. if you are looking for income, and there are lots of people looking for income, they have to take some level of risk. what is the magnitude of that risk in the corporate credit markets? relative to the incremental income you get, relative to what you get in treasuries, that risk is worth taking. jonathan: let's talk about that relationship between treasury yields and high yield notes. citigroup said that if yields fall below 2%, high-yield spreads have always been materially wider in the post taper tantrum period. walk me through what you think the relationship should be here. we have had 2% treasury yields a couple of times before. we have seen this level many times. should there be a natural relationship between where the two year yield is and where high

yield spreads should be? lale: it is focusing on the two-year because it is focusing on the funding cost, indicating some sort of pressure on the economy. rates are important to watch but this is the problem in this new regime we live in, where there are all sorts of geopolitical risks, going into election cycle, and the treasury keeps issuing on the front end. all of these different factors that are changing the dynamics. taking one data point and extrapolating is not right. is high-yield cheap? no. you do not buy high-yield until it crosses another 75 basis points. but i don't think, to krishna's point -- we have an aging demographic. the need for income is amends -- is immense. you cannot tell people that they just have to put their money under the mattress. jonathan: the view was the

10-year yield versus where spreads should be, but the point stands. michael: if you have a reasonably good economy, you don't have a lot of default. why should spreads blowout? carry is probably ok. krishna: the relationship between treasury levels and yield levels, it doesn't have to be a relationship. however, people who are looking for income look at 2%. they kind of live off of 2%. if they can get 3.5%, that is a lot better. there is an implied relationship from an investor preference, even from breakeven terms, that doesn't need to be there. jonathan: what i find fascinating is the investor bias and how they are shaped by what is happening in the treasury market. we referenced the seven-year auction. throughout the whole year, we have had a tug-of-war about risk assets that lower rates were a buffer from troubles. it is clear the second view has won out over the last couple of weeks. what was fascinating was watching a soft seven-year auction and then all of a sudden, risk assets turned. the idea that we are taking our cues from where yields go, and

intraday move on treasury seem to be shaping risk appetite on a daily basis. does that make sense? lale: i think people are trying to extrapolate too many things out of little data points. people have been nervous. it has been an odd rally. everyone was bearish in january. people were sounding the alarm and we had a phenomenal run in equities and credit. now this is their opportunity to turn it around. i don't think it is that bad. things can be expensive or cheap but i don't see any alarm bells. krishna: most equity investors don't even know that a seven-year bond exists. having said that -- jonathan: that is some real shade. [laughter] krishna: i am allowed to do that. they make fun of bond geeks all the time, so that is ok. the point is, that sort of tells

you as to the state of mind of equity investors. they missed out the rally from december on. they don't want to miss out the turn. they are taking clues from the bond market to the extent that it can provide any clues for a turn. if they see something move, they will pay attention to it. jonathan: michael schumacher, are bond markets in the driver seat, should it be? michael: i'm not sure that it is. if you look at the moves, it is bonds reacting to stocks, not the other way. jonathan: krishna, do you agree with that? krishna: i don't think so. michael: it is friday, you can be wrong. [laughter] krishna: i think they are kind of operating with different technicals, different risk profile of their respective investors. that is probably the difference between the markets. jonathan: krishna memani, lale topcuoglu, michael schumacher sticking with us. i want to get you a market check. yields shaping up as follows.

monster 18 basis points on the front end of the curve. unreal. two-year yields, sub 2%. still ahead, the final spread, the week ahead featuring an ecb rate decision and a big payrolls report. that is next. this is bloomberg "real yield." ♪

jonathan: i'm jonathan ferro. this is bloomberg "real yield." time for the final spread. over the weekend, china's tariff retaliation will take effect saturday. $60 billion of u.s. imports. tuesday, rate decisions from australia and fed speak from chairman powell, kaplan. thursday, rate decisions from india and the ecb. friday, a payroll report in the u.s. what are you looking for through

next week? lale: peaceful and quiet? [laughter] probably more of the same. the fed will echo what clarida said last week, ecb will try to calm. europe has been under a lot of pressure. look at european financial stocks. italy is at the center. i think more of the same. our goal will be not to react with a knee-jerk reaction. jonathan: listening to the fed communication, even the chief dove at the federal reserve comes on bloomberg -- no signal he wants to cut rates at all. there is a question from a bloomberg subscriber. do you think the federal reserve's hand could be forced by the president's tariffs tactics? krishna: i think it could be, if the markets take a big draw down and the economy slows down, we could see the action. again, it is very dependent on

where the data shows up. it is not next week's data. my expectation is the data in the second quarter will come in relatively weak as a payback on the first quarter. if the data is not weak, we react positively. rates rising rather than rallying on the back of that weak data. michael: if you take a three to six-month view, perhaps, but it is way too soon. jonathan: not seeing it in credit yet. you have made this point and i invite you to talk about it. yields, spreads in december were north of 5%, pushing 5.50%. we are just north of 400 basis points now. the primary market seized up in december. there might be a little bit of pushback this week but it is still functioning. there is a key difference between now and then. lale: it is. year end liquidity only made things worse. the primary market is functioning.

we are even seeing aggressive companies price yield at very low yield. it is not like there is a risk off environment in any shape or form. we are 60 basis points wider in the market today, 100 basis points still tighter year to date. it is fine. no need to ring alarm bells. i will say, yield spreads are back up another 50, 75 basis points. assuming nothing else changes in the world, we would buy more credit. jonathan: is that your base case, what you are expecting to happen? lale: if this craziness goes on and suddenly everyone is calling for recession, it is totally feasible we could back up another 50 bits. jonathan: is that what you are looking for, getting to 4.50 over? krishna: i don't think so. i think we stabilize at these levels. the difference between december and today is material. in december, the risk was the fed gets us to recession. that got priced out. no amount of tariffs can price

that back in in a hurry. jonathan: i wonder if we are moving to a place where in december, it was the view that if you hike again, that's a policy error. now the view is forming that if you don't cut sometime soon, that is a policy error. krishna: not quite yet. the economy needs to slow down meaningfully and more so in the second half of the year as opposed to second quarter. if the fed does not react to that, we would have a policy error. jonathan: let's get to the rapidfire round. three quick questions and three quick answers. first question, let's talk about mexican tariffs that may not happen. will the president follow-through on fresh tariffs on mexico, yes or no? lale: yes. michael: no. krishna: no. jonathan: can u.s. 10-year yields reach zero before the end of the year? lale: no. michael: no. krishna: i hope not. jonathan: high-yield spreads, which when will we see first,

3.50 or 4.50? lale: 4.50. michael: 3.50. krishna: 4.50. jonathan: thank you for the conversation, really interesting stuff. that does it for us. we will see you next friday at 1:00 p.m. new york time. this was bloomberg "real yield." this is bloomberg tv. ♪ the latest innovation from xfinity

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